The Federal Employees Health Benefit Program is the largest group health insurance program in the world. It provides health care coverage to Members of Congress, White House staff, and the federal judiciary, as well as approximately 9 million federal and postal workers and retirees and their families.
Though it is the largest group health insurance program in the world, the FEHBP is radically different in structure and organization from virtually every other private employment or government-run health insurance arrangement. The major difference: It is largely run on the free market principles of consumer choice and market competition. No other insurance-based system of financing and delivery in America provides patients with such a broad range of choice of plans and benefits.
Once a year, federal workers and retirees in any area of the country can personally choose from a variety of different plans. It is virtually the only system in the country in which individuals and families can choose from a broad range of health plans, picking the kinds of benefits and treatments they want, at the prices they wish to pay, while pocketing the savings of wise choices. In that key respect, it is the only health care delivery system that even vaguely resembles a normal market in health insurance.
The Office of Personnel Management (OPM), the federal agency that administers the FEHBP, has broad authority, repeatedly upheld in the federal courts, to negotiate premium rates and benefits on behalf of federal employees. Beyond its responsibilities for carrying out these sensitive annual negotiations, OPM is responsible for enforcing the basic ground rules for competition among private insurers and making sure that private insurance companies meet the fiscal solvency, consumer protection, and basic benefit requirements outlined under Chapter 89 of Title V of the U.S. Code.
As the Congressional Research Service observed in 1989, the basic structure of the FEHBP is "sound" despite changes in Administration and the health care sector of the economy. Historically, as the CRS further observed, OPM's managerial role in the FEHBP has been "passive." That managerial passivity, that historical tendency to refrain from attempting to micromanage the prices, plans, and benefits, has worked to the direct advantage of federal workers and their families, as well as the efficient functioning of the program. OPM has, in this respect, played a crucial role as both an umpire and a cooperative partner with the private sector in negotiating with health plans in order to secure high-quality health benefits while largely leaving the choice of those benefits to millions of consumers who make up the federal workforce and their families.
In recent years, there has been a noticeable change in this approach, with OPM pursuing a more aggressive regulatory approach and imposing the equivalent of "mandated" benefits on competing health plans. Nonetheless, although the FEHBP is not perfect, it retains many strengths, particularly its level of consumer choice and competition and the bountiful benefits of a market, which largely are unavailable to workers and their families in private, employer-based health insurance. Compared with Medicare and Medicaid, the levels of bureaucracy and regulation are very low.
While FEHBP retains a sound structure and superior performance as a health care delivery system for its enrollees, it is nevertheless a troubled program. Its problems are rooted in shortsighted government policies incompatible with its structure as a system of consumer choice and competition; and the solutions to those problems are rooted in government policies that not only are compatible with its structural advantages, but also would enhance consumer choice and competition.
The Problem of Rising Cost
For next year, OPM projects an average premium increase of 13.3 percent among FEHBP plans. This continues a painful pattern of significant premium increases over the past several years. And while these premium increases have been less than those commonly found in the private sector, they are nonetheless worrisome to federal employees, retirees, and their families. Ominously, such a premium hike in the FEHBP, which has a superior historical record of cost control compared to private employment-based health insurance, is a marker for even higher increases in premium costs throughout the rest of America's private, employment-based health insurance system.
Recent FEHBP cost increases surely reflect the broader changes in the health care market, particularly the growing patient demand for high-quality prescription drugs delivered through the mechanism of health insurance. But there are also factors, which are peculiar to the program, that are driving the cost increases in the FEHBP, and these factors are not inherent in the structure of program.
The first of these is the artificially skewed demographics of the federal workforce, which is significantly older than the private-sector workforce and is rapidly aging. Health care costs of older workers are, of course, significantly higher than those of younger workers. Related to the aging of the workforce is the disproportionately large number of FEHBP policy holders, roughly 40 percent, who are retirees. In sharp contrast, many private-sector companies have ceased or limited coverage for their retirees.
A second reason for recent cost increases is the recent tendency of OPM to break with what the CRS has described as its "passive" management of the program and adopt an active, aggressive, and regulatory approach to program management. Between 1990 and 2001, the executive branch, either independently or sometimes at the urging of Congress, made 44 specific decisions relating to health benefits. If understood as ancillary to the basic statutory benefit requirements established under Chapter 89 of Title V, these additions would have the equivalent economic impact of health benefit mandates that are a prominent feature of state health insurance laws. While any one of these benefit additions, taken alone, can be justified as fulfilling some particular desire or need, and while the degree of the impact of these benefit decisions on cost is a matter of some dispute, there is no debate that they add to premium costs. Whatever the merits of any particular intervention, mandates impose higher costs; the more mandates, the higher the costs.
WHY FEHBP PREMIUMS HAVE BEEN RISING
In recent years, FEHBP premiums have been rising at a troubling rate. Bush Administration officials and Members of Congress, however, should maintain perspective on recent FEHBP premium increases.
First, even with a projected 13.3 percent average increase in 2002, in the crucial area of cost control FEHBP is still likely to outperform private employment health insurance, which will surely experience double-digit premium increases next year, and even highly regarded public programs of a highly competitive character. This has been the historical experience. Indeed, the California Public Employees Retirement System (CalPERS), a program often compared to the FEHBP, announced premium increases averaging 15.5 percent in 2002; in 2001, the celebrated California program reported an increase of 12.9 percent, while FEHBP projected an increase of 10.5 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, is simply the right and ability of federal workers and their families to vote with their feet and choose lower-cost health plans through the process of the annual "Open Season," during which individuals and families change or renew their health plan selections. Based on previous experience, it is likely that actual premium increases in 2002 will in fact be less than the 13.3 percent projected by OPM. In sharp contrast, private-sector workers often have no choice at all of a health plan; they get what their employer gives them, which is usually some sort of managed care plan. And among those private-sector workers who do have a choice of plan, compared to the options routinely available to federal workers, their choice is sharply limited.
FEHBP Reflects Broader Health Care Trends
Premium increases in the FEHBP reflect the cost of benefits; and precisely because of the competitive character of the program, 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 the trends in the broader health care system that are driving costs upward, including the general aging of the American population, the increase in the demand for hospitalization, the 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.
In private, employment-based health insurance, health benefits like wages are 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 insurance to cover small, routine, or purely predictable medical services. This results in workers' huge overpayments into the health insurance system 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 tax relief that is 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 two other major reasons why FEHBP is experiencing significant cost increases.
The FEHBP insurance pool is aging more rapidly than either the private-sector workforce or the general population. Health care costs rise rapidly with age. There are 4.2 million active employees and retirees enrolled in the FEHBP. The average federal worker is roughly 46 years of age, much higher than the average for the private-sector population. Private-sector health insurance pools are considerably younger. Moreover, as of 1998, 1.85 million federal retirees also participated in the FEHBP; the average age of federal retiree participants is 71 years of age. The range of FEHBP retirees is broad because federal workers, with years and service, may retire as early as age 55; some, in certain occupations, may retire as early as 50 and get full health benefits. Even with Medicare coverage, federal retirees are more expensive than active employees. Unlike private employer-sponsored insurance where retiree coverage has been cut, drastically reduced, or discontinued, FEHBP continues to cover retirees, a growing group of policy-holders that has higher health care costs.
Complicating the problems of this pool has been the downsizing of the active federal workforce over the past few years. Since 1993, the federal workforce has shrunk by 324,580, disproportionately among full-time workers at the Department of Defense. Moreover, 71 percent of the federal government's permanent workforce will be able to take normal or early retirement by 2010, and an estimated 40 percent of these workers are expected to do so. Thus, the growing imbalance between active employees and retirees will only deepen, making retirees the fastest growing group in the FEHBP program.
OPM, sometimes with congressional authorization, has imposed a large number of benefit changes that have had the equivalent effect of benefit mandates and has also pursued a more aggressive regulatory policy. The Office of Personnel Management in recent years has largely broken with the past tradition of "passive management" of the FEHBP. That tradition emphasized give and take between the federal government and private plans in sensitive negotiations, and deference to private plans in the development of combinations of benefits and rates in meeting consumer demand.
According to OPM's own estimate, there have been 44 significant "benefit changes" between 1990 and 2001. Most of these were benefit additions, and a number were benefit restrictions. According to OPM estimates, these changes have resulted in a cost increase of $733 million, or 3.74 percent of total program costs, combined with a net savings of $507 million, resulting in a net increase in costs amounting to $225 million, or 1.15 percent of total program costs.
Some of these have been 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 restriction of the treatment to major academic medical centers. FEHBP coverage of bone marrow transplants for the treatment of breast cancer was, instead, the product of intense lobbying on Capitol Hill. The Clinton Administration ordered it to be included in the FEHBP benefit package. Subsequently, peer reviewed clinical trials of the procedure found that the transplants appeared to be no better than conventional chemotherapy in the treatment of breast cancer.
The trend toward more aggressive regulatory control over the program has spawned special-interest lobbying for additional benefit mandates. For example, at a September 1996 hearing before this Subcommittee, witnesses advocated the annual inclusion of audiological services, acupuncture, pastoral counseling services, and even medical foods as necessary benefits to be included in plans participating in the FEHBP. This type of aggressive lobbying serves, of course, to undermine the most basic feature of the program: the provision of benefits that patients actually want. Instead, patients increasingly are forced to pay for benefits that they do not want. While patient choice has been a distinguishing feature of the FEHBP, OPM policy has driven the program in a very different direction; it has been a process of gradually standardizing health plan policies, depriving individuals and families of the more customized options available to them in the 1980s. The difference in actuarial value of the packages offered in the FEHBP has likewise progressively narrowed.
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 impact over time. While any one benefit may be a minimal cost in its first year, increased utilization over subsequent years drives up overall costs. Moreover, as OPM has imposed an increasingly standardized benefit package on the program, there has been less opportunity for plans to offer different combinations of premiums and benefit options. In effect, this means that plan officials have had less room to initiate cost-saving innovations in the market that might be more attractive to federal employees and their families.
Furthermore, while OPM has used its authority to pre-empt state mandated benefits in plans offered on a nationwide basis, it has refused to do so among state-based HMOs, reducing the competitive position of these plans and forcing federal employees and their families in these states to pay higher premiums than they otherwise would have paid because of the additional cost of mandated benefits. These costs can be rather substantial in several states, like California and Maryland.
While OPM staff, as noted previously, have indicated that these "benefit changes" have had a positive effect on savings and little overall effect on the real growth of premiums, the Bush Administration and Congress should nonetheless take a good, close second look and pursue an independent economic analysis of the impact of these benefit changes over time. It is remarkable that independent, particularly private-sector, analyses of benefit mandates or regulation on health insurance show a significantly 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 claims costs in Virginia, which had 29 benefit and managed care mandates, and 22 percent in Maryland, which had 36 mandates. Last year, Governor Howard Dean of the State of Vermont cited the negative impact of Vermont's benefit mandates on health insurance costs, saying that they contributed to about 25 percent of 1999 health insurance premiums, and asked the legislature to stop enacting them. Private economic analyses of the relationship between health benefit mandates and premium costs show similar results. Do trust OPM, but please verify.
On a related matter, Congress and the Bush Administration should more closely re-examine the recent historical relationship between OPM and the private health care plans that participate in the program. For whatever reason, there has been an alarming exodus. In the mid-1990s, there were almost 400 health plans competing in the program. For the calendar year 2001, OPM announced that only 245 plans were expected to participate. Between 1998 and 1999 alone, the FEHBP lost 65 plans, a stunning 20 percent of plans participating in the program. For 2002, OPM has announced there will be only 180 plans in the program. When firms participating in a government program do not behave the way government officials expect the firms to behave, one must not automatically assume it is the fault of the firms. With the large number of dropouts, the FEHBP has become less internally competitive, substantially reducing enrollee choice and contributing to higher premiums.
A NEW POLICY FOR THE FEHBP
Inasmuch as most of the problems of the FEHBP, particularly in terms of cost and efficiency, are traceable to government policy, it logically follows that most of those problems can be resolved by government policy. In that respect, there is much that the Bush Administration and Members of Congress can do to improve the program. I offer the following proposals for your consideration.
- Seek an independent evaluation of the economic impact of "benefit changes" over the last decade, as well as regulatory initiatives, and make sure that OPM uses its legal authority to pre-empt state mandated benefits. The Bush Administration should not hesitate to rely on its statutory authority to negotiate benefits for federal workers and retirees and protect them from paying unnecessarily high premiums out of deference to state legislative mandates. Moreover, the Bush Administration should review the current regulatory regime in the FEHBP, including the addition of benefits beyond the core statutory requirements of Chapter 89, Title V, and seek an independent, preferably private-sector, evaluation of the economic impact of these OPM initiatives and specify their consequences on claims costs or premiums. Premiums reflect costs, and if premiums are to be restrained, costs must be restrained.
Meanwhile, the Bush Administration should return, to the extent practicable, to the older tradition of collegial private-public-sector negotiation to control costs and improve benefit offerings. For example, plans could be required to offer all of the current benefit packages, as reflected in the changes over the past 10 years or so, as a high-option plan. But they should also offer a variant of their core offerings, a low-option plan, without such "benefit additions" or mandates and allow consumers themselves to decide whether they want to pay the higher premiums to purchase such previously required benefits. This approach is perfectly compatible with the spirit of the program and fulfills its original intent of broadening consumer choice. Consumer choice and competition should be reinforced, not progressively weakened, if the FEHBP is going to remain a strong model for broader health care reform.
Ease the admission of new fee-for-service plans. Current law does not allow the OPM to admit any new fee-for-service plans into the FEHBP. New plans admitted by OPM must be health maintenance organizations (HMOs). Normal market efficiency is served when suppliers of services can freely enter and exit the market, responding quickly and efficiently to changes in consumer demand. This legal restriction is pointless and simply undermines both market competition and consumer choice.
Create a tax-free savings option for employees for the payment of routine medical expenses.Over 80 percent of large employers and a significant number of small and mid-size companies offer their employees benefits through pre-tax cafeteria-style plans. Among the most popular of these is the flexible spending account (FSA), the so-called Section 125 plans, that are routinely available to millions of workers in the private sector. An employee may pay for unreimbursed medical expenses from the FSA. Millions of workers in the private sector have access to flexible spending accounts, but federal employees today are not allowed to set aside tax-free income in FSAs for current or future health care expenses. Federal employees should be allowed this benefit, and its value should be increased by allowing federal workers to roll over unused funds tax free from year to year. At the end of their working career, they should be allowed to fold these funds into the federal Thrift Savings Plan (TSP) or use the funds built up in these accounts for health care expenses for their retirement.
A variation of this idea is allowing employees to use medical savings accounts (MSAs). Private health insurance plans competing in the FEHBP should be allowed to offer personal, tax-free MSAs to those workers who wish to have them. Likewise, under the tax changes, federal workers could roll over the funds from these accounts from year to year tax free and eventually use them to pay for health expenses in retirement, or offset long-term care costs, or fold them into their TSP accounts.
- Address lingering problems of risk segmentation and adverse selection. A persistent irritant in the FEHBP has been a tendency toward risk segmentation or adverse selection. While this problem has not been as acute in recent years as in the past, and competing plans have found ways to adjust, it is still a lingering problem in the program. OPM has never proposed, and Congress has never enacted, legislation to reduce or enable OPM to reduce adverse selection in the program.
Any time one has a choice of plans, even if there are only two plans from which to choose, one will have adverse selection. In the FEHBP, the problem is aggravated by both the underwriting rules and the formula governing the government contribution. Under current law, active workers and retired workers pay the same premiums for health insurance despite dramatic differences in risk and health care costs. FEHBP plans cannot 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. 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.
Obviously, a large infusion of younger workers or enrollees would alleviate the problem. Obviously, also, if plans could charge older workers or retirees premiums that reflected their actuarial cost, not only would one have a more rational insurance market, but the decision of older workers or retirees to pick a particular health 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 age groups different premiums, reflecting their real actuarial value in the market, and simultaneously adjust the government contribution to the plan premiums of higher-cost enrollees. Since age is the most significant risk factor, the government could adjust government contributions for a limited number of categories of enrollees: active workers, early retirees, retirees with Medicare, and the progressively smaller number of retirees without Medicare. Each of these groups can be protected from adverse cost effects by varying the government contribution. Since there is no risk adjustment mechanism at all in the FEHBP today, this would be a substantial improvement in the program.
- Remove the 75 percent cap on the government contribution to the FEHBP plan chosen and allow federal workers to pocket any difference between that contribution and the actual cost of the plan as a rebate. 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 purchased a plan that offered an annual premium of $4,000 would get a rebate of $580.
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 to 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 directly pocket any savings. Federal workers and retirees who choose more expensive plans with richer benefits packages would still pay more in premiums and out-of-pocket costs.
The major difference between federal and private-sector employees is that federal employees continue to have far more choices at competitive prices in a unique consumer-driven market. And with the removal of the 75 percent cap and allowance of a rebate of savings, the Bush Administration and Congress could make the already competitive private health insurance market in the FEHBP even more competitive.
- Create a younger, healthier insurance pool and open up the FEHBP to young military families. 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 all federal employees, retirees, and their families. Representatives of military families have testified that they want to be enrolled in the FEHBP.
These families have realized that under the FEHBP they would be given a much wider range of personal choice and a far superior medical system than they currently receive in the military health care system.
Because health care benefits, like wages, are normally counted as compensation, Congress could enroll military families in the FEHBP in a budget-neutral fashion and pass on any savings to these families in the form of rebates or pay increases. In any case, the movement of young military families into the FEHBP would be good not only for the military families, but also for the FEHBP itself. As noted previously, the average age of members of the federal workforce has increased in recent years, and is likely to continue to increase, while the number of workers eligible for retirement is expected to soar. The infusion of a large number of young military dependents would be the quickest and perhaps easiest way to provide them with access to a clearly superior health care system, improve the actuarial profile of FEHBP's subscriber pool, and stabilize future insurance premiums.
These policy proposals are not meant to be exhaustive, but they are compatible with the principles of consumer choice and market competition that are at the heart of the FEHBP's long record of success. I would be happy to answer any questions the Subcommittee might have.
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