Defined-contribution health plans the coming wave

Over the next decade, we are likely to see a shift in health insurance in the United States: So-called defined-contribution plans will gradually take over the market, shifting the residual risk of incurring high health care costs from employers to workers.
The market today is dominated by “defined-benefit” plans, under which companies determine a set of health-insurance benefits that are provided for employees. Under defined-contribution plans, companies pay a fixed amount, and employees use the money to buy or help pay for insurance they choose themselves.
The fundamental driver of this shift is the effort by American businesses to reduce their exposure to health care costs. But the recent health care-reform law may accelerate the shift.
The defined-contribution concept is already familiar to most American workers through their retirement benefits. Over the past two decades, company retirement programs have moved decisively away from defined-benefit plans, in which workers are paid a given amount of retirement income, and toward defined-contribution 401(k) plans, in which risks – from fluctuating financial markets, for example – are borne by workers.
The movement toward defined-contribution plans for health insurance is, in some ways, similar to the one that occurred for pensions, as Kenneth L. Sperling and Oren M. Shapira explained in an article earlier this year.
The change in health insurance is already well under way in coverage for retirees. In the early 1990s, in response to accounting changes and rising costs, companies began to re-evaluate retiree health plans, and some capped the amount they were willing to pay at a multiple of existing costs. Over time, as those limits were reached, most companies declined to raise them, thereby effectively creating defined-contribution retiree health-insurance plans, with the company’s contribution set by the cap. Exchanges have been created to allow retirees to use these employer contributions to purchase their own health insurance.
For current workers, the precursor to a defined-contribution approach is the “consumer-driven” health plan. This typically has higher deductibles and copayments than a traditional plan has, and it is often tied to a health savings account. It typically still provides generous insurance for catastrophic cases. The share of workers enrolled in such plans remains quite low but is expanding rapidly. A recent survey of large companies found that, in 2012, almost three-quarters will offer consumer-driven, health-insurance plans.
The natural next step will be for employers to strictly limit their health-insurance contributions to a set amount of money that workers could use to buy insurance. Companies will thus eliminate their exposure to unexpectedly high health care costs.
If most employers retain their health plans, the state insurance exchanges created under the new federal health care law will make the basic idea of a defined-contribution health plan more prevalent, and thus may speed its adoption. The regulations written to carry out the new law will determine how things play out. If defined-contribution plans that are sufficiently generous count as employer-based coverage – as is generally expected – the trend toward such plans will probably accelerate.
Whether this turns out to be a good thing will depend in no small part on whether the defined-contribution model helps to constrain overall health care costs. There’s little point (and much potential harm in terms of risk-sharing) in having individuals, rather than businesses, take on the responsibility of paying for health care if there is no change in the total cost.
I have written elsewhere that although consumer-driven plans could help somewhat, they are unlikely to be a crucial step toward reducing health care spending over the long term. The evidence to date, with a few exceptions, suggests that such plans reduce costs only modestly.
Full-blown, defined-contribution plans could perhaps generate better results, though it will still be crucial to get doctors and other providers to deliver more-efficient care, especially for high-cost cases.
In any case, the bottom line is that a shift toward defined-contribution plans seems likely. I’d be willing to bet $1 that most large U.S. employer health care offerings in 2020 will be defined-contribution plans. Any takers? &#8226


Peter Orszag is vice chairman of global banking at Citigroup and a former director of the Office of Management and Budget.

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