Members of Congress, their staffs, and millions of
other federal workers and retirees are now choosing their private
health care coverage for 2002 from almost 200 plans available
nationwide. These enrollees in the Federal Employees Health
Benefits Program (FEHBP) have repeatedly reported satisfaction with
their chosen coverage under this 42-year-old consumer-driven health
insurance system. Their choices include
fee-for-service, preferred provider organization, and managed care
plans, including those sponsored by unions and employee
organizations. Because of federal tax and
regulatory policies, no other Americans enjoy such a wide range of
Yet the FEHBP is a troubled program. Next year, continuing a
recent trend, it faces a projected premium increase of 13.3
percent. In some respects, the FEHBP's problems reflect its unique
character as an insurance program exclusively for the aging federal
workforce with a large and growing retiree population. Of the 4.2
million active employees and retirees enrolled in the FEHBP, the
average age is 54; in the Blue Cross and Blue Shield Service
Benefit Plan, one of the largest competitors in the FEHBP, the
average age is 60.
is demographics the only reason the FEHBP is experiencing problems.
Its difficulties result primarily from shortsighted, outdated
government policies that are inherently incompatible with the
free-market principles of choice and competition that lie at the
heart of the program. These contradictory policies reflect the
thinking of those who administer the program in the Office of
Personnel Management (OPM). Judging from their public comments to
the media, they too often appear to have little appreciation for
its unique character as a market-based system or the principles
upon which it is based.
of these factors converge so that the FEHBP today is working less
effectively and less efficiently than it should. Problems include
- Artificial restrictions on plan options,
including less expensive plans. The FEHBP is one of the few extant
models of a competitive health insurance market, yet it is governed
by policies and practices that are inconsistent with the
functioning of a normal market. Restrictions imposed on supply
include administrative or statutory barriers to such plans and
options as high-deductible plans, new fee-for-service plans,
medical savings accounts (MSAs), and flexible spending accounts
(FSAs). Restricting the supply of services in a market constitutes
a deliberate distortion of that market that drives up costs and
- A steady growth in benefit mandates and
regulation and a decline in plans. Over the past decade,
OPM--sometimes with Congress's authorization--has imposed benefit
requirements on the programs while expanding its own regulatory
reach. According to OPM, between 1991 and 2001, it made 44 benefit
changes in the program, including the introduction of new
regulatory initiatives. Moreover, by refusing to exercise its
statutory authority to preempt all state-mandated benefit laws and
insurance regulations on health maintenance organizations (HMOs),
it has forced the families of federal employees enrolled in those
plans to absorb the costs of the new mandates and regulations.
Meanwhile, the FEHBP today has fewer plans, and the plans it has
are more standardized and costly. OPM's approach thwarts
opportunities for plans to offer different combinations of benefits
and premiums, and discourages such lower-cost options as
- Policymakers' neglect of long-term
problems. Such problems include the aging of the program's health
insurance pool; the need to improve how the government contributes
to competing plans; and adverse selection, by which older and
sicker workers and retirees accumulate in certain plans, driving up
their costs. Making serious policy changes to correct these
problems would help to restrain costs and improve the functioning
of the program.
The Need for New Policy.
The Administration and Congress should take steps now to correct
the problems plaguing the FEHBP and improve health benefits for
federal workers and their families. The Administration should
reaffirm the OPM Director's statutory authority to negotiate
premium rates and benefits and to preempt all state-mandated
President should veto any new benefit mandates passed by Congress
and seek an independent evaluation of the effect of recent OPM
regulatory initiatives and benefit changes on costs. He should
insist that OPM promote cooperative plan negotiations,
private-sector flexibility, the use of consumer-friendly emerging
information technology, and innovation in benefit design and
Changes in the philosophy of governance
within the Administration, however, will not be enough. Congress,
working closely with the Administration, should pass legislation
that enhances employee options and eases the entry of new plans
into the FEHBP market. It should change insurance underwriting
rules and the government contribution formula to enable
participants to take full advantage of potential savings from their
choices. It should take steps to reduce the problem of adverse
selection, the congregation of higher risk and more costly
enrollees in certain plans. Finally, to broaden FEHBP's pool,
Congress should allow young military families and the families of
reservists called up for active duty to enroll in the program. This
would substantially improve health care coverage for these families
and help stabilize insurance premiums for federal workers and
A Washington Paradox: A Market-Based
The Federal Employees Health Benefits Program is a
paradox. It is market-driven, rather than centrally controlled like
the huge and financially troubled Medicare and Medicaid programs.
It promotes patient choice and market competition through a system
of defined contributions to competing private health care plans.
Yet thousands of federal workers who benefit from patient choice
and competition in the FEHBP market also administer the highly
bureaucratic Medicare and Medicaid programs, governed on the very
different principles of centralized planning and price
Because of its patient-driven character,
the FEHBP--the largest group health insurance program in the
world--is radically different in structure from almost every other
private employment or government-run health insurance arrangement.
(See text box, "Administering the FEHBP.") No other insurance-based
system of financing and delivery in America provides patients with
such a broad range of personal choice of plans and benefits.
Once a year, federal workers and retirees across the country
choose their own health plan from a variety of plans in the FEHBP.
Unlike conventional employment-based insurance, the FEHBP's plans
compete directly for the dollars of the consumer; they must win or
maintain a worker's allegiance by delivering quality health care
coverage at competitive prices. In recent years, the FEHBP's
benefit offerings have become progressively richer, including
universal availability of prescription drug coverage.
FEHBP is virtually the only system in the country in which
individuals and families can pick the kinds of benefits and
treatments they want at the prices they wish to pay while pocketing
any savings from their choices. During the program's annual open
season, federal workers can take advantage of consumer information
to make comparative shopping easier; the competing plans are rated
on performance, for example, by various employee and retiree
organizations. Historically, the level of employee satisfaction
with a personally chosen plan is very high.
Basically Sound Structure.
In terms of controlling costs, the FEHBP's record is superior. The
program routinely outperforms both conventional employer-based
private health insurance and the financially troubled Medicare
program, which covers approximately 40 million elderly and disabled
citizens. Although FEHBP health plan premiums, like those for most
Americans, will increase in 2002, federal employees and retirees
will be able to pocket health care savings (from $500 to $1,000
next year) by carefully choosing a plan.
Congressional Research Service (CRS) concluded in 1989 that the
FEHBP's basic structure is "sound." This
assessment still applies, despite subsequent changes in
Administrations and turbulence in the health care sector of the
Historically, the CRS also observed, OPM's
managerial role in the FEHBP has been "passive." OPM has played a
crucial role in the past as both an umpire and cooperative partner
of private-sector health plans, negotiating with them to secure
high-quality benefits for federal employees while largely leaving
the specifics of services to the millions of consumers in the
program. That tendency to refrain from micromanaging the prices,
plans, and benefits allowed federal workers and their families to
capitalize on the flexibility and diversity of program options. It
also contributed profoundly to the efficient functioning of the
FEHBP as a market-based system.
OPM Role Reversal: From Cautious Umpire to
Ordinary Americans might assume that a successful, decades-old
federal program--one that delivers high-quality health care
services in a competitive market governed by personal choice, with
a high level of consumer satisfaction and a low level of red
tape--would be largely immune to political attacks. But the record
far back as the first Bush Administration, OPM staff had put forth
policy initiatives that would have undermined the structure of the
FEHBP and turned it into a version of the heavily centralized
Medicare program. Fortunately, these efforts
were stymied by intense opposition within the Bush Administration
and in Congress.
1993, as part of a comprehensive plan to overhaul the entire
American health care system, President Bill Clinton sought to
abolish the FEHBP and fold its services into other parts of the
so-called Clinton health plan. In 1994, congressional variants of
the increasingly unpopular Clinton plan attempted much the same
thing; they would have maintained the outward appearance of the
program while changing its substance. However,
federal employee union leaders and organizations fought back
vigorously, in effect arguing that whatever merits the Clinton plan
might have had for the rest of the nation, it should not apply to
them and their program. This approach became a
recurrent theme in health care policy.
The Clinton Agenda.
With the failure of the Clinton plan, the Clinton Administration
adopted an incremental step-by-step approach to increase federal
control over the private health care sector of the economy. It
initiated a steady increase in federal regulation and control over
aspects of private plan operations or the delivery of care.
FEHBP's management, this meant the market was out; regulation was
in. In 1999, for example, former OPM Director Janice LaChance
described the projected average premium increase as
"unacceptable," suggesting that market
competition failed to control costs and indicating that she would
ask for greater authority to control costs administratively. Since
then, the FEHBP has been subjected to increasing standardization of
benefits, an increase in the equivalent of benefit mandates and
regulation, including the administrative implementation of the
Clinton Administration's "patients' bill of rights" initiative.
1999, pursuant to LaChance's desire to exercise more power to
"control" costs, OPM proposed Medicare-style direct contracting for
certain health benefits and entertained a proposal for bulk
purchase (eventually, government purchase) of prescription drugs
under federal pricing guidelines. The
idea was to reduce specific benefit costs through economies of
scale by making large-scale government or government-sponsored
purchases of benefits or services. It was
Certain federal employee union leaders
have urged this same approach for the purchase of prescription drug
coverage for federal employees. Of
course, the logical extension of such an approach is simply
standard government contracting under ordinary federal procurement
rules: OPM would establish a single standard for benefits and
services, request insurers to bid for the government contract, and
select one insurance company to cover all employees and
Often promoted as an efficient cost-cutting measure, the real
effect of such government monopoly purchasing would be structural,
profoundly transforming the dynamics of the program. Instead of a
pluralistic competition among insurers offering health benefits to
consumers at competitive prices, the government as purchaser would
procure each benefit at a preordained government price. It would
control both the price of the benefit and the supply of that
benefit, its quantity and its quality, in effect controlling the
benefit itself--much as the government now does in Medicare, the
huge government-run health program for America's seniors.
Medicare, the government determines--according to elaborate
formulas--the price of each of over 500 hospital services and each
of over 7,000 physician services. In the FEHBP, if a similar system
were adopted, political pressure would be exerted to maintain the
price of any given medical service at an artificially low level,
regardless of supply and demand, while lobbyists for the doctors
and other health care providers would fight to raise the official
reimbursement levels for the benefit or service in question. As
with Medicare, the government not only would be concerned with
price fixing, but also, in the interests of "appropriate"
utilization or the delivery of quality care, would be driven to
establish the conditions for the delivery of the benefit or service
for which it contracted. It would, in the process, set off a
These sorts of administrative decisions
are a politically irresistible invitation to congressional
micromanagement and ever broader, and more complex, OPM
administrative adjustments and counter-adjustments in an expanding
body of regulation. In Medicare, congressional intervention has
devolved into a low art. Between 1990 and 2000, for example,
Congress added 699 sectional changes just by amending Medicare law
in the annual budget reconciliation process. During that same
period, it made only four changes in the FEHBP statute.
the FEHBP, the dynamics of Medicare-style purchasing would likely
be the same. Artificially low prices set by cost-cutting government
officials would guarantee cost shifting and
periodic reductions in the supply of politically priced commodities
or services, such as the devastating Medicare reductions in skilled
nursing or home health care services under the Balanced Budget Act
OPM's Administrative Bias. In the recent
past, the FEHBP has had to operate in an atmosphere that was
inimical to the free-market principles on which it is based.
Policies were formulated and executed by an OPM that seemed to
favor the importation of a Medicare-style regulatory
Consider, for example, OPM's indifference
or hostility to medical savings accounts or high-deductible plans,
despite the fact that these options can lower premiums and are
popular with those enrolled in them.
Taxpayers would also benefit from opening the program to more
robust competition from these lower-cost alternatives, since the
government's contribution to average premiums is set by a formula
based on the weighted average premium of all FEHBP plans.
staff have long been aware of the deficiencies in the government
contribution formula, which caps the government's total
contribution at 75 percent of any plan's premium. The cap prevents
enrollees from realizing the full benefit of any savings they
achieve in purchasing a lower-cost plan--a perverse incentive that
weakens efficiency and cost control in the program.
Likewise, OPM staff know that the FEHBP
has no risk-adjustment mechanism and operates on the basis of very
crude underwriting as well as the flawed government contribution
formula. No distinction is made in the premiums paid, for example,
between higher-cost retirees or older workers and lower-cost active
employees. This aggravates the problem of adverse selection, with
older and sicker workers and retirees congregating in certain
plans, which drives up the utilization of services and thus the
costs and premiums in those plans.
risk segmentation is less of a problem today than it was in the
early 1980s, particularly since the extension of Medicare coverage
to larger numbers of federal retirees. But it is worth noting that,
historically, the plans' inability to vary premiums contributed
powerfully to the adverse selection problem. Allowing variation of
premiums at least on the basis of age or retirement status, coupled
with a variation of the government contribution to benefit older
enrollees, would largely ameliorate this problem. OPM staff have
shown little interest.
Harry P. Cain II, former Vice President of Blue Cross and Blue
Shield Association, who was responsible for the Blues' contracts
with the FEHBP, observed that if OPM staff were as committed to and
as knowledgeable about the principles and market dynamics of their
FEHBP program as the Centers for Medicare and Medicaid Services
staff (formerly the Health Care Financing Administration staff) are
about Medicare, the large and rapidly growing performance gap
between the FEHBP and the Medicare program would widen even
particular, the OPM could have supported extensive research on the
workings of managed competition, including the criteria and
processes needed for allowing or encouraging new plans to enter the
competition and the mechanisms needed for better risk adjustments.
In accordance with their respective charges and histories, however,
the OPM has supported no research on managed competition, whereas
HCFA has long operated an extensive research program related to
Parenthetically, in this HCFA/OPM
comparison there is an obvious and disquieting truth about publicly
managing a private competitive system. In the absence of some
special background or training, public sector managers, like
private sector managers, will continually seek ways to augment
their control over resources, their power to manage, and their
ability to do a "better job" of it. Private competitors'
innovations will typically be seen by the public managers as
irritants, disruptions, and unanticipated problems that need to be
controlled or quashed. There have been many incidents in FEHBP's
long history that underscore that danger.
FEHBP, then, is not only a paradox of Washington policymaking: a
government health care program based on the free-market principles
of consumer choice and competition. It is also a political paradox:
It periodically gets a hostile reception from left-leaning health
policy analysts and politicians, and even, in some cases, the
federal executives who are responsible for administering the
the broader national health care debate, the existence of the
FEHBP--and the fact that, despite its politically engineered
imperfections, it still works tolerably well--is a persistent
irritant to the ideological opponents of patient choice and
free-market competition in health care. The greatest support for
the consumer-driven character of the program is registered among
health care economists and the broad mass of federal employees and
retirees covered by it.
Expanding Regulatory Reach
As noted previously, the Office of Personnel Management has
traditionally exercised a deft touch in negotiating with private
health plans on behalf of federal workers and retirees. That track
record emphasized a give-and-take negotiating process between the
federal government and private plans, with deference given to
private plans in the development of a combination of benefits and
prices to meet changing consumer demands in a tough market.
recent years, however, OPM has largely broken with this tradition
of "passive management." According to its own estimates, it made 44
significant benefit changes between 1990 and 2001. Most of these
were benefit additions or, in their effects, the equivalent of
benefit mandates on private insurance plans similar to those
enacted by state legislatures. These changes, according to OPM,
resulted in a net cost increase of $225 million, or only 1.15
percent of total program costs.
These official estimates seem very low.
When OPM decided to apply the Clinton Administration's version of
the patients' bill of rights to the FEHBP, for example, it
testified that the entire panoply of patient protections would
amount to less than $10 per year for each FEHBP policyholder.
of the benefit mandates have been particularly controversial. In
1994, for example, the Clinton Administration ordered FEHBP plans
to cover an expensive and experimental treatment using bone marrow
transplants to combat breast cancer within 24 hours or face
exclusion from the program, even though the procedure was not
widely tested and medical authorities generally favored restricting
the treatment to major academic medical centers. FEHBP coverage of
bone marrow transplants for the treatment of breast cancer was the
product of intense lobbying on Capitol Hill. Years later, the
Clinton Administration still required that it be included in the
FEHBP benefits package.
Subsequently, peer-reviewed studies of the
procedure found that the transplants appeared to be no better than
conventional chemotherapy in treating breast cancer. Nevertheless,
in 2000, OPM retained the bone marrow transplant mandate and added
an administrative application of the Clinton patients' bill of
rights (including government standards for access to emergency
care, direct access to specialists, and requirements governing
information disclosure, performance, provider network
characteristics, and management of care) as well as new standards
for health care quality and customer service.
1998, OPM had attempted to impose cost accounting standards,
developed for defense contractors doing business with the U.S.
Department of Defense, to the FEHBP's private plans. It did not
seem to make any difference to OPM staff that Defense-style
contracting, with firms bidding to supply a particular product, and
the dynamic environment of a competitive market in the FEHBP, where
private plans compete directly for consumers' dollars and market
share, are entirely different institutional arrangements.
Remarkably, OPM wanted to take a form of government cost accounting
appropriate for the first and simply apply it to the second.
Fortunately, OPM's effort--a costly imposition on providers--was
blocked by Congress.
recent OPM trend toward more detailed benefit setting and more
aggressive regulatory control has been accompanied by
special-interest lobbying for additional benefit mandates. For
example, in hearings before the House Subcommittee on Civil
Service, various witnesses advocated the annual inclusion of
benefits and services, such as audiological services, acupuncture,
pastoral counseling, and medically beneficial foods, as necessary
health benefits. This type of aggressive political lobbying not
only threatens the traditionally sensitive process of negotiations
between OPM and private health insurance plans, but also serves to
undermine the most basic feature of the program: the provision of
health benefits and medical services that patients want. Instead,
patients increasingly are forced to pay for benefits and services
they do not want.
While patient choice has been a
distinguishing feature of the FEHBP, OPM policy in recent years has
been driving the program in a different direction, gradually
standardizing health plan policies. The difference in the actuarial
value of the packages offered in the FEHBP has thus progressively
narrowed. The effect has been to deprive federal workers and their
families of the more customized options available in the 1980s.
Even if one assumes that any given required additional benefit is
justified by a nominally small cost, the accumulation of these
additions can have a significant effect over time. While any one
benefit may be a minimal cost in its first year, increased
utilization over subsequent years will drive up overall costs.
OPM's aggressive regulatory campaign increasingly standardized the
private plans' benefit packages. Thus, competing plans had fewer
opportunities to offer different combinations of premiums and
benefits. Moreover, plan officials have had less room to initiate
more attractive cost-saving innovations.
example, in 1999, Blue Cross and Blue Shield, which covers almost
half of federal workers and retirees in its two major plans,
proposed to OPM the introduction of "cost sharing" in prescription
drug coverage to restrain rising drug costs. As the Blues' Senior
Vice President Stephen W. Gammarino told Congress,
be precise: our proposals to introduce cost sharing in our mail
pharmacy program for members with Medicare have been rejected
repeatedly, despite our having provided ample, unprecedented
documentation of the need for this change. While we have sought to
minimize unnecessary utilization and to assure that necessary cost
sharing was spread across our entire covered population, the
repeated denials simply maintain the free drug benefit for the
Medicare population while increasing the burden on active
the same time, neither OPM nor federal agencies have taken full
advantage of the rapidly emerging information technology that could
enhance patient choice of the benefits that patients do want and
improve the administration of this unique choice-based program. Such information technology
makes it much easier for workers and their families to compare,
pick, and choose the type and quality of coverage and the benefits,
physicians, and specialists that best suit them. Variants of this
technology enable workers and their families to enhance their
wellness and management of disease and could even help them
customize their benefit packages. Moreover, the confidentially
protected data from these software transactions would enable OPM to
enter negotiations with private plans with a much clearer idea of
patient preferences. Although OPM has only limited experience in
this area, greater competition and expanded use of information
technology holds great promise for federal workers and their
Paradoxically, while OPM in recent years has been an increasingly
active and aggressive regulator of health plan options,
centralizing authority over benefit design, it simultaneously has
surrendered its authority over the benefits offered to federal
workers and retirees by HMOs "domiciled" in the various states.
State benefit mandates unquestionably contribute to higher costs
for individuals and families purchasing state-based health care
plans. Today, state legislative requirements for health insurance
plans to cover services, providers, and disease groups total 1,403
nationwide. Not surprisingly, the
findings of medical science are often subordinated to political
considerations in the adoption of these "body part" mandates.
States are aggressive insurance
regulators. In the area of managed care alone, for example, between
1994 and 1999, state legislatures enacted more than 1,000 laws
regulating managed care plans. These
regulations can have significant transactional costs, just as
mandated benefits can have a significant impact on premium
would think that OPM would protect federal workers and retirees and
their families from these additional costs. It has not. While OPM
has used its statutory authority to preempt state-mandated benefits
in plans offered on a nationwide basis and HMOs that operate in
interstate commerce, it has refused to do so among state-based
HMOs, reducing the competitive
position of these plans and forcing federal employees in these
states to pay higher premiums than they would otherwise because of
the additional cost of the mandated benefits. These costs, which
are nowhere taken into account in OPM's own cost estimates of
regulatory or benefit changes, can be rather substantial in states
like California, which has 42 mandates, and Maryland, which has
Beyond OPM's administrative actions,
Members of Congress--in a bipartisan break with their traditional
policy--recently have begun to intervene in FEHBP benefit setting.
They have been proposing legislation to force federal employees and
taxpayers to pay for a whole range of currently fashionable
benefits, including acupuncture, osteoporosis screening,
contraceptive coverage, fertility treatments, Viagra prescriptions,
and encouragement of the use of generic drugs, as well as an
expansion of FEHBP coverage to the parents of federal workers and
same-sex domestic partners.
Proposing an unprecedented restriction on the right of federal
employees and retirees to spend their own money on medical services
of their choice, Senators Bill Nelson (D-FL), Richard Durbin
(D-IL), and John Edwards (D-NC) recently introduced a bill (S.
1606) that would deny federal payment to "any health care provider"
that charges a "membership fee or any other extraneous or
incidental fee to a patient" as a condition for getting a medical
Sharply Differing Analyses.
As noted, OPM staff have indicated that, taken together, their
"benefit changes" have achieved savings and had little overall
effect on the real growth of premiums. But the extremely low
estimates generated by OPM suggest, at the very least, the need for
a comprehensive and independent economic analysis of the cumulative
impact of these benefit and regulatory changes over time.
Independent, particularly private-sector,
econometric analyses of state benefit mandates and the
transactional costs of regulation on health insurance plans show a
much greater impact on health care costs and premiums than
indicated by the OPM staff analysis. For example, a 1996 study of
additional health benefits mandated by state governments, conducted
by the U.S. General Accounting Office (GAO), found that
state-mandated benefit laws accounted for 12 percent of the claim
costs in Virginia, which had 29 benefit and managed care mandates,
and up to 22 percent of the costs in Maryland, which then had 36
2000, Democratic Governor Howard Dean of Vermont cited the negative
impact of the state's benefit mandates on health insurance costs,
saying that they contributed to about 25 percent of 1999 health
insurance premiums. He asked the state legislature to stop enacting
Private economic analyses of the
relationship between health benefit mandates and premium costs show
similar effects. In this respect, the
Administration and Members of Congress should verify the
assumptions, analysis, and conclusions of OPM staff.
Sharp Decline in Plan Participation.
There has been a disturbing drop in the number of plans
participating in the FEHPB. In the mid-1990s, almost 400 health
plans competed in the program. For 2001, OPM announced that only
245 plans were expected to participate. Between 1998 and 1999, the
FEHBP lost 65 plans--a stunning 20 percent of the plans that had
participated. For 2002, OPM announced that only 180 plans were
expected to participate.
private firms participating in a government program in accordance
with government policies do not behave the way government officials
expect them to behave, it is not automatically the fault of the
private firms. The large number of dropouts has caused the FEHBP to
become less competitive internally, potentially reducing enrollee
choice and contributing to higher premiums.
Why FEHBP Premiums Have Been Rising
In recent years, the FEHBP's premiums have been rising at a
troubling rate. Estimates project that FEHBP
premiums will increase an average of 13.3 percent in 2002. While
Administration officials and Members of Congress should be
concerned, they should also maintain perspective on what these
premium increases mean.
First, even with a projected average
increase in 2002 of over 13 percent, in the crucial area of cost
control, FEHBP is very likely to continue outperforming private
employment-based health insurance, which is sure to experience
double-digit premium increases next year. Hewitt Associates, a
major benefits consulting firm, is now projecting 13 percent to 16
percent cost increases in 2002, and many private companies are
planning to pass on substantial cost increases to their
FEHBP also will likely outperform highly regarded public programs
of a competitive character. Indeed, the California Public Employees
Retirement System (CalPERS), which often is compared to the FEHBP,
has announced premium increases averaging 15.5 percent in 2002; in
2001, the celebrated California program reported an increase of
12.9 percent, while the FEHBP projected an increase of 10.5
FEHBP still enjoys a superior record in comparison to Medicare,
which, unlike FEHBP, is governed by a complicated and rigid system
of price controls. Based on the annual reports of the Medicare
trustees, the average cost of Medicare (both Part A and Part B) per
enrollee has risen from $3,834 in 1992 to $6,228 in 2001,
representing a 10-year increase of 62 percent. Over the same
period, the enrollment-weighted average premium in FEHBP, for both
single enrollees and families, has risen from $3,440 to $5,322, a
10-year increase of 54 percent.
Second, projected annual increases in
premiums do not automatically translate into actual annual premium
increases in the FEHBP. The reason, which does not generally apply
to workers who get their insurance through conventional
private-sector employer plans: the ability of federal workers "to
vote with their feet" and choose lower-cost health plans during the
annual open season if they are unhappy with their current health
plan. Based on previous experience, it is likely that actual
premium increases in 2002 will be less than the 13.3 percent
projected by OPM.
sharp contrast, private-sector workers often have no choice at all
of health plan; they get what their employer provides, usually some
sort of managed care plan. And among those private-sector workers
who do have a choice of plans, choice is often very limited.
Broader Health Care Trends.
Premium increases in the FEHBP reflect the cost of benefits; and
precisely because of the competitive character of the program,
which includes the real possibility of losing market share, there
is obviously no economic incentive for a health plan participating
in the FEHBP to set rates higher than necessary.
Nonetheless, the FEHBP is not immune to
trends in the broader health care system that are driving costs
upward: the general aging of the American population, the increase
in the demand for hospitalization, a continuing and growing demand
for newer and more effective prescription drugs, the recent double
digit increases in medical malpractice insurance, the economic
impact of a growing body of state and federal regulatory
initiatives, and the desire of patients to take advantage of the
best and newest medical technology to lengthen or enhance the
quality of their lives. These trends apply with equal force to
patients enrolled in private employment plans and the FEHBP.
private employment-based health insurance, benefits are another
form of compensation for work. Every dollar increase in health care
benefits amounts roughly to a dollar decrease in wages and other
compensation. Under current arrangements, persons today are using
health insurance to cover small, routine, or purely predictable
medical services. This results in huge and unnecessary overpayments
into the health insurance system in the form of prepaid health care
and a proportional loss of disposable income.
Federal employees are not immune. Ideally,
routine medical services should be paid directly out of pocket and
given the same favorable tax relief that today is exclusively
available for insurance payments. Allowing persons to pay routine
medical bills from tax-free flexible spending accounts or medical
savings accounts would be the best way to accomplish that end.
Beyond the general increase in health care
costs, particularly the demand for and higher utilization of new
and more expensive prescription drugs, there are other major
reasons why FEHBP is experiencing significant cost increases. Among
the most important is the FEHBP population itself.
The Aging FEHBP Insurance
Health care costs rise rapidly with age. Persons over the age of
65 have average health care expenditures more than twice that of
the general population, and almost three times more than persons
under the age of 65. And the federal workforce is
older and aging more rapidly than either the private-sector
workforce or the general American population. There are 4.2 million
active employees and retirees enrolled in the FEHBP. As noted, the
average FEHBP enrollee is 54 years of age, and the average enrollee
in the Blue Cross and Blue Shield Service Benefit Plan, one of the
largest competitors in the FEHBP, is 60 years of age. Private-sector health
insurance pools are considerably younger.
Unlike private-employer sponsored
insurance, where retiree coverage often has been drastically
reduced or discontinued, the FEHBP continues to cover retirees, a
large growing group of policy-holders that has higher health care
costs. As of 1998, 1.85 million federal retirees participated in
the program; their average age was 71 years. The range of FEHBP
retirees is broad, because federal workers may retire as early as
age 55; in certain occupations, some may retire as early as 50 with
full health benefits. Even with Medicare coverage, federal retirees
are more expensive than active employees in the program.
Complicating the problem has been the
downsizing of the active federal workforce. Since 1993, the
workforce numbers shrunk by 324,580, disproportionately among
full-time workers at the Department of Defense.
Moreover, 71 percent of the permanent federal workforce today will
be able to take normal or early retirement by 2010, with an
estimated 40 percent expected to do so. Thus,
the growing imbalance between active employees and retirees will
deepen, making retirees the fastest growing group in the FEHBP.
officials have been keenly aware of these disparities, yet neither
OPM nor Congress has taken any serious steps to change the
demographic dynamics that threaten the program. One might think
that OPM and Congress would seek ways to expand the youth of the
FEHBP pool. In 1998, however, Congress moved exactly in the
opposite direction, enacting a flawed demonstration program to
assess FEHBP coverage for military retirees in the Defense
Authorization Act for Fiscal Year 1999.
How to Improve the FEHBP
If most of the FEHBP's problems, particularly in terms of
cost and efficiency, are traceable to government policy, then most
of them can be solved by government policy.
What the President and the Administration
There is much that the Administration can do to improve the
- Veto any congressionally mandated
Under current law, it is the management responsibility of the OPM
Director to negotiate rates and benefits for federal employees and
retirees. Historically, Congress has respected the authority of the
OPM Director in this area and has refrained from interfering in the
sensitive process of negotiations with private plans trying to
compete in the program. In recent years, however, there has been a
growing inclination among Members of Congress to override the OPM
by imposing their own politically driven preferences for benefits,
medical services, or treatments and procedures legislatively. The
President should back up the authority of the Director of OPM in
this area and make it clear he will veto any legislation imposing
such mandates on the FEHBP.
- Seek an independent analysis of the
economic impact of the benefit and regulatory changes over the past
The Administration should review the FEHBP's current regulatory
regime, including the addition of benefits beyond the core
statutory requirements of Title V of Chapter 89 of the U.S. Code,
and seek an independent (preferably private-sector) evaluation of
the economic impact of these OPM initiatives on claims, costs, or
premiums. Premiums reflect costs, and if premiums are to be
restrained, costs must be restrained.
- Instruct OPM to use its legal authority
to preempt all state mandated benefits.
The Administration should rely on its statutory authority to
negotiate benefits for federal workers and retirees and their
families to protect them from paying unnecessarily high premiums
out of an inappropriate deference to state legislative mandates.
OPM, not state legislators driven by special-interest lobbying, has
sole responsibility for the rates and benefits in the FEHBP.
- Work cooperatively with private plans
to promote innovative cost-saving measures.
OPM should return, to the extent practicable, to a tradition of
collegial private-public sector negotiations to control costs and
improve benefit offerings. For example, plans could be required to
offer all of the current benefit packages to all employees and
retirees as a high-option plan. They should also offer a variant of
the core offerings, a low-option plan, that does not include recent
"benefit additions" or mandates and allow consumers to decide for
themselves whether they want to pay the higher premiums to purchase
those benefits. Consumer choice and competition should be
reinforced, not progressively weakened, if the FEHBP is to remain a
strong model for broader health care reform.
- Take full
advantage of patient-based information technology.
Today's emerging software programs enable
workers and their families to compare plans more effectively, seek
out the best plans, and identify the key features of plans,
including access to care, the benefit levels available, and costs
and quality measures. Federal workers and their families can thus
determine what is most important to them, rate the relative
importance of these features, and make detailed personal trade-offs
in costs and benefits. Existing technology also enables patients to
create a personal profile of their health needs and match that
profile with plan offerings, as well as make appointments with
physicians and specialists, e-mail their physicians, and maintain
their medical records. In effect, emerging information technology
introduces a whole new level of personal empowerment and, if fully
integrated into the FEHBP, would enable workers and their families
to customize their benefit and payment options.
What Congress Can Do
Working closely with the Bush Administration, Congress can make
substantial improvements in the efficiency and effectiveness of the
FEHBP. For example:
- Ease the restriction on new
Current law does not allow the OPM to admit any new
fee-for-service plans into the FEHBP. New plans must be HMOs. This
legal restriction is outdated and pointless. Normal market
efficiency is served when suppliers of services can enter and
function in the market freely, responding quickly to changes in
consumer demand. A statutory bias in favor of HMOs undermines
market competition and consumer choice.
- Create tax-free savings options and
allow for rollover of funds into the Thrift Savings Plan.
Over 80 percent of large employers and a significant number of
small and midsize companies offer their employees benefits through
pre-tax cafeteria plans. Among the most popular of these are
flexible spending accounts (FSAs, or the so-called Section 125
plans). An employee may pay for unreimbursed or routine medical
expenses from funds set aside tax-free in the account.
Millions of workers in the private sector
have access to flexible spending accounts, but not federal
employees. They should be allowed this benefit as well, and the
amount allowed in these accounts should be increased by allowing
the rollover of unused funds from year to year. The tax-free
rollover would enable federal employees to build up a reservoir of
funds for health care expenses. At the end of their career, they
should be allowed to fold these funds into their accounts in the
Thrift Savings Plan (TSP), a component of the Federal Employees
Retirement System, or use the funds either to purchase long-term
care or to pay for health care expenses in their retirement
A variation of this idea is to allow
federal employees to use personal medical savings accounts (MSAs),
now restricted to employees in small firms. Private health
insurance plans competing in the FEHBP should be allowed to offer
tax-free MSAs. Such accounts free the doctor-patient relationship
from third-party interference and end the federal tax penalty on
personal payment for routine medical services. MSAs can also
significantly reduce employer health care costs compared with
traditional health insurance.
As with FSAs, federal workers should be
able to roll over the funds in these accounts from year to year
tax-free, and use them later to pay for health care expenses in
retirement or long-term care, or fold them into their TSP accounts.
At the very least, Congress and the Bush Administration should work
together to authorize an MSA demonstration project within the FEHBP
and evaluate its impact on costs and employee satisfaction.
- Address lingering problems of risk
segmentation and adverse selection.
A persistent irritant in the FEHBP has been a tendency toward
adverse selection. While this problem has not been as acute in
recent years and competing plans have found ways to adjust, it is
still a lingering problem. Any time one has a choice of plans, even
if there are only two plans from which to choose, one will
experience adverse selection. In the FEHBP, the problem is
aggravated by the underwriting rules and the formula governing the
Under current law, active workers and
retired workers pay the same premium for health insurance despite
dramatic differences in both risk and health care costs. FEHBP
plans may not charge different rates based on these risks or costs.
In this narrow sense, the program operates under what can only be
described as a crude form of "community rating"; 22-year-old
joggers and 82-year-old smokers pay the same insurance premiums
despite the radically different costs and risks. Obviously, when a
larger number of older and sicker retirees congregate in a health
plan, its costs and premiums soar, encouraging younger and
healthier enrollees to drop out. These higher-cost plans find it
difficult to compete with lower-cost plans with younger enrollees,
and sometimes drop out of the program altogether.
A large infusion of younger workers or
enrollees would alleviate the problem. But if plans could charge
OPM more for older workers or retirees in a way that reflected
their actuarial cost, without raising the costs for these older
workers or retirees, not only would one have a more rational
insurance market, but the decision of older workers or retirees to
pick a particular plan would not necessarily mean sharply higher
premiums for younger workers and their families. Much of the
adverse selection problem would disappear.
The best way to accomplish this would be
to allow plans to charge different premiums, reflecting the real
actuarial value of differing age groups in the market, and
simultaneously adjust the government contribution to the plan
premiums of older and higher-cost enrollees. In other words, older
and retired workers would get a larger government contribution.
Since age is the most significant risk factor, the government could
adjust government contributions in a limited number of categories:
active workers, early retirees, retirees with Medicare, and the
progressively smaller number of retirees without Medicare. Since
there is no risk adjustment mechanism at all in the FEHBP today,
this would be a substantial improvement in the functioning
- Remove the cap on the government
contribution to a plan.
Under the current financing formula, the government, regardless of
how much it contributes in any given year, may not contribute more
than 75 percent of the cost of any health plan's premium. A real
consumer choice system should give individuals and families the
full benefit of any savings that accrue from wise purchasing
decisions. In calendar year 2000, for example, the maximum
government contribution for family coverage was $4,580. Under this
proposed change, workers who purchase a plan with an annual premium
of $4,000 would get a $580 rebate from the government. The family,
in other words, would realize the full financial benefit of picking
the lower-cost plan.
Although the government's contribution,
using the market-based formula, would vary every year and reflect
changes in the market, the removal of the cap on the government
contribution would give the competing plans in the FEHBP new
incentives to offer benefit packages at a premium level equal to or
below the government's defined contribution and thereby increase
price competition. More intensive price competition would help
stabilize the overall premium increases on which the total
government contribution is based. Federal employees would have an
incentive to purchase lower-cost plans to reduce out-of-pocket
costs and to pocket any savings. Those who choose more expensive
plans with richer benefit packages would, of course, pay more in
premiums and out-of-pocket costs.
- Create a
younger, healthier insurance pool.
The FEHBP needs young blood. One prominent option: Enroll
military families and their dependents under the age of 65 under
the same terms and conditions that apply to federal employees,
retirees, and their families. Representatives of military families
have testified that they want to be
enrolled in the FEHBP. They realize it would give
them a much wider range of plans and benefit packages and a far
superior medical system. Because health care benefits, like wages,
are normally counted as compensation, Congress could enroll
military families in the progra
Nonetheless, in spite of its recent
troubles, the FEHBP has many strengths. It has a level of consumer
choice that is unmatched in the private sector. Federal workers and
their families enjoy a richness and variety of options that are
unavailable to workers in private employer-based health insurance
plans. And they are able to pocket the savings generated by their
health care decisions.
Working together, the Bush Administration
and Congress can significantly improve the FEHBP for federal
workers and their families. They can improve it by enriching
benefit options, such as offering tax-free accounts from which to
pay routine medical expenses; reforming the underwriting and the
government contribution formula to sharply reduce the problem of
adverse selection; and broadening the insurance pool by including
younger families, particularly the families of military personnel
and reservists called up for duty, which would stabilize premium
There is no reason why such improvements
cannot be made in a program that has become a showcase of personal
choice and model of solid health care financing and delivery.
Improving the FEHBP can be the first step in the creation of a new
health care system for all Americans--one in which individuals and
families, rather than corporate or government officials, make their
own key health care decisions.
E. Moffit, Ph.D., is Director of Domestic Policy Studies at
The Heritage Foundation.