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New Directions For Public Health Care Purchasers? Responses To Looming Challenges
State public employee health plans (PEHPs) provide health benefits for millions of state and local workers, retirees, and their dependents nationwide. This paper explores major issues and challenges that PEHP leaders and state policymakers are addressing. These include the perennial challenge of funding benefits for a diverse and aging workforce; new accounting standards affecting public employers; and the changing relationship between states, retired public employees, and the Medicare program. Interviews with PEHP executives explored whether these are incremental challenges to which states can effectively adapt, or whether these challenges will catalyze broader and lasting change in the public employee and retiree health benefits arena.
STATE PUBLIC EMPLOYEE HEALTH PLANS (PEHPs) are large, employer-based health plans that provide health benefits for millions of state and local workers, retirees, and their dependents. Recent studies focusing on PEHPs have explored the unique constraints they face, from strong public unions and sometimes cumbersome procurement procedures to heavy reliance on political appropriations processes and cyclical revenues.1 Other recent studies compare the purchasing practices and benefit designs of PEHPs with those of large private-sector employers.2 We explore in this paper several major issues and challenges that PEHP executives, their boards, and state policymakers are addressing. These include the perennial challenge of funding benefits for a diverse and aging workforce; new accounting standards affecting public employers; and the changing relationship among states, retired public employees, and the Medicare program. To examine these issues, we conducted telephone interviews with executives and senior staff members representing twelve of the largest U.S. PEHPs.3 We examined whether these are incremental challenges to which states can effectively adapt, or whether these challenges will catalyze broader and lasting change in the arena of health benefits for public employees and retirees.
The PEHPs in our study provided health benefits for more than 6.6 million people in 2005, including active employees, covered dependents, and retirees in state governments and participating local and other quasi-public entities (Exhibit 1  ). Because our sample accounts for approximately half of state and local government employment in the United States, we estimate that total PEHP enrollment nationwide—including active employees, dependents, and retirees in all participating government entities—exceeded thirteen million in 2005.4
As health care programs, PEHPs are also responsible for an increasingly large share of state health care spending, second only to state Medicaid programs. In fiscal year 2003, the most recent year for which fifty-state comparative data are available, state spending on public employee and retiree health benefits accounted for about 16 percent of total state health spending (excluding the federal share), on average, up from 10 percent in FY 1997. Moreover, this figure does not include employer contributions from local and other quasi-state entities that also participate in PEHPs. Large numbers of covered lives and rising PEHP costs help explain the pressures on PEHPs to respond to changing market conditions and rising costs in the often volatile political environments in which they operate.
A legacy of rich benefits and modest cost sharing. In the private sector, purchasers have embraced the thinning of benefits and more aggressive member cost sharing.5 By contrast, public employers continue to pay higher premiums for more-comprehensive benefits. The gap between public and private employers in the actuarial value of health benefits offered is the result of several related factors: the political influence of public employee unions and labor-oriented governance structures embedded in often highly politicized environments; the electoral clout of public employee and retiree constituencies; and the public employment compensation strategy of emphasizing value of health benefit security and early retirement options rather than on competing with the higher wages found in the private sector. In addition, the accumulation and magnitude of these generous health care commitments for public workers has not had high visibility with taxpayers and voters. In the private sector, thinner benefits are having the effect of holding down premium growth for particularly price-sensitive consumers. Some adverse selection may be avoided if younger or healthier workers or their dependents do not opt out of plan participation. Thus, one potential consequence of the richer benefit packages offered by public employers is the difficulty in designing policies to serve the heterogeneous preferences and needs of a diverse population. For example, some PEHP executives cited difficulty establishing the right mix of benefits and premiums to encourage younger, healthier dependents and others participating on an optional basis to enroll and help finance growing cohorts of early retirees who are not yet eligible for Medicare. Cost containment strategies. As are major private employers, PEHPs are experimenting with numerous cost containment strategies, including disease and case management, more aggressive management of pharmacy benefits, and contracting with managed care plans. These strategies are discussed in more detail elsewhere.6 PEHPs in three of our study states are experimenting with so-called group value-purchasing initiatives. These are each relatively new and distinctive innovations among PEHPs, so we provide brief snapshots of these new initiatives and directions in public employer purchasing. California. Facing annual premium increases that exceeded a cumulative 50 percent in the previous three years (14 percent per year), the California Public Employees Retirement System (CalPERS) recently launched several new cost containment efforts, including the Narrow Network Initiative (NNI) in 2004. According to Jarvio Grevious, CalPERS deputy executive officer, "Instead of member cost shifting or swapping out health plans from year to year, we were looking for ways to get the health care market itself to be more efficient, promoting the principle of ‘value purchasing’."7 In partnership with Blue Shield of California (BSC), the NNI has the goal of yielding cost savings and quality improvement by restricting the Blue Shield health maintenance organization (HMO) provider network to hospitals and affiliated medical groups that lower costs while achieving quality outcomes. The NNI, which affects approximately 4 percent of the total CalPERS population, relies on all patient refined–diagnosis-related groups (APR-DRGs) to assess network providers’ relative cost and quality. Affected members must either stop using out-of-network hospitals and affiliated physicians or enroll in different CalPERS plan options that retain these providers in network and cost more. As a result of the NNI, thirty-eight hospitals were removed from the Blue Shield HMO provider network, effective January 2005. Ten later reentered the network by either lowering costs or increasing their quality scores.8 According to Grevious, the NNI has been "effective, but also very controversial," particularly since thirteen of the hospitals removed from the network were from the same health care system, Sacramento-based Sutter Health. As a result of the NNI, CalPERs estimated savings of approximately $36 million in 2005 and projects saving $50 million annually in subsequent years. Although these savings projections are significant, they represent only a fraction of total CalPERS premiums. A longer-term evaluation of this initiative may rest on the extent to which CalPERS can move additional members to the Blue Shield HMO network. Minnesota. In 2002, the Minnesota State Employee Group Insurance Program (SEGIP) introduced a new self-insured purchasing model (Advantage) that tiers providers at the group-practice level. All SEGIP members are enrolled in the program, which grew out of the earlier efforts of a state coalition of large private and public employers in the Buyers Health Care Action Group (BHCAG). The Advantage program ranks more than fifty "care systems" or "clinic groups" based on their risk-adjusted costs. Care systems are then assigned to one of four cost tiers as determined by claims experience, risk adjustment, actuarial models, and collective bargaining. Members select their care system and pay higher copayments, deductibles, and coinsurance when using higher-cost clinic groups. Three carriers—Blue Cross Blue Shield, HealthPartners, and PreferredOne—are contracted as third-party administrators providing a uniform and comprehensive set of benefits. Instead of differentiating members’ premiums among health plans, the Advantage program differentiates price distinctions among care systems at the point of service delivery. SEGIP has estimated that Advantage has resulted in cost savings to both SEGIP members and the state, including $33 million in premiums during its first two years. In 2004, SEGIP costs increased 10 percent, four percentage points lower than the national average. Advantage experienced a zero percent cost increase for 2006. Massachusetts. The Massachusetts Group Insurance Commission (MGIC) undertook an initiative in 2004 to leverage its purchasing power/data in the commonwealth to tier individual providers based on their relative quality and cost-effectiveness. The Clinical Performance Improvement (CPI) initiative requires participating health plans to submit aggregate medical, mental health, and pharmacy claims data to create a consolidated database to support individual-level provider profiling. All participating MGIC health plans use this information, based on longitudinal episode treatment groups (ETGs), to assign physicians and hospitals to two tiers. Members pay different copayments depending on whether they select providers assigned to different tiers. Three of the participating health plans are also tiering hospitals. According to MGIC executive director Dolores Mitchell, the methodology for assigning providers to different tiers is "neither easy nor perfect," but given health inflation trends, she argued that the MGIC "must start to put some heat on the provider community. This [practice pattern and cost-effectiveness variation] is not any one individual or institution’s fault, but I have a strong sense of urgency when I have a budget to put together."9 Private employers experimenting with similar provider-tiering efforts in recent years have reported major administrative difficulties and other hurdles.10 Similarly, the recent PEHP efforts we profiled have also been technically challenging, necessitating sizable investments to develop the data capacity necessary to collect and analyze risk-adjusted clinical information at the individual provider or group level. Moreover, these PEHPs have also faced numerous political obstacles, including resistant provider groups wary of methodologies used to rate individual providers based on efficiency, and assertive public unions wary of higher member costs or fewer provider options.11 Nonetheless, these new directions represent a shift from public purchasers focusing exclusively at the intermediary or health plan level toward focusing attention on participating providers as the loci for cost, quality, and care management. Indeed, like some large private employers, many PEHPs are also eager to leverage purchasing power with providers more directly and assertively and measure results on the basis of both cost and quality. The effectiveness of such efforts, however innovative, may largely depend on the degree to which states and PEHPs have achieved other health care purchasing fundamentals. For example, the combination of multiple plan choice in CalPERS and the state’s policy of contributing on behalf of state employees has produced a market of relatively cost-conscious employees/consumers.12 By contrast, in Massachusetts the state pays 80 percent of the premium of the plan of the employee’s choice, producing inelastic demand and fewer incentives for plans to hold down premiums. To be sure, states’ premium contribution strategies, among other factors, play an important role in determining whether members bear the burden of costlier plan selection.
Uncovering a growing problem. Retiree health care benefits are often major components of public employees’ compensation packages.13 Public employers provide retiree health benefits as a strategy to retain needed workers, along with early retirement options. Most public employers have funded retiree health care benefits (and other nonpension, postemployment benefits) on a pay-as-you-go basis (that is, as retiree claims actually occur) rather than on an accrual basis. A pay-as-you-go approach has allowed states to ignore future expenses that have been promised to retirees and hence to underreport substantial accumulated liabilities that have been incurred as well as those that will be incurred in future years. In 2004 the Governmental Accounting Standards Board (GASB), entrusted with establishing and improving standards of state and local governmental accounting and financial reporting, addressed this problem by releasing Statement 45, which increased the quantity and quality of information included in governmental financial reports.14 Beginning in December 2006, large public employers must calculate and report the annual required contribution necessary to finance future retiree benefits for workers earning those benefits in the current year, as well as the amount necessary to compensate for all unfunded retiree health care liabilities over a period of thirty years. The new standards, similar to standards affecting private employers starting in 1992 (Financial Accounting Standards Board 106), will influence credit and bond ratings for state and local governments. The previously unknown or underappreciated total unfunded liabilities that states and local governments have incurred for health and other retiree benefits will be enormous, with estimates as much as $1 trillion nationwide. GASB 45 is an important and needed contribution to public accounting and oversight that will help ensure that public officials will take the future costs of such programs into account when setting retiree benefits and premiums. Expected responses to GASB. PEHP leaders and policymakers in our study states are just beginning to grapple with the liabilities that have been incurred by PEHP employers. Many states are in a process of projecting their estimated liabilities, in most cases by contracting with outside actuarial consultants. Preliminary estimates are available for two states in our study: California and South Carolina. The California Legislative Analyst’s Office (LAO) estimates unfunded liability for state government to be $40–$70 billion, if not more.15 This figure does not include local governments, which if included would increase this estimate to $100 billion or more. A recent study commissioned by the South Carolina Budget and Control Board reported that the state’s total unfunded actuarial accrued liability is approximately $9.2 billion. The state’s estimated annual net required contribution to finance this liability is projected to be $535 million.16 Other state and local governments will have projections available in the coming months. By making future costs more visible, new GASB standards will place pressures on states (and, in turn, PEHPs) to cut benefits or shift more costs to retirees, as private employers are doing. However, all PEHP executives in our study speculated that policymakers will likely not consider cutting benefits for incumbent retirees or near-retirees in the short term. Several factors explain why responses to GASB 45 will likely be focused on newer or future employees rather than incumbents. First, the new GASB standards will encourage greater prefunding of retiree health care benefits by states and other public employers. Prefunding generally results in higher short-term costs compared with pay-as-you-go financing. Although benefits for current retirees or near-retirees will likely be spared, greater prefunding will place pressures on states to reconsider the level of support for state benefits and establish longer vesting requirements for newly hired employees or future retirees. Second, in many states, retiree health benefits are established and protected by law (and collective bargaining) and thus would require extraordinary political efforts to eliminate or reduce greatly. Moreover, public employee union representatives are elected by current, not future, employees, so they will be more willing to trade off the benefits and cost-sharing arrangements for future retirees to help ensure eligibility and benefit security for incumbents. Third, future or newly hired public employees do not carry the same electoral or political weight as incumbent retirees or near-retirees. Public officials will have to balance pressures for lower taxes, more spending on other worthy programs, and generous public benefits for new hires or future retirees.
The Medicare Prescription Drug, Improvement, and Modernization Act (MMA) of 2003 made government-subsidized prescription drug coverage available to all forty-three million Medicare beneficiaries, reducing cost pressure on PEHPs that provide or subsidize retiree health benefits. MMA allows PEHPs and other employers to discontinue their retiree drug benefit programs, coordinate with or "wrap around" Part D, sponsor or contract with prescription drug plans (PDPs) or Medicare Advantage prescription drug (MA-PD) plans, or continue providing retiree drug coverage (Exhibit 2 ).
To encourage employers to continue providing retiree prescription drug coverage, Congress authorized a retiree drug subsidy (RDS) for employers that can demonstrate that their retiree prescription drug benefits are at least actuarially equivalent to those of the standard Medicare PDP.17 The Congressional Budget Office (CBO) has estimated that Medicare will spend $71.1 billion on employer subsidies between 2004 and 2013, constituting approximately 17.5 percent of MMA’s estimated $407 billion price tag during this period.18 Nine of the twelve PEHPs in our study applied for the RDS and will continue providing retiree health benefits that are at least actuarially equivalent to the standard Medicare PDP. PEHPs participating in the RDS program encouraged members to continue receiving their prescription drug benefits through the PEHP. For example, CalPERS sent letters to members, actively encouraging them not to enroll in Medicare Part D.19 Most PEHP executives view the RDS option as the path of least resistance in the first years of MMA implementation that will give them time to consider other options. States were also attracted to the high degree of control over the subsidy payments that this approach provides. Moreover, at the time many states needed a decision, the final rates and design of PDPs and MA-PDs were not fully available. Further, PEHPs did not yet have the internal staffing or outside consulting expertise in place to comply with federal regulations associated with creation and management of a Medicare PDP or MA-PD. Three PEHPs in our study sample—in Minnesota, Mississippi, and Georgia—reported that they would not receive the employer subsidy. Minnesota’s SEGIP is ineligible because it does not fund retiree health benefits. Mississippi’s State and School Employees’ Health Insurance Plan (MHIP) does not qualify because the net value of its retiree drug coverage was not actuarially equivalent to Medicare’s standard drug coverage. Therefore, MHIP dropped prescription drug coverage for Medicare-eligible retirees and encouraged retirees to enroll in Medicare Part D. MHIP attempted to offset this benefit reduction by lowering premiums and paying retirees’ out-of-pocket Medicare expenses for covered medical services. Georgia’s State Health Benefit Plan (SHBP) elected to coordinate benefits with Medicare Part D, projecting greater savings than would have been available through the RDS or other options. To encourage enrollment in Medicare Part D, the SHBP increased its contribution to members’ Medicare premiums. Medicare-eligible SHBP members who do not enroll in Part D continue to receive primary drug coverage through the SHBP but face higher premiums. Most of the PEHP executives accepting the RDS suggested that they are actively considering alternatives for subsequent years, such as establishing or contracting with PDPs or MA-PDs. The main reasons for considering alternatives to the RDS are the additional possible savings from other options and the administrative burden of the subsidy. Under FASB accounting, private employers were able to reduce their retiree medical liabilities for the actuarial present value of the full subsidy. However, under GASB accounting, public employers must calculate the retiree medical liability without any reduction for the future subsidy they would receive. However, if they offer drug benefits through a PDP or MA-PD (subsidized by Medicare), their retiree medical liabilities can be reduced. These accounting rules will likely create additional incentives for states to move away from the subsidy option in future years.
With health care cost growth continuing to exceed growth in state revenues, with growing cohorts of pre-Medicare retirees, and with greater transparency of accumulated retiree liabilities, public employers face the "perfect storm." This storm will likely result in a substantial narrowing of the historical gap in health benefits "generosity" between public and private employers. In the short run, these challenges have renewed a sense of urgency among PEHP leaders to examine a broader array of strategies to mitigate rising costs. The jury is still out on the effectiveness of the "value purchasing" efforts we highlighted. As has been the experience of similar initiatives in the private sector, delivery-system reforms of this type are politically and technically difficult and will take years to structure, implement, and take full effect before conclusive evaluations are possible. Moreover, even though PEHPs are large purchasers, they cannot unilaterally reengineer the incentives and processes of the health care delivery systems in their states based solely on their own initiatives. Where possible, PEHPs should coordinate such efforts with the private sector (or large employer coalitions) and even state Medicaid programs. At the very least, these initiatives should be coordinated to prevent initiatives that generate different or competing incentive structures for providers and consumers. TO BE SURE, MEDICARE'S NEW prescription drug benefits and payments to employers provide welcome relief for public employers, as drug costs have been a major contributor to overall inflation in PEHP spending. However, these incentive payments will make only a modest down payment on the total unfunded liabilities that PEHPs have already accumulated. In the short run, new accounting standards making these liabilities more transparent are likely to compel state policymakers, public employers, and PEHP leaders to modify retiree vesting and eligibility rules and to change benefits and cost-sharing provisions for new and future employees. In the long run, public employees’ and retirees’ benefits are likely to undergo a gradual transformation, mirroring the private sector’s changes over the past few decades. The pace and form of this evolution will vary from state to state, for at least two reasons. The first is the enduring public employee benefits philosophy, more politically embedded in some states, of placing greater emphasis on benefit security and retirement than on wages, relative to the private sector. The second is the varied presence and role of unions. Policymakers in states with a stronger public employee union presence might be slower to modify (heretofore generous) PEHP benefits and cost sharing. Union presence and strength have similarly contributed to variation in how private employers have responded to rising costs and market changes. For example, only until the near financial collapse of General Motors did the automaker and United Auto Workers seriously engage in major health care benefit design and eligibility changes affecting GM’s union accounts. Nonetheless, to face the many challenges ahead, public employers will likely need to revisit their reliance on richer health benefits, modest cost sharing, and generous retirement plans as primary means for attracting and retaining workers in the future.
Aaron McKethan (aaron.mckethan{at}lewin.com) is a senior associate at the Lewin Group in Falls Church, Virginia, and a doctoral candidate in public policy at the University of North Carolina (UNC) at Chapel Hill. Daniel Gitterman is an assistant professor of public policy at UNC Chapel Hill. Allen Feezor is chief planning officer of University Health Systems of Eastern Carolina (in Greenville, NC), former health benefits administrator for the California Public Employees Retirement System (CalPERS), and former senior deputy commissioner of insurance in North Carolina. Alain Enthoven is the Marriner S. Eccles Professor of Public and Private Management (Emeritus) in the Graduate School of Business at Stanford University in California. In addition to PEHP interview participants and their staffs, the authors thank the numerous individuals and reviewers providing valuable insights, guidance, and assistance, especially Derek Guyton (worldwide partner) and George Wagoner (worldwide partner and chief actuary) at Mercer Human Resource Consulting. Aaron McKethan also gives special thanks for the patience and support of his wife, Sarah, who switched jobs, gave birth to their first child, and moved to a new state as her husband wrote this paper.
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