How Your Health Insurance Will Be Turned On Its Head
By Todd Hixon
In the next decade most health insurance will change from a defined-benefit — you know what services you will receive — to a defined-contribution — you know how much money your employer will pay towards the cost of your healthcare. This very profound change has already swept through retirement benefits, the other main category of employment benefit.
Percent of Fortune 500 Companies Offering Each Type Of Retirement Benefit To New Salaried Employees. Data via Workforce.com
The chart shows how this change quietly turned corporate retirement benefits on its head in three decades. Why? Partly, the change was driven by economics. Traditional defined-benefit pension plans provide a payment determined by a formula, e.g., 80% of final pay. In the last 30 years life expectancy has extended, and episodes of inflation have pushed salaries up faster than employers expected, causing the costs of traditional pensions to outstrip expectations and pension reserves. Also, cost accounting and funding rules for pensions got tougher for private employers, and as a result market fluctuations in the value of pension reserves had significant impact on earnings and cash flows, depressing stock prices.
The change also had a strong basis in workforce demographics. Defined benefit plans were designed for lifetime employees; those who left in mid-career typically lost substantial value relative to lifers. Today’s workers expect to have several to many employers during their careers. The government created a variety of portable individual retirement vehicles (IRAs, etc.) to address this need. Many employers also saw a need to respond to these changes. Employees seldom understood how much their retirement benefit cost, so employers saw they could get more bang for fewer dollars by paying the money transparently into a 401(k) or similar account. And, defined contribution plans gave employees more control: they could choose to have dollars contributed to the plan or paid to them, according to their needs, e.g. to invest in a house or education versus the stock market.
Similar financial and non-financial dynamics are now pushing health benefits to defined-contribution. Healthcare costs have about tripled in real dollars over the last 30 years. What was once a cheap benefit is now a major element of employee cost, and employers are working hard to control the growth of healthcare benefit costs and make them more predictable. Employees typically don’t appreciate how much their health benefit costs. Mobile employees and transient employment make portable health benefits essential: the contract needs to be between the employee and the health benefit provider. Third party payment for health benefits turns out to be a major cause of excessive costs. And the government, via the ACA*, has now created portable, individual access to health insurance, much as it created portable pensions. Déja vu all over again.
Plus, the ACA offers major subsidies to people in the bottom half of the income distribution if they do not receive health insurance from their employer. The employer pays a tax of $2,000-$3,000, but this is a fraction of the value of the subsidy for a lower income family, and a small fraction of the $12,000+ it costs the employer to provide family insurance. So, the rational course for many employers will be to discontinue health benefits and, instead, offer employees a contribution to their health care costs. McKinsey estimates that 30% of employers will do so**.
Those of us in the private sector are heading for a world where we get a defined health stipend, and we can use it to buy benefits from the employer’s plan, the private market, or the state exchange, or we keep the money, if we are fortunate enough to have a spouse with good benefits (or foolish enough to go without). This exposes us directly to high stakes cost/benefit decisions and health care inflation.
Much good will come of this. The awkward link between a job and access to health care is broken. Patients gain more control of a large part of their employment income, and they become consumers and start scrutinizing how their money is spent. Entrepreneurs are already bringing forth new ways to provide medical products and services that are more efficient, and often more effective and convenient. Medical providers will feel some market discipline, at long last. Perhaps voters will get tough on politicians who reward government employees and themselves with “cadillac” health plans of which citizens can only dream.
But this will not be fun. We are accustomed to health care as entitlement, paid for and managed by someone else. It’s a complex subject, and we need to “get smart” on it. Like it or not, this is the medicine we have to take.
*The Patient Protection and Affordable Care Act of 2010, commonly called the “ACA” or “ObamaCare”.
**”How US Health Care Reform Will Affect Employee Benefits”, McKinsey Quarterly, June 2011.
This post first appeared at blogs.forbes.com/toddhixon on May 3, 2013.