Defined Contribution Health Insurance

Policy Backgrounders | Health

No. 154
Thursday, October 26, 2000
by Greg Scandlen

Possible Models for Defined Contribution

Table II - Defined Contribution Models

Despite the regulatory problems, much work and money are being invested in developing models and products to make Defined Contribution possible. In some cases, the models go as far as they can under current law. In other cases, the models show what the market could look like if the laws were reformed. In broad strokes, these models fall onto a continuum between the pure individual, nongroup market at one end, and a "managed competition" model at the other. The important variables between the two ends of the spectrum include: (a) the degree of individual ownership and portability; (b) the level of employer involvement in plan design and carrier selection; (c) the barriers to entry for competing carriers; and (d) the need for regulatory changes. Table II summarizes the characteristics of five models.

"Despite the regulatory problems, much work and money are being invested in developing models and products to make Defined Contributions possible."

The Individual Market Model. Today's individual market is much maligned by policy makers and employers. In truth it is far better than most observers realize, but not as good as it needs to be. Because of the extraordinary tax advantage provided exclusively to employer-based coverage, anyone who can possibly access group coverage will do so. Those remaining to purchase individual health insurance are generally people too ill to work, those with uncertain incomes, those with poor employment records, the semi-retired or fully retired, seasonal workers and those employed in high-risk jobs that group carriers don't want to cover.

The people in the individual market are older, sicker and poorer than those in the group market.40 They are also unsubsidized by either their employers or by the government, and collecting their premiums is a major challenge. Lapse rates are high as people acquire coverage when they have the money, and drop it when they run out of funds or lose the extra income from seasonal overtime. Underwriting and marketing expenses are very high, as carriers use the services of insurance agents to screen for egregious risks.

Despite all of these problems, individually underwritten coverage is fast becoming more affordable than group coverage, especially small group coverage. HIPAA has made it possible for groups to remain uninsured while the workers are healthy and purchase coverage only after someone gets sick or pregnant. Other cost-increasing regulations also are more prevalent in the small group market. For example, states often apply more mandated benefits, such as those requiring coverage for substance abuse or infertility treatment, to the small group than to the individual market, and states are more likely to apply rating restrictions to the small group market. Few of these costly requirements apply to the large group market, which is often defined as employers with 50 or more workers.

In its purest form, Defined Contribution would allow employers to make funds available to employees, who would use that money to purchase coverage in the individual market. The money would remain tax-advantaged because it would be available solely for the purchase of health insurance. Employers might reimburse their workers for paid premiums, or they might use payroll withholding and send payments directly to the employee's chosen carrier.

The employee would choose from any insurance plan available on the market and would be the policy holder. If the worker changed jobs, he or she would continue the exact same insurance plan, paying premiums directly from his or her own resources. When the worker got a new job, the new employer would make the contribution it could afford to the same plan.

"In its purest form, Defined Contributions would allow employers to make funds available to employees, who would use the money to purchase individual coverage."

In such a system, both the worker and the health plan would have an interest in providing long-term contracts for coverage to reduce the costs of underwriting,41 marketing, retention, and re-enrollment. The insurance plans would use underwriting to set an appropriate premium at enrollment, and the employer would adjust its contribution accordingly. But once in the plan, the worker would no longer have to worry about rate spikes due to changes in health status. Premiums would increase based only on overall trend and possibly increasing age of the insured.

Advantages for Employers: This model takes the employer out of the business of choosing and managing health care plans, lowers administrative costs and probably increases employee morale. The firm's contribution can be determined by business resources and labor market demands. The responsibility of the firm would be limited to using payroll withholding for the employee contribution and forwarding that along with the firm's contribution to the health plan chosen by the worker.

Advantages for Employees: Workers have access to the full range of health plans available on the individual market and can customize their benefits according to their needs and resources. They are the policy holders, so the plan is accountable directly to them, and the coverage is guaranteed renewable, so it should be permanent as long as premiums are paid. Portability is absolute, unless a new employer isn't offering its own group plan.

Advantages for Carriers: Carriers gain access to a very attractive new population made up of active workers who are generously subsidized by employers and by government. Many of the costs associated with the current individual market, such as retention and premium collection, are solved. Plus, carriers should be able to relax their underwriting restrictions for this population.

Disadvantages: The intersection between employer payment and worker ownership creates severe regulatory problems. Employer payment may mean the coverage is regulated as "group," even though individual ownership means it is "individual." There would likely have to be new legislation to resolve this conflict.

While carriers might relax their underwriting, they would still want to charge premiums based on age, sex, geography and possibly health status. Having risk-based premiums would make higher-risk people more attractive to cover, but employers would need to adjust their contribution accordingly. There would also need to be a high-risk pool or some other "residual market" for very high-risk employees who are priced out of coverage.

Some workers will not want to shop for coverage on the open market, so employers would need to provide a default plan for people unwilling or unable to find their own health plan. Plus, individual enrollment will add marketing costs over what employers currently incur.

Non-Employer Group Coverage Model. In this model, the employer's role is exactly the same as above, but to enjoy the marketing efficiencies of group coverage, workers would band together for joint purchasing arrangements. Typical sponsors might include fraternal organizations, church groups, homeowners' associations, credit unions and labor organizations.

"To enjoy the marketing efficiencies, workers could band together for joint purchasing agreements."

The members of these groups would collectively shop and negotiate for coverage, seeking discounts or added services from carriers in exchange for bringing a large number of customers to the table. The individual would still be the policy holder, and coverage would remain constant despite employment changes. The employer would still send its premium contribution plus any payroll withholding to the plan of the worker's choosing.

Advantages: Non-employment groups might actually be better than employer groups for marketing purposes. Other forms of group enrollment involve relationships that last longer, or may be larger than all but a few employers. People often belong to a church or fraternal organization for their adult lifetimes, and the numbers of people involved in a credit union or labor organization can dwarf most employers.

The coverage would be fully portable and independent of employment. Very likely, long term contracts would evolve.

Disadvantages: The group shops for and selects coverage, much as employers do today. This removes the worker/consumer from the most powerful of tools: the ability to choose the plan most in keeping with personal needs and resources.

The arrangement runs into many of the same regulatory problems as the Individual Market model. Plus, some states ban such arrangements for not being "true groups," a problem that is magnified if most of the premium is coming from the employer.

Employer Buy-in Model. This model attempts to combine the best elements of the group and individual markets. It starts out with the employer choosing a health plan for the entire group. But after a transition period, the coverage converts to individual and employees may choose to stay with the existing carrier or switch to another.

The coverage is then "owned" by the individual, and the usual renewal and underwriting rules for new enrollees apply. Only carriers who are willing to convert a block of group business into nongroup policies would be eligible to participate.

Advantages: Both employers and insurance companies must be comfortable with the initial enrollment and rating procedures. Carriers know that they will enroll the whole group, which may include a mix of risks, and that initial premiums will be set on a group basis. Employers will not have to do anything differently than before, other than communicate to their employees that after some period of time (three years is most commonly suggested), they will convert to nongroup coverage.

The comfort level for employees should also be high. At first they don't have to do anything, but they will convert to nongroup coverage after three years. If they want to stay with the same plan at that time, they are free to do so. If they prefer a different plan, they will be free to shop for something else.

"The Employer Buy-in Model attempts to combine the best elements of the group and individual markets."

Disadvantages: As with most of these models, regulatory obstacles must be overcome. Beyond that, potential selection problems arise with this and most of the models. In this case, the highest-risk employees may stay with the employer's original carrier, while lower-risk employees shop around for a better deal. To address that problem, employers may want to risk-adjust their contributions, so that higher-risk workers get a larger contribution than do low-risk workers and each group receives a contribution appropriate to the premium they will be charged. Such adjustments may be difficult to perfect in an open market in which different insurers use differing methodologies for setting individual premiums. Another way to address the issue and discourage annual plan-hopping could be with longer-term contracts in which the insured makes a commitment of three years or so - enough time to smooth out most acute care episodes and ensure enrollment stability.

The Aggregator Model: The aggregator model may be one way of resolving some of the enrollment and rating problems mentioned above. The aggregator acts as a third-party trust to facilitate the collection of monies and choice of plans. Aggregator firms will offer a variety of health plans, hold both employer and employee premium contributions and provide a marketplace in which employees can decide how to spend their health care dollars.

These firms42 typically use an e-commerce approach to plan selection, so plan information is displayed and enrollment completed online. They may select the carriers that participate, using criteria such as ability to process applications and claims electronically, 24/7 customer service information and minimal underwriting. They also may negotiate discounted premiums to enable the carriers to access this new market. Aggregator firms might also risk-adjust the employer contribution to accommodate age, sex, geographic and even health status variations among employees.

An aggregator firm would hold a contract with the employer, very much as employers choose a 401(k) administrator, and might even be partially paid by the employer for the value of the health plan administration services provided. These firms would most likely serve a large number of employers and target their services at specific geographic areas or industries. It is possible that business coalitions or industry associations would form such a firm to service their membership.

"An aggregator firm acts as a third-party trust to facilitate the collection of monies and choice of plans."

But while the employer makes a contract with the trust to provide these services, the employee is the policy holder. There is no direct relationship between the employer and the health plan. If a worker leaves his or her job, the coverage continues as is, with the trust now collecting the premium either directly from the employee or from the employee's new employer. Alternatively, the employee might deal directly with the carrier and discontinue the relationship with the trust.

Advantages: The aggregator serves as a marketplace for plan selection, risk adjustment and resource consolidation and allocation. It may screen the carriers that participate, according to certain underwriting and customer service criteria. Much of this should be backroom accounting and invisible to the worker/consumer, who knows simply that he or she has certain resources and may use them to choose among several plan and benefit options.

Employees will be able to select among the same plans, whether they are working or unemployed. There should be complete portability, provided the old and new employer both use the same aggregator.

The employer simply chooses an aggregator and pays out a sum for each employee. Even the usual employee questions and complaints, normally fielded by company HR staff, are addressed to the aggregator. Use of the Internet should lower marketing and enrollment costs.

Carriers should be attracted by the minimal marketing effort required and access to an extremely desirable population.

Disadvantages: Again, the blending of group and nongroup coverage is a large regulatory problem, as is the possibility that the aggregator will be treated as a Multiple Employer Welfare Arrangement (MEWA). Portability could be lost if two employers use different aggregators, or use none at all. Assuming the regulatory problems are solved, a new employer should be able to make payments to the aggregator, even if the company has no other relationship with the aggregator.

Private and Statutory Managed Competition. Managed competition may take two forms. It may be enabled through legislation, or it may be set up by employers as a cooperative program. In either case, it is based on the belief that there are efficiencies to be gained through the concerted effort of a large number of employers, and an agency selects the participating carriers and negotiates conditions of participation on behalf of the employers. There will usually be an annual open enrollment period, at which time every worker can change plans. In some cases, the open enrollment provision is continuous, so that workers can change plans at any time during the year.

"It is not clear that there are savings under managed care."

Statutory managed competition programs are usually aimed at the small group market in a specific geographic area. They often have a social mission beyond merely helping employers access coverage. They may be created in the hope of reducing global health care costs or increasing the numbers of uninsured individuals. They may also include waivers of certain regulatory restrictions, such as mandated benefits, premium taxes or enrollment criteria. On the other hand, the agency may actually add restrictions beyond those of existing state law, such as standardizing benefit plans or restricting price discrimination.

Private managed competition programs are similar except they are organized without the benefit (or burden) of enabling legislation. Like their statutory brethren, they typically feature an agency that "manages" the participating health plans.43 Unfortunately, this management process often results in standardized benefit programs, which misses the point of individual choice.

In both cases, the agency is the representative of the employer and acts in place of the employer in negotiating with the health plan. The individual worker is not the policy holder, and coverage will terminate along with the worker's employment.

It is not clear that there are savings under these models. Managed competition may simply add a layer of administrative and regulatory complexity between the employer and the state insurance department. The agency overseeing managed competition might add its own mandates and regulatory obstacles and actually diminish the ability of individuals to choose how to spend their resources. The track record of states that have tried this approach locally, notably Florida, is not encouraging, and employers are rightly concerned that a managed competition approach could easily lead to mandatory participation.44

Advantages: Employees of smaller firms get a far broader choice of health plans. Employers get the services of an agency with more managerial expertise than most small employers possess. There may be some cost savings as a result of joint purchasing, though the cost of running the agency may offset this. In theory, the competition between health plans should lead to greater efficiency, lower costs and higher quality.

Disadvantages: The potential savings and efficiencies are often overstated, and the worker still has only a one-year (or less) contract with the carrier, with no continuity or portability. To the extent that managed competition uses community rating, it provides carriers with a strong incentive to avoid higher-risk individuals. It also enables workers to choose a comprehensive plan when their health care needs are greatest and a less comprehensive plan when their need is less.

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