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Executive Summary #1453es on Health Care

June 28, 2001

Executive Summary: Improving Health Care Coverage Through Defined Contributions

By and

The debate in Washington over enacting a patients' bill of rights ignores the potential results of that approach: a barrage of lawsuits that will further increase health care costs and compound, not solve, the nation's health care problems. A far more effective means of addressing the health care needs of Americans is to foster a system that offers employees and their families a defined contribution to the health plan of their choice. This new idea, which empowers employees to make decisions about their own health coverage, reflects the successful approach of the health insurance system that currently covers 9 million federal workers, their dependents, and retirees. It is similar to the use of 401(k) plans that enable Americans to control their savings for retirement.

More and more employers are considering changing from offering "defined benefits" in a health plan they have selected to offering employees a "defined contribution" to the plan of the worker's choice. A recent Booz-Allen & Hamilton study found that most executives surveyed from Fortune magazine's 100 "best companies to work for" anticipate a shift to defined contributions in the very near future. They predict, in fact, that within 10 years, defined contributions will be as common in health care as they are in retirement planning today.

The reason for this coming change: Employees and employers are increasingly frustrated with the current system. Employees are limited to the plans their employers select, and employers are concerned about the increasing cost of providing health coverage, with double-digit premium increases increasingly common, and by their potential exposure to liability for the decisions they make. The patients' rights bills before Congress could throw open the door to such liability. The unfortunate but predictable result of these concerns is that some employers are changing and may even be forced to drop coverage for their employees.

The combination of employer-employee frustration and capacities for new information technology is fueling a growing interest in new solutions that would enable employees to choose from among several health plans in their area and to switch plans if they are dissatisfied. Offering employees a defined contribution toward the cost of their health plan premiums would make health care costs more predictable for employers. Adding the proper protections would encourage more employers to help to offer health coverage for their employees, which would reduce the number of Americans without health insurance.

Before voting on any patients' bill of rights, Members of Congress would do well to examine the growing move toward defined contributions because:

  • Defined contributions help address many of the current problems. Problems in the current system, such as lack of choice, uncontrolled costs, the increasing threat of lawsuits, and restricted doctor-patient relationships, would be addressed by implementing defined contributions. Based on free-market principles, the defined contribution approach enables employees to choose coverage to suit their needs; this consumer empowerment would facilitate competition in the health market to ensure that policies would be available at affordable prices.

  • Defined contributions are popular. Employers and employees respond positively when surveyed about moving to a system of defined contributions. According to a survey by the accounting and consulting firm of KPMG, LLP, almost half of the 103 senior executives from Fortune 1000 companies surveyed were receptive to this idea. Among employees, there was even greater support. Almost three-quarters of the more than 14,000 employees surveyed from 117 Fortune 1000 companies responded that they were "extremely," "very," or "somewhat" interested in using defined contributions to purchase their own health insurance. A 1999 Employee Benefit Research Institute survey found that 89 percent thought they could choose the best health insurance if their employer offered that choice, and 81 percent believed they could do so if their employer stopped offering coverage.

  • Defined contributions are working. For example, federal workers enrolled in the Federal Employees Health Benefits Program (FEHBP), which serves over 9 million federal workers and retirees, receive a contribution from the government of up to 75 percent of their health insurance premium to a maximum of $2,250 for singles and $5,090 for families. Employees select a plan from participating plans in the program. In most locations, they can choose from between 12 and 20 plans. Insurers compete for their enrollees. This competition has resulted in higher satisfaction rates and average annual premium increases that are lower than in the private market. Many workers utilize 401(k) plans, and medical savings accounts that rely on similar defined contributions from employers are now available.

What Washington Should Do.
Congress and the Administration could facilitate a move to defined contributions by ensuring that it brings no adverse tax consequences or additional legal liability to participating employers and that the broadest range of insurance pools are available to employees. Tax policy should ensure that the employer's tax deduction is maintained and that contributions to health coverage are not considered part of employees' taxable income. Caps on medical savings accounts should be ended to empower more employees to take control of their health care expenditures. And the Employee Retirement Security Act (ERISA) of 1974 should be amended to allow interstate pools of citizens for health insurance and to enable employees to purchase state-regulated individual plans.

Conclusion.
Although there are hurdles to clear before America's employment-based health insurance system shifts to a system that allows defined contributions, the benefits of such a move are too significant to ignore. Americans clearly want more choice and control of their health care decisions and health care costs. Defined contributions would lead to such empowerment.

James Frogue, Legislative Director for U.S. Representative Kay Granger (R-TX), contributed to this paper in his previous position as Policy Analyst for Health Care at The Heritage Foundation. Grace-Marie Turner is President of the Galen Institute, a research organization in Alexandria, Virginia, that focuses on health and tax policy.

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