This report was produced by the Advisory Council on Employee Welfare and Pension Benefit Plans, which was created by ERISA to provide advice to the Secretary of Labor.  The contents of this report do not necessarily represent the position of the Department of Labor.

November 7, 2003


The ERISA Advisory Council, in a report dated November 14, 2001, studied the challenges to the U.S. employment-based health care system. One of the fundamental conclusions of the Council at that time was, that if designing a health care system, starting with a blank slate and learning from the problems of the current system, a new system would be very different from today's model. However, the report pointed out that designing a new system would not be feasible from both a practical and political perspective, and that the approach of the Council should be to consider how to improve the current system and move forward.

The defined contribution health and welfare plan model was one of the alternative concepts reviewed by the working group in that November 14, 2001 report.

The term “defined contribution (DC) health plan ”,(1) in general, denotes a health plan in which the employer provides the participant a contribution of a fixed dollar amount, as opposed to a fixed benefit. In such a plan, any health care costs above the fixed dollar amount are the responsibility of the participant.

DC plans can take many forms, from a plan in which the employer provides more dollars in the employee’s pay check that the employee can use to purchase health coverage on the open market, to a plan in which the employer provides a fixed dollar amount that can be spent by the employee on one of a variety of health plans selected and maintained by the employer. The role of the employer varies considerably in each of these designs, ranging from merely a variant of current employment-based plans to approaches in a completely different conceptual territory.

The term defined benefit employment-based health plan, in general, denotes a health plan in which the employer provides a determinable benefit which may be in the form of a reimbursement to the covered plan participant or a direct payment to providers or third-party insurers for the cost of specified services. This benefit can be self-insured (employees’ medical expenses are paid for by the employer), fully insured (benefits are paid through the direct payment of premiums to the insurance company by the employer) or a combination thereof.(2)

In the November 2001 report, the Council concluded that defined contribution plans that eliminate the employer as intermediary would likely not be as effective and cannot provide the same advantages (pooling, corporate purchasing power, etc.) as a defined benefit employment-based plan.

Since 2001, as costs for health insurance products as well as medical costs have continued to escalate, defined contribution health and welfare plans have become increasingly popular as an alternative form of health and welfare benefits offered by employers. In particular, consumer-directed health plans, a hybrid type of defined contribution health and welfare plan virtually unknown until a few years ago, are gaining acceptance as an interesting alternative health care product offered to employees. These consumer-directed health plans vary widely, but, generally, the plans attempt to engage the participants more directly in the health care purchasing decisions by making them aware of the costs and providing them increased power to make decisions about their health care.

In a consumer-directed plan, participants have more financial responsibility for the health care choices they make and are more involved in the selection of services and providers. Consumer-directed health plans attempt to shift greater responsibility for the cost and quality of services to the participant and away from the plan sponsor. A typical consumer-directed plan design has a health care spending account that the employer provides to the participant, and a high-deductible health policy (see page 8 for alternatives in structuring consumer-directed health care arrangements).

The usage of consumer-directed health plans is on the rise, rapidly gaining acceptance by employers and employees. Since these plans have only been in existence for a few years, the Working Group felt it is too early to provide valid comparative statistics on the potential for these plans to impact health care costs and usage. Given their growing popularity but relatively short time in existence, the working group determined that it would be beneficial to provide the general public with useful information on the workings of these plans as well as some points to consider before adoption of or enrollment in such a plan. This report provides general information on consumer-directed health plans as well as insight and “lessons learned” from companies and service providers who already have implemented these types of plans.

Consumer-Directed Health Care Arrangements

The consumer-directed health care arrangement (CDHC) is an alternative health care product that has come about solely as a response to rapidly rising health care costs. According to an annual study by the Kaiser Family Foundation and the Health Research Educational Trust, employers increasingly passed along higher health care costs to employees in 2003 - a year that marked the largest rise in health insurance premiums since 1990 and the third consecutive year of double-digit premium hikes. Rapidly increasing premiums have generated speculation that employers may move to new types of health insurance arrangements in order to help control future costs. While it is argued that the CDHC may not be the “silver bullet” to drastically reduce health care costs, some employers and health care providers believe it may be one alternative to help control costs.

The idea behind the CDHC is that, if consumers are held financially responsible for the health care choices they make, they will increase their awareness of health care costs, and they will make cost savvy-choices for health care, thereby reducing the costs for the employee and, ultimately, the employer. This idea is also known as “health care consumerism”. Consumerism is a movement to raise the employee’s awareness of cost and quality, to eliminate waste and to reduce costs for discretionary care. It promotes a more prudent use of services. For example, if consumers are provided information regarding a generic alternative for a prescription, they may choose the lower-priced generic drug that provides the same benefits as the higher-priced brand name drug.

In CDHC arrangements, incentives can be provided to employees to encourage awareness about consumption and accountability for their health care decisions. Both education and tools are provided to get consumers actively engaged. The concept behind CDHC plans is to promote greater self-reliance and use of self-service tools. CDHC plans attempt to encourage a healthier lifestyle and provide cost-saving benefits with the ability to accumulate savings for future health care needs. By providing the proper incentives, information, skills and tools, it is hoped that consumers will make informed decisions.

A popular argument promoting CDHC arrangements is that participants actually want to have greater purchasing power regarding their health care and will welcome greater decision-making ability in the health care benefits offered by the plan sponsor. A key factor in empowering participants with greater decision-making ability is that participants will be given the proper level of healthcare information from which to base their decisions. They will need health care information from which to base their initial decisions upon enrollment regarding personal spending account levels and deductibles. They will also need health care information to make decisions regarding their ongoing day-to-day decisions for health care.

Since the Internal Revenue Service ruled in favor of health reimbursement accounts - the funding mechanism for CDHC arrangements - the number of companies offering these products has greatly increased. According to an analysis from Forrester Research, Inc., consumer-directed health plans currently make up less than 1 percent of the market. Bradford J. Holmes, lead author of the analysis, told BNA August 18 he estimates that 500,000 people currently are enrolled in CDHC products. The analysis projects that the number of enrollees will jump to 43 million and will account for 24 percent of the health insurance marketplace by 2010. According to Mercer Human Resource Consulting, 30 percent of large employers say they are likely to offer CDHC plans in the next two years. Several witness testified that while large employers are starting to test the waters, small employers are holding back with a wait-and-see attitude.

Description of CDHC

Many forms of consumer-directed plans exist, and they are usually offered as part of a group benefit plan. Typically included is a health reimbursement arrangement (explained below), a high deductible plan design, web-based tools for employee research on health issues and providers, and other support features such as health care coaches and disease management programs. CDHC arrangements focus on behavior modification toward healthy lifestyles, preventive care and more personal injury or disease monitoring, education and general participation.

In June 2002, the Internal Revenue Service formally recognized Health Reimbursement Arrangements (HRAs). An HRA is an arrangement that (1) is financed or paid for solely by the employer, (2) is not provided pursuant to an employee salary reduction election or under a cafeteria plan and (3) reimburses generally only Code Section 213(d)(1)(A) medical expenses (medical care includes amounts paid for diagnosis, cure, mitigation, treatment or prevention of disease, or for the purpose of affecting any structure or function of the body). The HRA is typically offered in conjunction with a high deductible insurance product.

The consumer-directed arrangement is a hybrid defined contribution/defined benefit health and welfare plan because it incorporates elements of both; benefits being paid out of individual participant accounts as well as additional amounts at risk to be paid by the company once the HRA is used up.

Plans incorporating the use of an HRA are only one of several new approaches in the market today. For example, some employers make a fixed contribution to the employee, and the employee then chooses among an array of products, with different design features, provider networks and employee cost sharing.

A key determinant in the success of the CDHC is the ability of the participant to make informed decisions regarding initial enrollment and ongoing day-to-day health care. Consumers need to be educated regarding the terms of the plan, which can be complex depending on the design. Companies will need to have the infrastructure, or outsource to an outside service provider, to manage the education process regarding plan terms and initial enrollment decisions. In addition, the availability of useful health care data, which participants would need to make day-to-day health care decisions, is still developing and somewhat uncertain. While some insurers offer quality ratings of doctors and hospitals on their Web sites, it does not yet appear that centralized depositories of standardized health care information are available to the general public.

Alternatives in Structuring CDHC Arrangements

While there are many variations of CDHCs, the following illustrates the typical plan offerings.

Health Reimbursement Account. A key component of the CDHC is the health reimbursement account. Funded by employer contributions, these personal spending accounts are set up for each employee who draws down on the accounts to pay for their health care needs. The unused HRA may be rolled over each year. While the HRA is normally set up to cover Code Section 213 medical expenses, the definition of expenses covered can potentially be tailored to suit plan sponsor/participant needs.

Health Coverage Beyond the HRA Prior to Major Medical Coverage. When the employee's personal HRA account is depleted, the employee pays out-of-pocket medical expenses up to an annual deductible limit.

Health Coverage Post Major Medical Coverage. When the deductible is reached, a traditional major medical policy goes into effect. In addition, an annual out-of-pocket limit on employee expenses may be included.

When setting up the plan, the employer must make an assessment of the trade-offs regarding deductibles, premiums and HRA levels based on the financial needs and the desired behavior of their employees. For example, some employers are averse to the idea of first-dollar coverage in the HRA if the funds aren’t depleted in the HRA by the end of the year and may consequently choose to add a front-end deductible to the HRA.

The employee oftentimes must make trade off decisions as well regarding deductibles, premiums, and HRA levels based on their individual needs and perceived health care risk. For example, if an employee is relatively healthy with no known health care issues, he/she may choose a higher deductible and lower monthly premium.

The HRA may be offered in conjunction with a cafeteria-type medical health care flexible spending account (FSA). In such an arrangement, employee funds are directed to the FSA, while employer-only funds are directed to the HRA. The availability of both a FSA and a HRA expands the options for tax-favored funding of benefits and provides more flexibility to the employee.

Participant Issues

From the perspective of a participant, the structure of a CDHC plan is more complex than a traditional indemnity or PPO plan. An effective CDHC plan would rely to a great extent on participants making informed decisions. The basic assumption underlying these plans, as Joyce Dubow from the AARP described in her testimony, is that when given choices, participants will maximize and optimize their preferences and needs.

The decision-making process for a participant begins with an evaluation of the initial enrollment choice. While 35% of employees with health care coverage have only one plan offered to them by their employer, according to “An Employers Guide to Patient-Directed Healthcare Benefits”, included in the testimony of Ronald Bachman of PriceWaterhouseCoopers, the remaining 65% must evaluate enrollment options which may include traditional indemnity plans, Preferred Provider Organizations (PPO’s) and, increasingly, a CDHC option. In the process of evaluating enrollment options, participants must assess their future health care needs, and determine which option provides the best fit for their particular circumstances. The financial implications for employees are not clear-cut.

Participants should be aware that in assessing future health care needs, Dubow refers to an optimism bias, which may impact these decisions. Dubow indicates, “Substantial evidence exists that people consistently underestimate future personal risk…” As such, the Working Group believes that participants must take care to recognize the potential for an optimism bias in their decision-making process. The Working Group also recommends that employers design enrollment information in a way, which fully informs the participant of the advantages, disadvantages and potential risks of their CDHC plan. This is particularly true when the CDHC plan design is a new option for participants to consider, since most employees are likely to be unfamiliar with the concept.

There are a variety of models for CDHC arrangements. Some plan designs are structured so that pricing is determined by choices a participant makes before enrolling in the plans. In such a model, as discussed in testimony, a participant must choose providers for numerous (nineteen, as indicated in one example) different services prior to enrolling in the plan, since the plan is priced based on the choices made.

A participant in a CDHC plan, confronted with a pocketbook spending decision, must evaluate service providers, therapies and treatment options. Confronted with various options, the participant must require enough information to make good choices, and realize that in evaluating these choices, price information may be available but quality or performance information may be lacking. Several witnesses cautioned that participants may see higher cost sharing arrangements as a disincentive to seek proper care or they may be less likely to comply with a physicians recommended course of treatment, or more likely to defer regular exams.

From a participant viewpoint, the out-of-pocket element of CDHC plans, which appears to be essential to increasing participant awareness of true health care costs, may appear to be unattractive. Also, since the HRA account must be funded by the employer, the participants may also feel that the money in the account is not their own, and therefore the concept of spending it rather than saving it for future needs is less significant. Unless an employee feels “ownership” of the account, the concept of an educated health care consumer and a rationalization of health care expenses, the driving concepts behind CDHC plans, may not be effective.

CDHC arrangements do include features, which may be particularly appealing to some participants. One of the potentially attractive features of CDHC arrangements for participants is that the HRA is often structured to provide first dollar coverage when it is needed, and for care and/or treatments which the participant desires but which may be excluded from coverage under the guidelines for other types of plans. Thus, under certain CDHC arrangements, the HRA may be used for treatments such as chiropractic services, acupuncture, homeopathic therapies or other non-traditional therapies, which may not be covered under traditional plans. A recent IRS ruling also permits HRA accounts to be used for over-the-counter medicines.

A second potentially attractive feature is that under an HRA, a participant is generally permitted to rollover unused amounts for use into the following year. Although there are no legal limits on how much may be rolled over from year to year, some employers incorporate a limit in their plan design. Balances may rollover to pay for future qualified medical expenses without adverse tax consequences to employee. Participants must note, however, that these accounts are currently not “funded” accounts but are notional accounts. The disposition of the account upon termination of participation in the CDHC option would be guided by the plan design, and the participant should take note of these features before enrolling in such a plan. The status of the notional account, should the employer declare bankruptcy, may vary from plan to plan, or may be addressed by bankruptcy courts.

Notwithstanding the cautions listed above, the rollover of unused HRA balances may be an attractive feature for many CDHC participants. Depending on plan design, the funds may be used for medical expenses after the participant has changed jobs, retired or become unemployed. Distributions for qualified medical expenses are not counted as taxable income to the participant, even if the distribution is from a former employer.

Several witnesses alluded to the notion that rolling-over HRA balances could provide a funding mechanism for post-retirement health care, which, in the opinion of the Working Group, would be a good thing. The HRA is an unfunded notional account to which employee contributions cannot be made under current tax law. Therefore, as discussed earlier, participants may view the funds as the employer’s funds and not as their own funds, and may be more likely to spend the amounts rather than conserve funds to roll over for future expenses. The Working Group believes that permitting an employee pre-tax contribution to the HRA might increase their attractiveness and provide more options for participants; however, this raises a number of tax issues that are beyond the Departments purview.

We note that the Federal Employees Program is now offering a CDHC option with an HRA, and that a maximum amount of $4,000 is permitted in the HRA. One shortcoming of the Federal Program is that participants may have an incentive to spend funds unwisely perhaps on unnecessary goods or services, rather than lose the funds. The Working Group believes that plan designs should avoid encouraging over-utilization of health care resources through unnecessary use-it-or lose-it provisions.

Additional potential issues and risks for participants were identified in testimony as follows:

  • Dissatisfaction for those participants with chronic conditions;
  • Cost shifting to the less healthy employees
  • Participants may have out-of-pocket expenses that are difficult to budget for once HRA funds are exhausted;
  • Participants may not want the increased consumer role with decision-making responsibility;
  • Participants may skip necessary and/or preventive care in order to save money if preventive care is paid through the HRA;
  • Participants may not have adequate sources from which to draw information.
  • Participants may not be able to use the available information due to inability to process information, illiteracy or language barriers.

The Education Component of CDHC Arrangements

An education component is a critical element of CDHC arrangements. At their core, CDHC arrangements attempt to rationalize health care expenses by shifting to the participants some part of the costs through a cost-sharing arrangement. Critics of current health care arrangements point out that if a doctor visit costs a participant $10 through a co-payment, then the perception for the participant is that the visit only cost $10, when in reality the cost was many times the out-of-pocket cost to the participant. The goal of CDHC arrangements is to educate participants to the true cost of health care, and encourage a rational selection of services and providers through the use of information regarding costs, efficacy and quality. All of the witnesses agreed that, at this point, there still needs to be significant improvement in both the quality and quantity of information.

CDHC arrangements are presented to participants and their families as offering more choice in the health care marketplace. Testimony indicates that, from the employer perspective, the lynchpin for the successful implementation and operation of CDHC health plans is the widespread availability of accurate, relevant and understandable consumer information regarding those choices (e.g., the quality and competence of hospitals and providers). Until those sources of information are developed and have a track record of success, employers, who have an interest in healthy employees, may be reluctant to expose their employees to the consequences of ill-informed choices.

While participant education is critical to the approach to health care, employers may not be willing to undertake costly communication efforts unless they are satisfied that the tools to make those efforts successful are reliable. In efficient markets, educated consumers can be influential in shaping the market. Currently, however, an efficient marketplace does not exist in the health care industry, so the extent to which markets will become more responsive to consumer concerns is uncertain.

Joyce Dubow indicates in her testimony that research shows that consumers, who are engaged in their care, are part of the decision-making process and help to determine the goals of their own care, have better health outcomes. The success of the consumer-directed approach rests on the basic assumption that if consumers are given financial incentives, choices, and information to support their decisions, they will take charge of their health care and make prudent choices. Being in charge implies more than just having the right information. It means understanding and accepting a higher level of responsibility and possessing the knowledge, skills, and confidence to take this on. Dubow indicates that there is no question that the health care system would be more appropriately used and individuals better off if they were more activated. The key question is, what will it take to activate more consumers, and what will happen to those who do not become activated?

The difficulty of the decision tasks required of consumers and the skills needed to manage within these plans may be beyond the level of effort many consumers are willing to expend, and may be beyond the ability of others. If this is the case, many consumers may not make the types of informed choices that are necessary to achieve either individual or policy goals. The amount of effort, skill and knowledge needed to make choices could discourage voluntary enrollment in these plans by those with low decision and literacy skills, possibly leading to an important source of selection bias.

Making an initial enrollment choice when offered a variety of health care arrangements involves making trade-offs concerning deductibles, premiums, and personal spending accounts. Does the individual want more discretionary dollars for spending on a broad range of health care and health products, a lower monthly premium cost, or a lower level of financial risk? If a consumer does not anticipate needing much care, then having a higher deductible and a lower monthly premium might be a sensible choice.

These trade-offs require judgments about the likelihood and extent of care needed in the coming year. Research suggests that individuals consistently underestimate personal risk. This is particularly likely when hazards are perceived as low in probability, when individuals have little personal experience with the risk, or when the risk is judged to be controllable by personal action. This optimism bias in risk judgments, as discussed in the Dubow testimony, is robust and widespread. Thus, there is likely to be a strong tendency for those who are in good health to assume the best and make choices that may not turn out to support their best financial or health interests. Those who use health care services often may be better able to fine-tune their needs as a result of their experiences.

There are also day-to-day decisions about which enrollees need to make educated decisions that have financial and health consequences. These include decisions about:

  • When to seek care,
  • Selecting providers,
  • Spending the personal spending account versus saving funds for a future serious illness, and
  • Seeking care once the account is exhausted.

Randy Johnson of Motorola, representing the ERISA Industry Committee, discussed a promising venture related to efforts to bring useful information to health care consumers. The effort is the “Consumer Purchaser Disclosure Project”. The project is funded by the Robert Woods Johnson Foundation, and involves both purchasers, purchaser coalitions and consumer groups, including the AFL-CIO and AARP. The goal of the project is that, by 2007, consumers will be able to select their hospital, physicians, physician groups or integrated delivery system and treatment programs based on publicly-reported, nationally standardized measures of quality and consumer experience, equity and efficiency. As described by Mr. Johnson, national standards are essential as is commonality across markets, so that there can be credibility for those standards. Randy Johnson testified that he estimated consumer directed health care designs could potentially result in a 50% increase in quality health care and a 40% decrease in health care costs.

Employer Issues

For the third consecutive year, health care costs for employers are rising at double-digit rates. In the words of witness Ron Bachman, “health care costs represent the greatest cost pressure facing corporate America today”, adding that not only is it one of the highest costs, but it is the least appreciated benefit provided to employees. Employers who have attempted to control costs by negotiating with vendors, improving administrative efficiency and shifting costs to employees are looking at CDHC arrangements as an alternative to traditional plans. Employers appear willing to try alternatives such as CDHC arrangements in an attempt to control costs, rationalize health care benefits and develop an appreciation for the benefit dollars they are spending.

Employer-provided plans cover approximately 67% of the population. As indicated by several witnesses, employers have a vested interest in healthy employees. For employers, health care issues impact productivity, absenteeism, disability, worker’s compensation and other issues. Under the current system, employers face not only the challenge presented by the rising cost of health care benefits, but also a complex administrative burden with health care programs, and a perceived need to offer employees more choice.

Offering additional and innovative health care choices may increase an employer’s administrative burden; therefore it is important that each employer carefully consider the type of plan design to offer. As discussed earlier, CDHC plans vary widely. Some of the issues an employer should consider to determine the type of CDHC arrangement, which would be appropriate for their particular situation, include:

  • The number of employees,
  • The profile of covered workforce,
  • The Company’s philosophy regarding benefits, overall business objectives, and Options available in the Company’s particular geographic area.

Small employers who do not currently offer healthcare benefits may find that CDHC plan arrangements offer a viable option.

In offering a CDHC plan, employers must also develop a strategy for effectively communicating the potential risks and benefits for participants in CDHC arrangements, develop a strategy for ongoing employee education and address transition issues. The employer has fiduciary responsibility to provide accurate and complete information to participants. Providing accurate and complete information allows the participants, to make an informed choice when the plan is offered and may avert problems down the road. Participants will have to make decisions that they have not made before, requiring the employer to address and manage increased employee information needs.

Employers must be aware of the possibility that those participants who will opt for the CDHC plan will be those without chronic health care needs, the healthiest employees. This concept is known as adverse selection. If an employer offers several health care options, it is possible that the healthiest employees will choose the option that allows them to accrue funds for future use in an account. As a result, those employees with the greatest health care costs, for whom a CDHC arrangement would not make sense, would likely stay in traditional plans, potentially causing higher premiums for those options.

Employers must also be aware of the COBRA issues with CDHC plans, especially the treatment of the HRA. The disposition of the assets upon termination of employment also must be addressed, as does treatment of the account in divorce cases. Arrangements that distribute unused HRA amounts at termination as a death benefit or as a severance payment will not qualify as an HRA. All benefits received under the HRA are taxable if any person has the right to receive cash or any other taxable or non-taxable benefit under the HRA.

Employers need to be aware that offering CDHC plans creates additional fiduciary responsibilities which may be more difficult to satisfy given the information and educational issues involved in these plans. The law is not yet fully developed in this area, which creates uncertainty.

In addition, there could be possible accounting issues for employers relating to whether or not a liability should be recorded for notional account balances due employees, possibly creating further uncertainty.

Public Policy Issues

The development of Consumer-Directed Health Care plans has the potential to impact the overall health care system. While CDHC arrangements may not ultimately be the “silver bullet” that some may hope they are as a vehicle for controlling health care costs, they do, as Phyllis Borzi, Of Counsel, O’Donoghue & O’Donoghue and Research Professor of Health Policy, School of Public Health and Health Services, The George Washington University Medical Center, indicates in her testimony, have a potential to rearrange the incentives somewhat in the health care system. Employees eventually pay the cost for health care, either directly through higher premiums and cost sharing, or through lower wages offsetting higher premiums. There is, therefore, an incentive for employees to lower true health care costs, and rationalize health care spending. Engaging the consumer in health care decisions through more choice and providing more information should lead to better decision-making by participants.

A number of witnesses testified as to the concentration of costs in the current health care system within those who are either chronically ill or suffer a catastrophic illness. According to a recent study, in any given year, 15% of the participants generate 78% of the costs. One of the concerns around CDHC arrangements is the issue of adverse selection and the potential for concentration of the chronically ill in traditional indemnity plans, which would drive up costs for those plans. As a consequence, traditional plans could experience a death spiral where, because of higher and higher premiums, such plans are no longer offered.

While traditional health care plans are based on a defined benefit model, CDHC plans are a mix of both the defined benefit model and a defined contribution model. The HRA represents the defined contribution element. The defined benefit attributes include the l indemnity coverage above the threshold level and may include other plan features such as first dollar coverage but this in not universal.

Several witnesses testified that CDHC plans, as they are generally structured, have positive attributes but expressed concern that, at the extreme, a CDHC plan could be composed entirely of an employer contribution to a health care account, with all further insurance, purchase, decision-making and spending issues decided and negotiated by the employee participant. Such an approach would rely solely on a defined contribution model, with individual ownership and selection of health insurance. Some proposals also endorse the replacement of the current employer tax exclusion for health care benefits with individual tax credits.

The Working Group believes that a move toward a complete defined contribution model for health care, including individual ownership and selection of health insurance, would be counterproductive. The Working Group shares the concern that such a model could increase overall health care costs substantially, as employers are typically more capable and proficient at screening options, negotiating discounts and administering plans than would be a typical individual participant on their own.

The advent of CDHC plans raises a number of other public policy considerations. The unfunded nature of the accounts presents challenges in determining policy toward portability of notional account balances as well as the treatment of notional account balances in bankruptcy cases. Potential accounting issues are raised to the extent that financial statements accurately present a liability for notional accounts while healthcare expenses are expensed when incurred (as opposed to when the notional account is created). An additional issue for both employers and participants is that under current law employers are able to cancel accumulated health care account balances.

One of the main public policy issues in the health care area today is the large and increasing number of number of citizens without health insurance. Through the current employment-based system, approximately two-thirds of non-elderly Americans are covered for medical expenses by an employer-provided plan. According to a recent study by the “U.S. Census Bureau, more than approximately 43 million Americans lacked health insurance in 2002. Most of the uninsured are employed. 78% of the uninsured are full-time employees, and 84% are in families headed by someone who is employed.

It is unclear whether an increasing trend toward CDHC arrangements would have an impact on the uninsured. To the extent that such plans offer options and opportunities to small employers who otherwise would not offer a health care benefit, the trend could have the potential to increase healthcare availability. On the other hand, should CDHC plans gain greater acceptance and usage, the potential exists for the consequences of adverse selection to shift health care costs to the unhealthy, which, remaining in traditional plans, may cause premiums for those plans to increase and become unaffordable for the employee to purchase or the employer to maintain. In such a case, the availability of health care may decrease.


What Employees Should Consider Regarding Enrollment in a CDHC Plan

Consumer-Directed Health Care Plans are new and differ in meaningful ways from traditional health care plans. It is important that employees carefully review the plan description and information distributed by the employer, and develop an understanding of the plan.

Employees must recognize that under most CDHC arrangements, a higher level of involvement concerning their health care choices will be required. This involvement will require the employee to seek more information and become more educated regarding doctors, providers, and courses of treatment. The employee must determine if this information is readily available, understandable, reliable and objective.

If offered in conjunction with a flexible spending account, the employee must consider the implications of spending the funds in the FSA or HRA. Current IRS rules indicate that unless otherwise indicated in the plan, the HRA account must be tapped first. FSA funds can’t be rolled over.

Employees should consider consequences to the HRA coverage should they elect to move to another medical option in subsequent years. It is important for the employee to fully understand the disposition of HRA account balances upon separation, and to plan accordingly.

Participants should be aware that there appears to be an optimism bias among individuals when evaluating future risk, especially where personal behavior may impact those risks. Employees should consider the financial impact of a worst-case scenario – for example a catastrophic illness – when choosing the CDHC arrangement.

CDHC arrangements potentially provide for a broader coverage of health care expenses for some employees, through coverage for expenses, which may not be covered under a traditional plan.

If so structured, a CDHC plan can provide the means to accumulate funds in the HRA through the rollover of unused funds from year to year. Funds may also be accumulated for post-employment/retiree health care expenses. This feature provides flexibility in budgeting and the potential to pre-fund retiree health care expenses.

What Employers Should Consider Before Offering a CDHC Plan

CDHC plans offer the opportunity for employers to engage their employees in health care decisions, provide choices, which give more flexibility to employees, and illuminate the value of health care benefit dollars. For these plans to be successful at rationalizing and perhaps controlling costs, an education component is essential.

As a new plan design, CDHC arrangements offered as an option may increase administrative burdens and expenses.

Employers must be mindful of the potential impact of adverse selection when structuring the plan. Having a strategy to manage the impact of adverse selection at the outset may avert additional problems later.

CDHC plans allow employers to discontinue their roles as arbiters of coverage and medical necessity by transferring levels of responsibility to employees and health care providers. This may lower liability risks and legal exposure in this area.

Employers must develop a strategy for managing and delivering information and resources to employees in CDHC plans, who will be making healthcare choices which were not available under other plans.

CDHC plans currently in the marketplace vary widely. An employer must evaluate their particular circumstances, those of their employees and local markets to determine which type of CDHC arrangement makes most sense in their particular situation.

In structuring a CDHC plan, employers will need to develop different, explicit contribution levels for employees with different requirements related to marital status, family status, location, etc. These subsidies exist today primarily behind the scenes, so developing a coherent approach to the issue and anticipating employee perceptions going in will avoid issues later.

The extent to which CDHC plans produce savings in medical costs is not yet clear. In some instances, the early savings being reported appear to be largely due to savings in prescription drug benefit costs. Savings coming from better use of prescription drugs benefits may be achievable through changes in traditional benefit delivery systems without the CDHC component.

The HRA contribution may represent employer expenditures to those employees who need it least; the 80% of the plan participants who comprise only 20% of the annual cost of the plan.

Employers need to be aware that offering CDHC plans creates additional fiduciary responsibilities which may be more difficult to satisfy given the information and educational issues involved in these plans. The law is not yet fully developed in this area and that creates uncertainty for employers.

There may be possible accounting issues for employers relating to whether or not a liability should be recorded for notional account balances due employees, which could create an additional uncertainly for employers.

CDHC options for group health plans are new models for providing employee health coverage. The usage of CDHC options is on the rise and rapidly gaining acceptance by employers and employees. While several witnesses have testified that CDHCs have potential to favorably impact health care costs and benefits, the Working Group believes it is too early to comment since they have only been in existence for a few years.

The Working Group recommends the following with respect to CDHC options in group health plans:

  • Employers should take care to design enrollment information, which will fully inform the participant of the advantages, disadvantages and potential risks of the CDHC plan.
  • CDHC plan designs that provide for rollovers of unused HRA balances for future medical expenses should be encouraged. This type of design also discourages excess and unnecessary health care consumption, which results from end-of year use it or lose it provisions.
  • A move to a complete defined contribution model including individual negotiation, selection and ownership of personal insurance policies would be counter productive. Employers are typically more capable and proficient at screening through options, negotiating discounts and administering health care plans.
  • Employers who offer CDHCs face additional fiduciary issues relating to providing information and educational materials to plan participants. The Department should thoroughly review and issue formal guidance on the fiduciary responsibilities facing employers who offer a CDHC option.

The Working Group also believes that CDHC plans could have a positive impact on health care benefits by providing the possibility for smaller companies to provide coverage through CDHC plans, whereas otherwise they would have chosen not to provide health care benefits (or chosen to reduce previous levels of benefits.

Summary of Testimony Received

Summary of Testimony of Ronald E. Bachman

Mr. Bachman testified that the rapid rising costs of health care over the past several years has really pushed the health care cost issue up to the CEO level at companies to find a solution. It is not longer just a “VP of HR” issue. The healthcare costs represent the greatest cost pressure facing Corporate America today. It is also the least appreciated benefit. CEOs are looking for answers on how to manage costs as well as provide employees with greater appreciation of the benefit.

Consumerism and aspects of the consumer approach are taking hold in the marketplace. This is also known as consumer-driven. Patients have lost control and are frustrated. They don’t understand health care because there is not much transparency in the system and managed care is not controlling costs. Consumerism means involving planned participants in health and healthcare decisions. It includes information and decision support tools combined with financial rewards, incentives and other benefits that encourage personal involvement in altering health and healthcare purchasing behaviors. The idea behind consumerism is to change behavior to reduce costs. Studies show that individuals are more interested, more prepared and more capable of getting involved in areas like healthcare than anyone gives them credit for. The biggest resistance is multi-language problems.

Consumer-driven health care has been picked up as a possible answer to frustrations in the market place on behalf of the CEO and employees. Early offerings in the consumer-driven health line have really only been in place for 1-2 years and represent offerings of mainly Definity and Lumenos. Only recently have the major carriers been introduction products. Now Aetna, United, Cigna all have major product lines in the marketplace.

Quality information on health care is developing rapidly. In the future, there will be more information on consumer quality rather than clinical quality. Most vendors are developing new systems to get quality information out there for their participants.

Bachman recommends a consumer driven health care plan that has preventive care coverage at 100% with a health care reimbursement account with some type of catastrophic coverage added. With this type of plan, you get first dollar coverage for items the participant is personally interested in. You can then tailor the plan to get the behaviors from employees that the employer is interested in.

Bachman recommends legislation to be modified to allow varying HRA amounts with different employee contributions. Also, the definition of qualified medical expenses needs to be clarified. Also, being able to get an immediate tax deduction for funding the HRA would be helpful. He also would like to see the creation of a zero balance HRA created on PPO plans as they exist today. There are a lot of other creative uses.

Summary of Testimony of Jon Gabel

Consumer-driven health care is a result of the managed care backlash and the reemergence of health care inflation. The managed care backlash has reduced the use of gatekeepers and there is not a lot of medical management.

Defined contribution refers to employer contribution formula. In pure defined contribution plans the employer cashes out of the health benefits business and offers a managed competition model of fixed absolute contributions for health insurance. Consumer driven health care refers to plan design and empowers the stakeholder to improve value. Benefit consultants drive these new models. The common elements of consumer-driven products are increasing financial risk for consumers; increase choice of providers and/or benefit design, and use of e-health insurance medical information products. There are three models; personal spending plans, personalized plans, and customized plans. The upgrade is a tiered network.

Case for consumer-driven health care:

  • New strategy needed due to political failure of managed care
  • Cost-sharing may prevent consumers from viewing cost control as taking away benefits
  • Cost-sharing reduces use of services
  • Cost-sharing does not reduce health status for healthy people
  • More choice is associated with better satisfaction
  • Internet provides tools to empower knowledge
  • Some insurer-based plans will increase pooling

Case against consumer-driven health care:

  • Cost-sharing impairs access to care for low-income populations, is a tax on sick persons, impairs health status for some chronic conditions
  • Plans less able to secure discounts
  • Could raise administrative expenses
  • Who will hold providers accountable for quality of health care
  • Breaks down risk pools
  • Need more rather than less coordination in health care especially for chronic care.

Key issues:

  • Will consumers use the web tools?
  • Will it really control costs?
  • How will it affect access to care?
  • Selection bias
  • Legal and legislative issues
  • Quality of care

Humana used its Louisville employees as test site for their HRA product. In the first year, 31% of participants had no claims costs. 18% exceeded the $500 use it or lose it spending account. 5% exceeded the deductible. Claims expense fell 30% in first year.

Most employers will see 10% to 25% migration to CDHPs if using a flat contribution strategy. Some employees will always want a traditional plan and will be willing to pay for it.

Lessons learned:

  • Low utilizers and higher income employees more likely to enroll in CDHP.
  • Lower income more willing to pay more premiums for better coverage
  • Adverse selection is a risk for traditional plans
  • Positive selection will occur in CDHPs
  • Keep risk pool together and price for adverse selections

20% of largest employers are offering high-deductible plans and most have HRAs. At best, CDHC could be competition for managed care. At worst, CDHC could transfer costs from healthy to sick people.

Summary of Testimony of Paul Fronstin

EBRI is a private, nonprofit, nonpartisan public policy research organization based in Washington, DC, which is committed to the accurate statistical analysis of economic security issues. Through its research, EBRI strives to contribute to formulating effective and responsible health and retirement policies, but does not lobby or advocate specific policy solutions.

Mr. Fronstin noted that the titles “defined contribution” and “consumer-driven” are used interchangeably to describe a wide range of approaches to designing employer-provided health care plans to give employees more incentive to control the cost of their health care and to reduce the amount and volatility of employer cost of these benefits by shifting more costs to employees. The most common new model combines a high-deductible health plan with a health reimbursement arrangement (“HRA”). Typically, the HRA provides coverage for an initial amount of out-of-pocket and deductible expenses under the plan. The employee must pay the difference between the HRA coverage and the plan’s total deductible out of the employee’s pocket (the “deductible gap”).

Employers have significant flexibility in determining the amount provided in the HRA, the level of the plan deductible, the comprehensive coverage provided by the plan, the services that count toward the deductible, and the services that can be reimbursed from the HRA, all of which control the deductible gap. The employer also decides whether an unused balance in the HRA can be rolled over to the following year, and any limits on HRA balances that can be rolled over or accumulated.

HRAs can be set up as funded accounts, but are most commonly only notional arrangements that exist on paper. An employee’s HRA “balance” is adjusted whenever an expense is reimbursed to the employee. The notional nature of most HRAs puts the employee at risk if the employer goes out of business, because the employee would lose any current or accumulated amounts in the HRA.

HRA balances accumulate tax-free as long as they remain employer-provided funds and are paid out only for qualified medical expenses. Distributions from an HRA for qualified medical expenses are tax-free even if made to a former employee. HRAs can also “earn” interest, again at the discretion of the employer, and any interest “earned” is also tax-free as long as it is distributed only to pay for qualified medical expenses.

Mr. Fronstin noted that allowing rollovers of unused HRA balances could act as a disincentive for employees to use HRA funds for preventive health care services. Limiting the amount that an employee is permitted to rollover can encourage an employee to use current year HRA funds for preventive health care services.

Mr. Fronstin indicated that the amount employers annually allocate to employees’ HRAs varies widely, and there is no significant survey data at this time on this question. He noted that some employers link the amount allocated to an employee’s HRA each year with the type of health care option the employee elects under the employer’s group health plan.

Healthy employees benefit from HRAs more than unhealthy employees, because healthy employees can accumulate an HRA balance to be used for a catastrophic event. However, unhealthy employees may exhaust their HRA each year and incur more total out-of-pocket expenses than under a more traditional health plan design. Lower-income employees with health conditions are the most adversely affected by the high-deductible/HRA combination.

An employer can permit rolled over HRA balances to be used for retiree medical expenses. Employers are also creating retiree medical accounts (“RMA”), to be used exclusively for post-employment health care costs. RMAs are also typically notional accounts. RMAs balances can be established based on years of service, age and years of service, or a flat dollar amount. The advantage for an employer is that the employer’s retiree health care cost is a fixed dollar amount. However, an EBRI survey shows that the gap between potential HRA/RMA accumulations and the projected cost of retiree health care is “depressing,” indicating that retirees bear the financial burden for retiree health care once HRA/RMA accumulations are exhausted.

According to Mr. Fronstin, one of the greatest challenges facing an employer who adopts HRAs or RMAs, or both, is to change how employees and retirees think of the balances in their accounts. Employees and retirees still generally think of amounts in their accounts as employer money, not as their money, and do not spend those amounts as carefully as they would spend their own money.

Summary of Testimony of Raylana Anderson

SHRM represents more than 175,000 human resource professionals, and serves the needs of those HR professionals by providing the most essential and comprehensive set of resources available. SHRM also advances the human resource profession by ensuring that HR is an essential and effective partner in developing and executing organizational strategy.

Ms. Anderson stated that health care costs are not only an HR issue, but are also a CEO and CFO issue because of the significant employer costs involved. She also indicated that large employers must lead the health care market in the area of defined contribution and consumer-directed health care plans. Once large employers develop models, insurance carriers will be able to offer the same or substantially similar models to smaller employers. Also, it is difficult for small and medium sized employers to obtain data on health care use in order to make effective plan design changes, and these employers rely on patterns and trends designed and tested by large employers who have access to useful data.

Ms. Anderson noted that better information on health care providers and health care costs is needed by both employers and employees in order for employers and employees to become informed health care consumers and make informed decisions on plan design and effective and efficient use of plan benefits. An employee cannot make the same informed decision about obtaining health care, as the employee makes about a significant purchase of any consumer good because the comparative data is not available. In the absence of information about total costs and comparative data, an employee thinks a physician office visit only “costs” the $10 or $20 co-pay that the employee pays out of his or her pocket, rather than the total cost of the office visit paid by the employee and the plan combined.

Health reimbursement accounts (“HRAs”) are one element of health care plan designs that give employees a fixed amount of employer funds to use tax-free for pre-approved health care expenses. These plan designs are intended to make employees responsible for their health care decisions and related expenditures. The HRA provides the first level of coverage for health care expenses. The employee then has to pay for a “bridge” amount between the HRA limit and the plan’s out-of-pocket or deductible maximum. Health care expenses in excess of the bridge amount are paid at a specific percentage (usually 80% to 100%) under the plan.

Employer cost savings from defined contribution health plan designs are already reported by employers including Budget Group, Inc., and Humana, Inc. Budget has reported a cultural shift in employees who participate in its defined contribution plan; those employees ask more questions about their health care costs. For both of these employers, extensive and thorough communication has been essential in encouraging employees to elect the defined contribution option and to use the HRAs effectively.

In order for defined contribution plans to achieve their cost-saving goals, employees need information and education that enables employees to effectively and efficiently manage their health care. Information, such as information on conditions and illnesses and options and costs for treatment, can be provided through internet-based tools if employees are given the skills needed to use these tools. Employees also need to be educated to change their relationships with their health care providers, and to apply consumer skills to those relationships, e.g., inquiring about fees and costs upfront, requesting information on optional treatments, and even shopping around for lower fees.

Ms. Anderson recommended that a new “system” of defined contribution plan accounts be adopted to replace the overlapping and confusing distinctions between HRAs, medical expense flexible savings accounts, and medical savings accounts. The new system should create an opportunity for all individuals, regardless of income or employment status, to save for future health care costs on a tax-favored basis. The health savings accounts proposed by Representative Thomas of California is a good starting point, but imposes limits on account contributions based on income. The new system should address employee concerns with the current “use it or lose it” rule applied to medical expense flexible spending accounts under a proposed Treasury Regulation, by permitting rollovers or cash-outs of unused employee contributions. Similarly, the new system should address the requirement, imposed by the same proposed Treasury Regulation, that an employer must reimburse expenses to an employee before the employee has contributed the amount to be reimbursed.

New technology such as debit cards can enable employees to more easily access funds in their HRAs and medical expense flexible spending accounts. This increased access can assist employees in becoming more informed consumers. However, employers must find ways to ensure that withdrawals made by debit cards are limited to reimbursements of expenses eligible for reimbursement.

Ms. Anderson advised against creating a federal agency similar to the PBGC to protect amounts in employees’ HRAs if an employer becomes insolvent, preferring that the market handle this situation. If HRAs become portable, government protection may not be necessary.

Ms. Anderson indicated that small and medium size employers are not rushing into defined contribution plan designs for two primary reasons. First, employees of these employers do not have the information they need to understand and appropriately use this type of plan. Second, employers have heard that defined contribution plans can help control costs, but they are waiting for the market to make these plan designs widely available. Both employees and employers need data to make the choices necessary for best use of the defined contribution plan model.

Summary of Testimony of Phyllis C. Borzi

Ms. Borzi testified that the healthcare system is a mess. It is in flux and the healthcare costs have resumed their upward spiral after a short period when they seemed to stabilize which affects every one including the employer. There is concern about the costs to employers in a voluntary employee benefit system.

Many have termed consumer directed health care as the silver bullet for health care costs. Many thought that managed care was also the silver bullet. But employees became dissatisfied with the tightly managed care programs that employers first moved to. Costs increased as employers moved to programs with more choices.

Consumer directed health care plans are being sold to employers as a way to reduce costs. Employees are not buying them. There are no employee groups that are interested in these products.

If consumers have more choice and more information, they will make better decisions. We should move quickly on providing more information to consumers…that is a good by-product of these new consumer directed plans.

But employees have concerns with the consumer directed products that are on the market currently. The biggest concern is that employees are concerned about a cut back in benefits. Employees will see a cut back in the amount of coverage for their health care. There will be a gap in coverage above a certain level. Employers will try to convince participants that this new plan will provide more choice but the fact of the matter is that you are dis-insuring employees to a certain extent. You may also have employees that don’t choose the right coverage because they have not been sick in the past. These employees are at risk greater than before. Employees will be confused about this new three-tier system and the choices they have to make. Also, employees will have a difficult time getting information to make their decisions. Health care is local and not national and providing accurate timely health care information to make choices has been limited in the past. I am also concerned about full replacement plans and adverse selection.

The HRA designs give people the ability to tailor the benefit in a way that more reflects their personal medical needs. On the other hand it goes back to the old fee-for-service system where people decided what they needed and they went and spent the money on it and had a third party pay for it. Just the fact that it’s a 213(d) medical expense doesn’t mean it is a necessary medical expense.

Congress could look at the MSA, FSA and HRA rules and make them consistent for each. The “use it or lose it” issue and “rollover” issues are important. Rollovers are great from an employee standpoint but not from an employer standpoint. But the problem is that most HRAs are not funded. The best thing about these HRAs is that they can be designed to suit an employer’s needs.

Summary of Testimony of Joyce Dubow

Ms. Dubow testified that the move has been made from managed care to cost shifting with respect to higher cost sharing to these consumer-driven plans always looking for a silver bullet. Employers are trying to shed responsibility for the increase health expenditures that they are incurring. They are pushing them off to consumers who are being asked to bear more responsibility for cost and quality.

There are many features of consumer directed plans but they all offer more choices with respect to cost sharing and benefit levels. They rely on consumers to be well informed and pay a central role with reliance on the web. The objective is to shift more cost and responsibility to the consumer.

The advantage is that the consumers to get more choices. There is a potential to save as a consumer if you are healthy.

The advantage to the employer is lower cost.

Consumers will have to make initial enrollment choices, and day-to-day decisions on when to use HRS. The stakes are higher is they make a bad choice. Thus, they need to understand the implications of their choices for their future health needs. People typically underestimate future risk.

You also need to have information regarding doctors etc. and that information is not yet out there. We also don’t yet know if consumers will be able to research and make good decisions regarding medical care. The information is not available and consumers may not have capacity to process the information due to a number of reasons (e.g. language barrier, illiteracy, intellect, desire). Also, this information is costly. Will employers be willing to spend the money on providing this information?

Summary of Testimony of Randall Johnson

Mr. Johnson testified that health care costs are increasing 15%. Cost of poor quality represents up to 30% of expenditures. Provider and treatment selection is a blind process. We should care because status quo is unacceptably hazardous. Caregiver selections are a life or death situation. Greater consumer responsibility requires adequate information. The market is failing to assure excellence by hospitals and doctors. The focus for the future should be to reengineer the health care system. We recommend a tax deduction for all who purchase their own coverage. There should be changes in the tax code to encourage workers to fund for their retiree medical coverage. Medicare should be reformed to include a comprehensive drug program. We should identify new quality cost effective delivery systems. The Consumer Purchaser Disclosure Group is project sponsored by RWJF with many participating organizations. The goal is that by 1/1/07 americans will be able to select health care providers and treatments based on public reporting of nationally standardized measures for quality, experience, equity and efficiency. National standards are essential for comparability, credibility, understandability, and improved quality.

Funding for future medical care could occur with an individual medical account established with contributions and/or transfers on a pre-tax basis funded through rollovers or tax credits. Questions for the future include; who should have primary responsibility for health care coverage? Should individuals be required to have coverage? Should financial planning and health education happen in high school?

Summary of Testimony of John Young

Mr. Young testified that employers are facing sustained double-digit cost inflation (14% for 2003). Health care costs are projected to nearly double by 2011. Health insurance premium increases far out pace other indicators. CFOs are facing a decision to cost shift to employees or take away benefits. Health cost drivers include hare and technological advances, increased chronic conditions, aging Americans, increased consumer demand, drug costs etc. Defined contribution plans have been around a long time and represent your classic cafeteria plan with a medical FSA. Pure defined contribution health care plans are generally not feasible. Consumer directed health care plans are based on individual repponsi9lbity. They include a health reimbursement account, a high deductible group health plan, disease management, active employee involvement, medical library, etc. Health care consumerism aims to transform the employee into a responsible consumer from passive participant to active consumers. With incentives, information, skills and tools that will enable them to get their health care needs and expectations met, consumers will make informed choices. There are significant savings when people care about health care consumption. Definity’s Health CDHC model includes a personal care account (HRA), health coverage with member responsibility for balance of deductible and tools and resources for participant use. There are many variations of CDHC model. Each model should be tailored to a companies needs. The best practice is to give employees choice. Definity's average renewal rate was flat. Definity’s health tools and resources include my care account, medical library, personal health tools, research provider, healthcare prices, on-line handbook and telephone nurse line.

Pros for employees:

  • Better health
  • Medical cost savings
  • Choice
  • Quality
  • Satisfaction of participation in treatment and recovery
  • Retirement savings

Cons for employees:

  • More accountability
  • May have more out of pocket
  • May have to diet or exercise
  • Have to change from entitlement attitude
  • May not have sources for health information

Pros for employers:

  • Can truly impact costs
  • Able to offer choices
  • Savings
  • Goodwill
  • Shift some responsibility
  • Raise employee awareness of costs

Cons for employers:

  • More involvement in plan design
  • Limited markets for insured products
  • HR disruption
  • Care may be delays
  • Total replacement seen as taking away

May result in more employers being able to offer retiree plans. We urge legislation for rollovers or consolidate all accounts into one (FSA, MSA etc). Treat partners, sole proprietors, 2% shareholders and individual purchasers same as group plan participants under tax code for health care purchasing.

Summary of Testimony of Greg M. Scandlen

Mr. Scandlen testified that the essential problem in health care is that third-party payment leads to excess consumptions which leads to runaway costs which lead to third-party rationing which leads to limited supply of services, which leads to consumer discontent which leads to governmental interference. 2/3 of the US population says that the US is not spending enough on health care. There is a coming revolution in health care delivery with 800 new drugs in the pipeline and new medical treatments. There are also new services (facilities, information and customization). The historical health care system was the Blue Cross model with an industrial age structure that was provider no patient based. Protecting the hapless patient (e.g. tax code and regulations) may be an obstacle to reform. New financing mechanisms to empower the patient; balance insurance and direct pay, make patient care central, true indemnity, personal and portable, web-enabled information, agency, and ability to merge resources. The milestones of reform include many governmental actions such as expand MSAs and HRAs, allow FSA rollovers, tax credits, roll-back regulations, association health plans, malpractice reform and the modernization of Medicaid and Medicare. The milestones of reform also include private sector actions such as the implementation of MSA, HRAs, and FSAs, defined contribution health type plans, information patient supports, physician refuseniks, and individual market improvements. HRAs began in the private sector and were inspired by the MSA and collapse of managed care.

Issues related to HRAs:

  • Benefit design
  • Cap or vesting on roll-0over
  • Cap or vesting on post employment
  • Funded or unfunded
  • No employee contribution
  • Help with retiree benefits
  • Need good customer support.

1.5 million enrolled in HRAs at the end of 2002. 44% of employers are looking into them. Those plans with HRAs have better use of generics and nurse hotlines, more physician visits, less emergency room visits. The prospects for HRAs include strong enrollment growth, legacy company competition, rival payment systems; MSA expansion could replace HRAs, unified health accounts. Problems included portability and ownership of accumulated benefits.

Summary of Testimony of Edward Kaplan

Edward Kaplan testified that 95% of clients are having conversations regarding defined contribution health care but so far there is not a lot of action seen taken yet. 20% of wages represent health care costs. The trend is for the costs to rise at 5 times the consumer price index.

The reason for the cost increases is threefold:

  • Over consumption due to third party paying for services
  • Consumer behavior to buy now and worry about paying later
  • No competitive pricing or supply side economic pressures

Pure defined contribution health plans a rare today. There are no pure defined contribution health care plans with greater than 500 participants because they do not have pooled purchasing power. The hybrid plans, which have defined contribution features with ultimate defined benefit coverage, are no being considered. The problem with traditional defined benefit plans is that there is no accountability for costs and health employees no longer want to subsidize the costs of unhealthy employees. The heath cost reimbursement account with a high deductible plan is one model that is being considered. This model could have preventive care covered at 100%, a deductible bridge that would be the responsibility of the employee and traditional health care coverage for costs above the deductible.

Advantages of the hybrid approach:

  • Employee out of pocket costs
  • Creates employee choice
  • Managed care
  • Insurance coverage for high claimants
  • Group purchasing advantages
  • Strategic pricing

A recent study on diabetes showed that with preventive care there could be a 38% reduction in medical costs as a result of less office visits.

It is recommended that the Government clarify the usage of the rollover amounts for HRAs.

Employers need to make sure that it is not only the healthy employees that choose the health reimbursement accounts and get the portability of benefits or the remaining costs of the non-healthy employees in the traditional defined benefit plans will go sky high.

The HRA plans should be typically offered as full replacement plans.

There is also a question as to whether the health coach is deemed a fiduciary if the coach helps choose health care providers. The Government should address this question.

These HRS plans are too new to determine if they will result in the costs of health care decreasing. Another 2-3 years of history on these plans in operation in needed before it can be determined if they could reduce costs.

Summary of Testimony of Michael Parkinson

Mr. Parkinson testified that he was excited about consumer-driven health care. As physicians, along with patients, he has grappled with what’s the best way to get this system to support evidence-based quality medicine in a cost-effective fashion. Consumer-driven health care is very promising. Lumenos believes that health care needs a lot of light shown on it. We need quality information. We need cost information and we need transparency at all levels. Lumenos also believes that we have to address the true drivers of health care costs, which ultimately are not co-pays, deductibles, and five different tiers to get a drug prescribed. It really is human behaviors and human health behaviors. Fifty percent of all health care dollars come from behaviors we choose to make or do. Thirty-five percent of all health care spending is waster and inefficiency, yet at the individual doctor-patient level, we’re all working as hard as we can do “quality medicine”.

The incentives are misaligned currently. There is no infrastructure to help with patient. What Lumenos tries to do is realign incentives with infrastructure built around the patient to complement that being built around the physician and the hospital.

Lumenos currently has 150 employees and has been in existence for four years and have been actually operating with members since January of last year. Lumenos is coming on the second full year of enrollment starting January 2004. At that point in time Lumenos anticipates having 50 self-insured companies that will be offered their plan to either as full replacements or as an option. When offered as an option, alongside an HMO, PPO or other type of plan, they draw anywhere from 2 to 49 percent based on the benefit design and a number of factors.

Total replacement characteristics tend to be smaller, self-insured companies on average anywhere from 500 to 2,000 to 3,000 with more emphasis on the low end. They are also starting to see unions move in that direction too.

Defined contribution really is just giving money to employees. Drop the money and run and nobody wants to do that.

Nobody spends their own money if they can spend somebody else’s. So employers who are trying to actually avoid cost shifting or who have already shifted as much as they can are trying consumer-driven care by giving more visibility and control over the first 40-60 percent of the dollars directly to the consumer.

Lumenos believes consumer-driven care preserves the true insurance safety function of insurance, while also delinking the financing mechanism of first dollar coverage and getting the consumer engaged with support systems on the web, over the phone or with a personal health coach to help them understand to navigate the very difficult system.

Physicians are saying that they are so tired about the status quo in terms of having to see more patients for a decrease in unit and a lack of clinical tools and support. Baylor Health Care Systems in Dallas finds that consumer-driven plans reduce the administrative hassles at the point of care so they don’t have to worry about 25 different ways to collect a co-pay or deductible with administrative rules. It also provides tools and support information that a physician is not able to provide. There are administrative and clinical advantages. Also, patients would have a health coach assigned to them to make sure they are following the doctor’s orders.

Lumenos is advocating a health reimbursement account with a bridge amount that is properly designed and we would like to see it no more than half or ideally no more than one time what the health savings account is. The out of pocket maximum with the traditional health care coverage, which is traditional PPO, has got to be two things, competitive and compassionate in order to attract employees in an optional menu.

The employer advantage is that they may possibly reduce health care baseline spending. It is also a retention tool. It is a great way to retain employees if the money can be rolled over each year and is not portable to another company.

First recommendation: Legislative initiatives should cover portability. We see the portability issue as a new way for employers to get back in the retiree health care area. The money could be portable as long as it is used for retiree health care coverage.

Second recommendation: More information regarding quality and claims information.

Early results: After a year and a half into the program, based on 2002 clients, 98% are satisfied with the plan and would recommend it. It is not complicated and consumers are capable of doing it Personal health behaviors are the true drivers of 50% of health care costs. 55% of our participants said they were more aware of prices and quality. 25% of members said they changed their behavior. 55% said they exercise more and 37% said they diet. Consumers empowered with new incentives and the infrastructure will make this work.

Summary of Testimony of Dr. Cyril M. Hetsko

Dr. Hetsko testified that this was an important issue due to the national health care crisis of the uninsured. The predominate system of health care coverage in the US is the employment based system, one of the primary health care financing issues today is the large number of Americans without health insurance. More than $41million Americans lacked health insurance at some time in 2001. This problem will likely get worse as health care costs climb. Additional problems of the current health insurance system include lack of patient choice as only one of six employers offer workers a choice between two or more health care plans. Another problem is employees who choose to leave their jobs, leave their insurance behind. There is also a lack a patient control. Most coverage results from employer not employee decisions. The cost of insurance for those of us outside the employment-based system is unaffordable.

The goal of the American Medical Association is to see that all Americans have expanded coverage and a choice of health plans.

Our proposal is for employers to shift their health benefits from providing a defined benefits program to a defined contribution program. The approach would transition to tax credits offered to individuals for the purchase of health insurance.

The proposal follows five principles:

  1. Define contributions from employers
  2. A fully portable individual ownership and selection of health insurance
  3. Replace the current tax exclusion with individual tax credits
  4. Develop new health insurance markets
  5. Streamline the market’s regulatory environment

Key goals would be to provide patients with more choice and control. They will have a larger number of options and be able to select their own health plans and their own health providers. In today’s environment, patients have the ability to act as informed consumers through the use of the internet and electronic educational systems that are now available and being developed to help patients select health insurance plans that meet their needs and their priorities. If patients were given the control of their health benefits, then plans would have to satisfy patient choices rather than employer preferences. Because individual purchasers would have a greater choice of plans, those plans would need to compete on the basis of price, plan features and quality of delivery and care. Such a competition would push premiums closer to their true cost.

Summary of Testimony of James Bentley

Illness is not evenly distributed. The chronically ill are the difficult population to consider. 10% of the population uses 70% of the health care spending in the U.S. We have subsided the under 65 10% with three different mechanisms; employer sponsored group health insurance, government programs, and cost shifting. The various options around defined contribution and consumer choice health plans are confusing to the publican and the DOL should help standardize the terminology.

There are 6 hospital concerns to moving to either defined contribution or consumer choice help plans.

  1. The allocation in the employee’s contribution may increase the number of uninsured. Will the way in which the premium support money is distributed lead groups of populations?
  2. Healthy people may underinsure when purchasing coverage
  3. People may under use low cost ambulatory care.
  4. If we move to fast without care, we are going to wind up with a multi-tier health care system that is incompatible with the regulatory and accreditation structure that hospitals operate in.
  5. Will hospitals go back to insisting on large cash deposits?
  6. Hugh barriers to consumer information

Summary of Testimony of Gail Shearer

Gail testified that there would be winners and losers as a result of consumer-driven health care. Concept has evolved from at first when it was a purely defined contribution model into the healthcare reimbursement model of today.

The biggest problem in health care continues to be the folks that have no insurance coverage at all (uninsured and underinsured).

Early experience is mixed regarding whether these new plans will reduce costs. We are allowing the market place to move our system from one that features modest deductibles to high deductibles as the only choice.

Ten concerns about consumer-driven health care:

  1. Market fragmentation
  2. Diversion of scare funds from the sick to the healthy
  3. Increased financial burden on the sick
  4. Increase financial burden on people with moderate income
  5. Death spiral: end of traditional low-deductible coverage
  6. Deceptive language that misleads consumers
  7. Inadequate information
  8. Health care as a commodity
  9. Inadequate risk adjustment
  10. Eronization of health care

Too early to say what impact of consumer driven health care will be.  May possibly be a fad while until the economy recovers? Employers may begin to offer low deductible health care to attract employees. Could be potential to increase the burden on sick and those with moderate income. Need to continue to support health care reform to provide affordable health care for all.

Summary of Testimony of Charles H. Klippel

The market for consumer directed health care has shaken out quickly. The conventional model is the high deductible PPA and a bunch of informational tools has become the standard in the industry quickly. This is a simple model that is easily understood especially for large employers. The brokers have adopted this model has their lead horse. The IRS codified or put in place by opinion the framework that supported this model. Aetna and other companies worked on developing a product for small and medium size companies. The percent of what employers pay for health care peaked in 1999-2000 at 80%. In 1980 that number was 65-70 percent. In the 60s it was 50%. For 2003 it is more like 75%. There is a current trend to share more cost with employees. The thought is still very prevalent in large companies that we have to protect patients when they are patients but we can also help them when they are consumers in other ways. Potentially broader coverage is a plus of the new CDHC product. Treasury authorized HRAs and FSAs to pay for over-the –counter drugs last week. Another plus is that the product connects provider pricing with consumer –relevant costs. Employers are pricing these plans assuming that while the person’s in the plan they have this accumulating feature but if they quick, they have lost it. If a vesting rule comes along that says these products have to be completely portable, it will discourage employers from getting into these products. There is a question as to whether or not employers should fund these vehicles if they become portable. Also, should they be accruing a FAS 106 liability if they are for retired employees? Employers are not yet ready to give up their defined benefit plans yet. Benefit decisions are being made by CFO in conjunction with the benefits managers. I believe in employer based health care and the benefits of pooling of risk. I think retirees benefits are where we are seeing employers dropping out of the defined benefit model or they will be providing defined contribution benefits until you to retirement. The notion that you have a durable benefit, which may stay with the employee regardless of which other health plan they switch to, is important. The durability of benefits is one of the things that ERISA was designed to promote and protect in the world. ERISA preemption is going to be important with respect to these retiree accumulation plans. It was clear that the treasury does not want to encourage a defined contribution health and welfare plans and wants to distinguish them from the consumer directed health plans. COBRA doesn’t work well with these plans. The problems is that if you have a partial qualifying event, it was suggested that that result would be that you had to duplicate the balance in the fund without increasing the COBRA premium. Employers are struggling with this and the treasury will rethink what they have proposed. There are lots of pros and cons to portability. It is a big issue.

Four quick suggestions about ERISA:

  1. You’re a fiduciary if you provide advice and your sort of a negligent standard if your providing information. It would be helpful to clarify this.
  2. The DOL should look back at the proposed draft regulations in light of CDHC plans and see whether there is a little more flexibility to be provided to employers.
  3. Clarification and flexibility around the process of payment would be helpful.
  4. Regarding vesting, there is a big distinction between looking at the CDHC plans as an unstructured benefit versus employee entitlement funds. We need to be thoughtful about whether these benefits should vest and be portable.

The market will drive many of these recommendations.

Additional Information Sources

June 25, 2003: Working Group on Healthcare Security

  1. Agenda
  2. Official Transcript
  3. Outline for group’s study for the year
  4. Statement on Defined Contribution Health Care Plans by Paul Fronstin, Ph.D., Senior Research Associate and Director, Health Research and Education Program, Employee Benefit Research Institute
  5. Statement on “Are Defined Contribution Health Plans the Silver Bullet?” by Phyllis C. Borzi, Of Counsel, O’Donoghue & O’Donoghue and Research Professor of Health Policy, School of Public Health and Health Services, The George Washington University Medical Center
  6. Statement by Raylana Anderson, CEBS, SPHR, National Committee on Compensation & Benefits, Society for Human Resource Management
  7. Statement on Defined Contribution Health Care Plans by Ronald E. Bachman, FSA, MAAA, PricewaterhouseCoopers, LLP, as well as “An Employer’s Guide to Patient-Directed Healthcare Benefits;” “Defined Contribution Healthcare: Reframing Relationships and Benefits Delivery;” “Consumer-Centric Healthcare;” a yet-to-be released paper on “Consumer-Centric Medicare: Expanding Benefits and Saving the System for Boomers and Beyond” and “Boomers Will Revitalize an Aged, Ineffective System” by Newt Gingrich and Ronald E. Bachman
  8. Statement on “Consumer-Driven Health Care 101: Getting Started” by Jon Gabel, Vice President; Health System Studies, Health Research and Educational Trust, as well as a MarketWatch article from the March/April 2003 issue entitled “Self-Insurance in Times of Growing and Retreating Managed Care” by Jon R. Gabel, Gail A. Jensen and Samantha Hawkins
  9. A publication issued in May 2003 and entitled “Decision Making in Consumer-Directed Health Plans” by Judith H. Hibbard, Dr. P.H., University of Oregon; Joyce Dubow, M.U.P., AARP Public Policy Institute, and Ellen Peters, Ph.D., Decision Research, University of Oregon

July 23, 2003: Working Group on Healthcare Security

  1. Agenda
  2. Official Transcript
  3. Slide Presentation by Randall Johnson, Director of Human Resources Strategic Initiatives, Motorola, Inc., Washington, DC, representing the ERISA Industry Committee as its Vice Chair and Chair of ERIC’s Health Policy Committee.
  4. “Self Funding of Health Care” by Terry Humo, Marsh Advantage America, from Spokane, Washington, replaced at the hearing by John Young, Midwest Region Sales Director, Consumer Driven Marketing of Eden Prairie, Minnesota, for Definity Health on the topics of Consumer Driven Health Care and Self-Funding
  5. Statement by Greg Scandlen, Director for Consumer Driven Health Care at the Galen Institute in Alexandria, Virginia, as well as “A Walk Through the Woods of Association Health Plans – Separating the Forest from the Trees;” “Consumer-Driven Health Care: New Tools for a New Paradigm” and “The New Consumerism” by Mr. Scandlen
  6. A slide show presentation on “Defined Contribution health Plan Strategies: A Long Run Perspective” by Edward Kaplan, National Health Practices Director, The Segal Company, New York, New York
  7. A Syndicated Survey of Consumer Attitudes Toward Health Coverage Issues and Emerging Health Care Plans conducted by the Dieringer Research Group and the Pareto Health Group as well as copies of news articles: “Savvy Consumers Ready to Step into Healthcare Cost Containment Fray” of May 14, 2003 and “Interest in Consumer-Directed Health Plans Keyed to Company Size” of June 4, 2003

September 22, 2003: Working Group on Healthcare Security

  1. Agenda
  2. Official Transcript
  3. Outline of Group’s Final Report as well as rough draft of section five, six and seven of the outline
  4. “Expanding Health Insurance: The AMA Proposal for Reform” provided by Dr. Cyril M. “Kim” Hetsko, as well as his written testimony for the Board of Trustees, American Medical Association.
  5. “Consumer-Driven Health Care” Presentation by Gail Shearer, Director, Health Policy Analysis, Consumers Union, as well as a graph, “Variation in Health Care Costs of People with Employer Coverage, 2000” from Lewin HBSM, AHRQ MEPS (1996)
  6. Power Point Presentation on “Consumer-Directed Plans: Perspectives on the Market Implications for ERISA” by Charles H. Klippel, AETNA
  7. Statement of James D. Bentley, Ph.D., Senior Vice President, Strategic Policy Planning, American Hospital Association

Advisory Council Members

  1. John J. Szczur, Chairman
  2. Michele Weldon, Vice Chairman
  3. Ronnie Sue Thierman, ex-officio, Chair of the ERISA Advisory Council
  4. David Wray, ex-officio, Vice Chair of the ERISA Advisory Council
  5. Robert Patrician
  6. John S. Miller, Jr.
  7. Thomas C. Nyhan
  8. C. Mark Bongard
  9. Norman Stein
  10. Antoinette Pilzner


  1. Defined contribution health and welfare benefit plans provide benefits based on the amounts contributed by the employer and employee to the employee’s individual accounts plus or minus forfeitures, investments experience and administrative expenses.

  2. Originally the Council contemplated including in this report a discussion of the different models of self-insured plans. However, upon further review, it was determined to narrow the topic to address defined contribution plans focusing on consumer-directed health care.