Health plans go 401(k) way

Over the next decade, we are likely to see a shift in health insurance in the United States: So-called defined-contribution plans will gradually take over the market, shifting the risk of incurring high health-care costs from employers to workers.

The market today is dominated by "defined-benefit" plans, under which companies determine a set of benefits that are provided for employees. These will gradually be replaced by defined-contribution plans, under which companies pay a fixed amount and employees use the money to pay for insurance they choose themselves.

The fundamental driver of this shift is an effort by businesses to reduce their exposure to health-care costs. But the recent health-care reform law may accelerate the shift.

The defined-contribution concept is already familiar to most American workers. Over the past two decades, company retirement programs have moved decisively away from defined-benefit plans, in which workers are paid a given amount of retirement income, and toward defined- contribution, 401(k) plans, in which risks - from fluctuating markets, for example - are borne by workers.

In 1985, 89 Fortune 100 companies offered new hires a traditional defined-benefit pension plan. Today, only 13 do.

The movement toward defined-contribution health plans is in some ways similar, as Kenneth L. Sperling and Oren M. Shapira explained in an article earlier this year. The pension shift occurred in stages: First, the traditional defined-benefit plan was redesigned. Then a hybrid approach (the cash-balance plan) was introduced. Finally, defined-benefit plans were frozen.

The change in health insurance is already well under way for retirees. In the early 1990s, companies began to reevaluate retiree health plans, and some capped the amount they were willing to pay. That effectively created defined-contribution retiree health plans, with the company's contribution set by the cap. Exchanges have been created to allow retirees to use these employer contributions to buy their own insurance.

High deductibles

For current workers, the precursor to defined contribution is the "consumer-driven" health plan. This typically has higher deductibles and co-payments than a traditional plan, and it is often tied to a health savings account. It typically still provides generous insurance for catastrophic cases.

The share of workers enrolled in such plans remains low but is expanding rapidly. A recent survey of large companies found that almost three-quarters will offer consumer-driven health plans next year.

The natural next step will be for employers to strictly limit their contributions to a set amount that workers could use to buy insurance. Companies will thus eliminate their exposure to unexpectedly high care costs.

Some insurers are already anticipating the shift. Bloom Health of Minneapolis will begin offering defined-contribution exchanges in 2012.

Reform's effect

The transition to defined-contribution health insurance may get a little push from the new health-care law. Indeed, the legislation may have a greater impact on the type of health plan employers offer than on whether they drop health benefits altogether.

A misleading survey by McKinsey & Co. suggested a potential for huge declines in employer-based insurance. But the Congressional Budget Office and other respected researchers generally point to only a modest net decrease. And the experience to date with similar reforms in Massachusetts is consistent with this.

If most employers retain their health plans, the insurance exchanges created under the federal law will make the idea of defined contribution more prevalent and may speed its adoption. The regulations that carry out the new law will determine how things play out. If defined-contribution plans that are sufficiently generous count as employer-based coverage - as is generally expected - the trend toward such plans will probably accelerate.

Whether this turns out to be a good thing will depend on whether the defined-contribution model helps to constrain overall costs. There's little point (and much potential harm) in having individuals take on the responsibility of paying for health care if there is no change in the cost.

Although consumer-driven plans could help, they are unlikely to be a crucial step in reducing health spending over the long term. The evidence to date, with a few exceptions, suggests that such plans reduce costs only modestly. After all, the majority of costs come from the expensive cases that are still generously insured by consumer-driven plans.

Full-blown defined-contribution plans could generate better results, though it will still be crucial to get doctors and other providers to deliver more efficient care, especially for high-cost cases.

In any case, the bottom line is that a shift seems likely. I'd be willing to bet that most large U.S. employers' health-care offerings will be defined-contribution plans by 2020.