Pay-related health care plans bring equity to cost sharing

Pay-related health care plans bring equity to cost sharing

Kenneth M. Coughlin

Several companies are experimenting with programs that link health care costs to employee’s annual salaries.

When Xerox Corp. decided nine years ago to shift a portion of its health care costs to its employees, company officials tried an approach that they hoped would make the medicine go down easier. Rather than ask all employees to pay the same out-of-pocket charges, the company took the then-unusual step of basing the employee’s contribution on his or her salary.

The program’s design was simple: An employee’s deductible would equal 1% of annual salary. When the employee’s out-of-pocket costs reached 4% of annual pay, the plan would pay 100% of the charges.

“We knew that cost sharing was not going to be popular among our employees,” recalls Patricia Nazemetz, Xerox’s director of benefits, “and we were looking for a way to sell the concept. We also wanted to avoid having to increase the deductible every three or four years because that tends to get people upset.”

Xerox’s strategy worked on both counts. Employees appreciated the fact that their higher salaried colleagues would be shouldering a larger share of the health cost burden, and Xerox since then has not raised its employee copayments.

Nine years ago, the concept of “pay-related health care plans” was new. Since then, such plans have been slowly catching on among employers of all sizes. Industry consultants now estimate that between 10% and 15% of businesses base what an employee pays for health care on what the employee earns. And the percentage is said to be growing.

Fairness is the chief reason companies adopt the strategy. As workers are asked to assume an ever-larger share of the health care price tag, some employers see an inequity in asking an employee earning $25,000 to bear the same load as an employee earning $100,000.

An emerging trend

“Health plans are becoming less generous,” says John Hickey, a partner at Kwasha Lipton, a benefits consulting firm in Fort Lee, N.J. “It’s easier to sell that fact to your rank-and-file employees if they feel that the higher-paid are paying their fair share as well.”

But equity isn’t the only incentive for businesses to consider pay-related plans. Tying benefit costs to salary may temper utilization among higher salaried workers. In theory, if higher paid workers pay markedly increased deductibles, they may hesitate to use the services of doctors as frequently as they did in the past. In addition, such plans offer a built-in cost escalator, as Xerox discovered. Because premiums are paid to salary, an employee’s deductible is increased as his salary is increased.

But despite a trend to shift more responsibility for health care costs to employees, many employees may be paying a smaller share of their total medical expenses today than they were five years ago, according to an analysis by Milliman & Robertson, an actuarial and benefits consulting firm in Radnor, Pa. The reason, the firm says, is that many employers did not sufficiently index either the deductibles or limits on the maximum out-of-pocket expenses at a time when health care costs were rising faster than the general rate of inflation. (See “Value of deductible as a percentage of total medical costs,” page 40.) For example, the firm’s study shows that a $250 deductible paid by an employee in 1987 represented 16.5% of his or her total expected medical costs. Today, that same $250 deductible represents only 9.8% of total medical costs.

Nevertheless, benefits experts stress that pay-related health care plans do not make sense for every employer. Also, such plans have almost as many variations as there are companies using them, meaning that employers are initially confronted with what can look like a dizzying array of options.

A variety of strategies

Employers interested in setting up such plans must make two basic decisions, according to benefits consultants and employers offering these plans.

First, the employer must decide what cost will be keyed to the employee’s salary–will it be the deductible, the out-of-pocket maximum, the employees’ premium contributions, or some combination of these? For companies that offer flexible benefit plans, another option is to peg benefit credits to salary. Under such a system, higher salaried employees would receive fewer credits than lower paid workers.

After the employer has determined what costs to tie to salary, the next step is to decide what formula to use. The Xerox approach, which has been adopted by several other companies, is to use a flat percentage of salary.

For example, an employee’s annual contribution to the health care plan could be set at half a percent of his or her salary. Thus, an employee earning $30,000 a year would contribute $150 annually for health care coverage, while an employee earning $100,000 would pay $500 each year. Such plans are often capped at some salary level so that the highly compensated employees do not pay for most or all of their health care.

An alternative strategy is to establish a number of salary ranges and then determine what employees in each range will pay for their coverage. For example, an employer could set up a plan in which employees who earn less than $30,000 a year have a $250 deductible, employees earning $30,000 to $60,000 have a $400 deductible, and employees earning more than $60,000 have an $800 deductible.

The salary range approach can be administratively simpler than the percent-of-pay strategy because the charges to the employee change only when he or she shifts to another earning level, says Bob Braddick, a principal at A. Foster Higgins & Co. Inc., benefits consultants in New York.

By contrast, pegging each employee’s deductible or out-of-pocket limit to a percentage of his or her pay can be complex, says Braddick. “You have to transmit information to your claims administrator and the claims administrator has to do the programming,” he says. Focusing the pay-related plan on an employee’s contribution to the monthly premium can be cleaner, says Braddick, since the calculation is simply a payroll function and does not involve the insurer or administrator. “But it all depends on the capabilities of the firm that is paying your claims and the additional costs involved for programming and adjudication,” he says.

Basing the pay-related plan on the employee’s contribution–as opposed to the deductible or out-of-pocket limit–also is a better way to ensure that the employer or the plan sponsor is going to achieve its financial objectives, says Timothy Ray, a partner in the Washington office of Coopers & Lybrand, an accounting, tax, and benefits consulting firm. “In any given year, you can’t predict who’s going to get sick and who’s going to use the plan, but you can predict your payroll costs,” Ray notes. By basing the pay-related plan on those payroll costs, employers know in advance what they will be recouping in employee premiums.

Pay-related payoffs

One advantage of pay-related plans is that they can limit the number of times employee contributions, deductibles, or out-of-pocket limits must be raised. If employee salaries are rising 5% annually, health care charges to the employee will rise the same amount.

In addition, basing an employee’s health care costs on his or her salary may directly affect utilization. For example, an employee with a $100 deductible who makes $100,000 a year is not going to have an incentive to cut costs. “You want to make the cost shifting meaningful for every employee, and what’s meaningful for a higher paid employee is different from what is meaningful for a lower paid employee,” says Kwasha Lipton’s Hickey. “Making cost shifting meaningful for everyone impacts utilization.”

Salomon Brothers Inc., a securities firm based in New York, instituted a pay-related health care plan last July. Under the plan, higher paid employees are paying more than they used to, while lower paid employees are contributing about what they paid before, says John Raffaeli, vice president of employee benefits. Executives believe that the pay-related health care plan is going to shift costs to those with the most claims activity–the higher paid employees.

“We have found that the higher paid people use the health care plans more,” says Raffaeli, adding that the company has noted that the families of higher paid employees tend to be larger. Moreover, he conjectures, “They may have more access than lower paid employees to the health care delivery system, particularly as it relates to care outside of their region of residence.”

It’s too soon to tell whether utilization has been affected, notes Raffaeli, but “we expect that longer term there will be some impact on utilization.”

The plan is complex in design but simple to implement, Raffaeli says. Deductibles, out-of-pocket limits, and employee contributions all depend on which of four salary ranges an employee falls within: under $50,000, $50,000 to $99,999, $100,000 to $199,999, and $200,000 and over.

The employee’s costs also depend on which of four family-size categories apply. At one extreme, a single employee earning $45,000 a year would have a $300 deductible and a $1,000 out-of-pocket limit, and would contribute $10 a month to the plan. At the other extreme, an employee who earns $210,000 a year and has a family of four would have an $800 deductible and a $4,000 out-of-pocket limit and would contribute $75 a month.

Raffaeli says there were virtually no costs involved in implementing the program, which covers the company’s 4,500 employees. Enrollment will soon be easier when the company shifts to a voice-response enrollment system. Employees will be able to dial a toll-free number and enter their income and family size via the telephone–during the workday, or on evenings and weekends.

As was the case at Xerox, the pay-related scheme adopted by Owens-Corning Fiberglas in January 1990 was the sugar coating on the bitter pill of first-time employee contributions.

Prior to that time, workers at the Ohio-based manufacturer of Fiberglas yarns, insulation, and roofing products had not contributed to the health care plan. With the pay-related health care plan now in place, employees opting for single coverage still pay nothing, but those choosing employee-plus-one or family coverage contribute an amount based on a percentage of their salary. Employee-plus-one coverage costs half a percent of an employee’s base pay, while family coverage runs 0.7% of base pay. The base pay, which does not include incentives or overtime, is calculated on Oct. 1 of each year.

The pay-related plan gives employees a sense that the company is trying to limit future increases, says health care manager Marty Lahey. “The employee contributions are relatively modest, and our intent is not to raise them; that’s why we indexed them to salary,” he explains.

Because Owens-Corning does not have a central corporate payroll system, the pay-related plan must be installed, maintained, and audited at every location. Fortunately, additional administrative costs have been minimal, Lahey says.

Indeed, administering pay-related plans has been relatively simple. “When we put it in, everybody was terrified that it would be really hard to administer,” says Xerox’s Nazemetz. “But that wasn’t the case. We freeze the deductible for the entire year based on what the employee earned the prior year, so the employee is actually working off an old pay base. We weren’t looking to get it exactly to the penny.

“We send our plan administrator a tape with each employee’s salary at the beginning of the year, and that figure doesn’t change during the year.”

Not for everyone

Industry consultants point out that pay-related health care plans are effective only in companies that have broad salary bands. “If you have a high-tech company in which everybody is making close to the same amount, who cares?” notes Coopers & Lybrand’s Timothy Ray.

Law firms, for example, typically have the broad salary ranges suited to a pay-related approach. Employees in law firms are often divided into three distinct categories–partners, associates, and administrative staffers. There are broad salary differences among the groups.

At Cadwalader, Wickersham & Taft, a law firm in New York, an employee’s deductible depends on whether he or she is a lawyer. Lawyers have a $300 deductible, while administrative staffers have only a $150 deductible.

In addition, the amount a Cadwalader employee contributes to the health care plan depends on his or her salary. Those who earn less than $20,000 a year pay 0.05% of their annual salary for individual coverage and 1% of their salary if they opt for the family plan. Employees in the $20,000 to $50,000 range pay 0.6% for individual and 1.1% for family coverage. Those who earn between $50,000 and $100,000 pay 0.85% for individual coverage and 1.6% for family, and those who earn $100,000 and up pay 1.1% and 2%, respectively.

The percentages, which are based on salary plus overtime and bonuses, were recently raised. 10% for all employees except those in the $20,000-and-under bracket.

Maryanne Braverman, Cadwalader’s director of employee benefits, says problems in administering the plan are minimal. “The plan does require payroll input to code people for their charges,” Braverman notes. “I have to get reports on it and we pay the payroll service a small fee for that. But it was not very complex to set up.”

As is the case with many companies, Cadwalader had paid all health care costs for its 700 employees prior to introducing the pay-related plan in 1990. “When we paid full coverage, everybody enrolled,” says Braverman. “We felt that if we started a small contribution, people would begin to exercise some judgement about whether they needed the coverage.”

The pay-related plan had an impact on who dropped out. “The higher paid people thought a little bit harder about whether they needed this,” reports Braverman, while some of the lower paid employees continued to carry two coverages–their own in addition to their spouse’s coverage–because it costs so little to keep the law firm’s coverage in place.

Lowering the hurdles

One critical hurdle that any pay-related plan must clear is top management approval. Potential resistance is understandable, since the people who have the most to lose from such a plan–the high-salaried–are the very individuals who must approve it.

Nevertheless, executives may be beginning to see pay-related plans as an equitable solution to the cost shifting problem. “I think the morality issue is setting in. We can’t expect an $18,000-a-year employee to pay $400 toward his premium when there are a number of $60,000-a-year people paying the same amount,” says Bruce Smith, vice president of human resources for Crown Central Petroleum, an oil company based in Baltimore.

So far, Crown Central does not relate employee contributions to salary, says Smith, “because we have done a good job of controlling costs and our employee premium is not a killer. But,” he adds, “that’s not to say that we may not go that route somewhere down the road.”

COPYRIGHT 1993 A Thomson Healthcare Company

COPYRIGHT 2004 Gale Group