A Rational Marketplace
These differences won't go away with the onset of the defined-contribution revolution, but consumers will be able to sort through the confusion and select products that best fit their circumstances. The underwriting structure of defined-contribution retailing will, at long last, create a rational marketplace.
We envision a three-tiered risk structure as a way of thinking about purchasing decisions under defined-contribution approaches. Under this scheme, the roles of the players (employers, consumers, insurers, intermediaries) are much clearer and product arrays sort out into a more clearly understandable set of choices. Employers and consumers will need to think about the three levels of risk that generally are masked in one overall premium today:
1. Catastrophic/extraordinary coverage will, most likely, continue to be borne by employers. Stop-loss coverage is a feature virtually everyone needs, regardless of product or plan type. Given sufficient group size (about 200 is the minimum for a $50,000 stop-loss policy), coverage is fairly inexpensive — about $30 to $50 per month in most cases. Even under a defined-contribution approach, we anticipate most employers purchasing this for their employees. This is only a small amount more per month than many large employers currently spend simply to administer their health-benefits plans.
2. Normal risk products will be purchased by employees with defined-contribution dollars. Already covered for catastrophic loss, employees would enter the retail marketplace, almost certainly through an online system. An employer's contribution might be combined with that from a spouse's employer. What consumers purchase will be determined by their appetites for risk — essentially "drawing the line" on deductibles and co-pays. The more risk they assume, the smaller their premiums.
3. Out-of-pocket costs and risks borne by the employee, the final tier of the model, will drive a move toward higher deductibles. Consumers will discover that they have very limited leverage on premiums if they insist on low deductibles. For example, doubling a deductible to $500 from $250 would produce only about a 6 percent savings on premium payments, whereas increasing the deductible to $2,000 would lower the premium by about 25 percent. Such considerations are likely to reinvigorate the demand for limited-panel HMOs as a mechanism for reducing one's risk for out-of-pocket expenses.
Although some of the harsh realities of cost/feature trade-offs may be exposed in the early days of the transition, the overall effect will be to clarify and simplify products, risks, choices, and costs. Two major product categories will emerge. For those who see themselves being at low risk ("immortal" single males in their 20s, for example), high-deductible, high-choice insurance products will dominate. People with families (or those starting them) will likely trade some choice for limited-panel health-services plans (e.g., HMOs). (See Exhibit 4, below.) The affluent, regardless of health status, would likely continue to pay differentials to maintain a high level of choice offered by more traditional insurance (indemnity) products.
The Medicare system, already experimenting with vouchers (an implicit defined contribution), could also fit into the defined-contribution system by allowing beneficiaries to choose between insurance and health-services plans on a community-rated basis. Working couples could combine their defined-contribution dollars and select a single, more comprehensive product. Today, without the coordination of benefits, these couples are often forced to choose between two marginal sets of coverage.
Product innovation and mass customization will also take hold as part of this more rational and consumer-driven paradigm. Once freed from offering a limited product set to a given group, insurers can design new products tailored to specific needs. For example, one could envision a low-cost insurance product that would require the customer to get routine care (age- and gender-appropriate) but pay for it out-of-pocket — the benefit of which could be not only lower premiums, but also a richer set of benefits if the policyholder does become ill ("do the required maintenance and we'll give you a full warranty on everything else").