Over the next decade, we are likely to see a shift in health insurance in the U.S.: 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. These will gradually be replaced by defined-contribution plans, under which 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.
In 1985, a total of 89 of the Fortune 100 companies offered their new hires a traditional defined-benefit pension plan, and just 10 of them offered only a defined-contribution plan. Today, only 13 of the Fortune 100 companies offer a traditional defined-benefit plan, and 70 offer only a defined-contribution plan.
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 pension shift occurred in a series of stages: First, the traditional defined-benefit plan was redesigned. Then a hybrid approach was introduced (the cash- balance plan). Finally, defined-benefit plans were frozen.
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 co-payments 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.
Some insurers are already anticipating the shift. Bloom Health Corp. will begin offering defined-contribution exchanges in 2012. Bloom, based in Minneapolis describes itself as “a leader in the defined-contribution health benefits marketplace,” and says it is “committed to assisting employers of all sizes move toward an employer-sponsored system that has effective cost predictability for employers and increased choice and personalization for employees.” In September, the company announced that Health Care Service Corp., Blue Cross Blue Shield of Michigan and WellPoint (WLP) Inc. had purchased a majority of its equity.
The inevitable transition to defined-contribution health insurance may get a little push from the new health-care-reform law. Indeed, the legislation may have a larger impact on the type of health-insurance plan that employers offer than on their decision about whether to drop health-care benefits altogether.
A misleading survey by McKinsey & Co. has suggested the potential for huge declines in employer-based health insurance. But projections from the Congressional Budget Office and other respected researchers generally point to only a modest net decrease. And the experience to date in Massachusetts, which has a health-care law similar to the Affordable Care Act, is consistent with this prediction. (All such estimates are highly uncertain, and what actually happens will probably depend, in no small measure, on herd behavior. Employer surveys indicate that most companies will consider dropping their health plans only if other firms do.)
If most employers do 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. After all, the majority of costs come from the expensive cases that are still generously insured by catastrophic-care provisions in consumer-driven plans.
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?
(Peter Orszag is vice chairman of global banking at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.)
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