Center for Studying Health System Change

Overview of Defined Contributions

           DR. TRUDE: Thank you.
           Let’s see, do we have the lights?
           Defined contributions have become the latest rage in employer-sponsored insurance. Is this the beginning of a new revolution in health insurance, or does it merely reflect employers’ frustrations with the current system? Hopefully by the end of this conference, we’ll have a better sense of which.
           For my part, I’d like to clarify some of the uses of the term "defined contributions," discuss the trade-offs between the approaches, and conclude with a look at the potential policy implications of a widespread move to defined contributions.
           What I also hope to show is that for a discussion of defined contributions, the definitions matter. They especially matter for understanding the trade-offs and the policy implications.
           The framework I will lay out for you today should also provide a useful context for the panelist discussion that follows.
           The Jackson Hole Group first popularized defined contributions in the 1970s with their concept of managed competition. They felt that health insurance would be improved if consumers would bear more of the cost burden.
           First, purchasers were expected to pay a fixed dollar amount toward premiums, ideally the cost of the lowest-priced plan; second, purchasers are expected to offer a range of plan choices and information to help the consumers make their decisions; third, employees were expected to pay any extra costs if they chose a higher-price plan.
           This whole package requires substantial administration and oversight on the part of purchasers and, hence, the name managed competition.
           Today we see that some of the structure of managed competition has become part of the health insurance landscape, although the inroads of fixed contributions has not been as extensive. There’s only 8 percent of employees who have a choice of plan with the fixed-dollar contribution. Employers limited to offering a single health plan are sort of the main reason for that.
           And so the employers that offer a choice of plans do see substantial administrative burden. As I mentioned, they have to choose among the competing plans, assess the plan performance, and convey all of this to their employees. Yet for all this, employers find themselves faced with the managed care backlash and potential liability.
           So now, in counterpoint to managed competition, defined contributions for pensions have recently been suggested as an alternative model for health benefits.
           Similar to retirement benefits, the employer contributes a dollar amount toward health benefits and shifts the risk and responsibility for those dollars to the employee. For employers, this could substantially reduce their administrative burden, expand choice, empower consumers and avoid the backlash, and make their costs more predictable.
           But there are drawbacks to defined contributions for health benefits that don’t apply to pensions.
           Currently, employers pool risk and all employees within that pool pay the same amount for coverage, despite differences in likely use. Without this, older and sicker workers may be unable to obtain or afford health insurance.
           In addition, under current arrangements, employers and health plans limit the range of choices to avoid adverse selection. A defined contribution approach may not be able to expand choice for these same reasons.
           Furthermore, many workers look to their employers to negotiate with plans on their behalf, for example, in negotiating with plans on their behalf on issues of price and coverage. This advocacy role could be lost under a defined contribution approach.
           The benefits and consequences of moving to defined contributions will depend on the approach taken, however. I’ve already discussed the fixed-dollar contribution approach. More recently, there’s been a proposal, what we call a cash transfer, which involves paying the workers higher wages in lieu of health insurance. If the worker chooses, they can buy health insurance on the individual market, or they can use the cash for other purchases. This approach, however, would lose the current tax advantages.
           Another approach would be to issue vouchers to ensure that the money is used for health benefits and, therefore, you can preserve the tax advantages.
           As you can see from this slide, the voucher and cash options promise to reduce the employer’s administrative burden and also expand choice. Now, as designed, the fixed-contribution approach was also supposed to expand choice, and there has been an expansion of choice, but not because of the widespread adoption of fixed contributions.
           The extent to which vouchers and cash transfers might expand choice will depend on what’s available on the individual market.
           As mentioned earlier, vouchers and cash approaches leave more responsibility to the employee, but then they lose the value of the purchaser clout and the risk pool.
           Risk selection is common among all three scenarios, although under the fixed-contribution approach it’s typically handled by the health benefit manager, by the management of the benefits and plan offerings.
           In the future, though, emerging Internet ventures may affect employers’ health insurance strategies and whether or not they move to defined contribution. There’s been an explosion in this area of new Internet ventures offering a vast array of options for employers. I have broken it into basically three groups:
           First, there are ventures that provide some technological improvements that reduce administrative costs but basically operate under the current system.
           Second, there are some ventures that would require employers to go to fixed contributions or a defined contribution approach. And even within this group, there is a wide variety of options which you are going to see today.
           The third group supports those purchasing health insurance in the individual market. The California Health Care Foundation recently published a report contrasting three web sites that offer these services, and this approach may radically change the role of brokers in some of the local markets.
           Today’s panel are all representative of the second group I mentioned: Internet entrepreneurs that should facility employer’s move to defined contributions. With the help of both panels today, I hope we can resolve whether defined contribution approached are the wave of the future and what role the Internet might play in all of this.
           In closing, I’d like to note some of the policy implications a movement to defined contributions could make, although what the implications are is ultimately going to depend on the approaches that employers take. And one impact could be on the number of uninsured persons.
           If employers used defined contribution approaches to target low-wage workers, we could reduce the number of uninsured, for instance, by offering one plan at no cost, and that would make it affordable for the low-wage workers who typically don’t take up insurance due to cost.
           On the other hand, substantial reliance on the individual market without reforms to that market could potentially increase the number of uninsured. EBRI estimates that workers in large companies would pay about 32 percent more on average if they had to buy their premiums on the individual market. And older workers would be faced with much higher premiums than would younger workers, who might not bother to even buy the insurance. And that way you could see that there might be more uninsured as a result of that.
           Finally, defined contributions can also have implications for patient protections. Currently, employers play an important role resolving customer service issues and disputes over coverage. Some employers also play an important role in patient safety, quality improvement, and insuring accountability. So if employers move to defined contributions to avoid the managed care backlash and employees lose their employers as an advocate, there may be a call for government to play a stronger role in patient protection and regulation to take up the role that employers have left behind.
           DR. GINSBURG: Thank you, Sally.

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