The rising cost of health care is hurting small companies everywhere. While there are no grand solutions, there are steps you can take to keep your costs down

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It hasn't come to this. But with the general inflation in health-care costs, who could blame a company owner for fantasizing about placing such an ad? After all, annual premium increases of 20% to 40% have been routine in recent years. And many experts expect rates to rise an average of 15% a year over the next five years, which means that employer costs could double between now and the mid-1990s.

None of this comes as a surprise to Jim MacDougald. When he renewed his company's medical plan last year, the insurance company had raised the premium 70%. That was tough to take for a business with 25 employees and $4 million in sales. It was especially tough for MacDougald, chief executive of Applied Benefits Research Inc., because his Clearwater, Fla., consulting firm assists other companies with their benefit plans.

The reason for the hike: an employee's dependent was confined to a hospital with a long illness. Since no other insurer would touch MacDougald's company, "we got stuck," he says, "with paying any blackmail price they wanted to charge."

Being at the mercy of an insurer is fairly common for small companies these days. But MacDougald knew better than to let himself be whipsawed again. He's making changes in his medical plan, including various cost-containment programs and cost sharing with employees.

Unfortunately, though, not all cost-containment strategies are available to all companies. One variable is location; generally, businesses in densely populated states have the most choice. Another is size. Insurers offer companies with more than 100 employees a broader selection of medical plans than they do smaller companies.

Still, most CEOs owners can follow Jim MacDougald's lead and take steps to reduce their premiums, or at least limit the rate of increase. And they can do it without gutting their plans or compromising the care their employees receive.

While the steady increase in health-care costs is a tide that no single company can turn back, there are strategies to help you manage these costs more effectively. Yet the most successful CEOs go beyond what's written in an insurance contract. They give employees an incentive to be involved in the company's health. Whether it be because of profit sharing, information sharing, equity participation -- or all three -- these employees are cost conscious not only about health care but about every phase of the business. Holding down costs is to their advantage as well as the company's.


What group of 125,000 people has received increases of only 21% in their health-insurance premiums since 1984? A big company with the muscle of, say, Mobil Corp. or Procter & Gamble Co.? Wrong. It's a coalition of 6,400 small companies in the Cleveland area whose $105 million in annual premiums speaks the language that insurers can understand: size and power.

Companies with fewer than 100 employees get little attention in the insurance marketplace; they are the small fish that everyone throws back. Their choices are limited and they pay more for everything they do get. That's why, in 1974, the Council of Smaller Enterprises (COSE) in Cleveland, part of the Greater Cleveland Growth Association, bargained with Blue Cross/Blue Shield of Ohio for a 10% discount on the cost of group health-care benefits for its member companies.

The plan was not very successful; between 1978 and 1982, premiums soared by 130%. So COSE tried a different tack. Instead of acting simply as a conduit through which its members bought insurance, COSE itself became the customer, looking to all the world like a Fortune 500 company. Premiums dropped 15% in 1985, the first full year under the new plan, and in the next four years rose by an average of less than 9% annually -- at a time when increases nationwide were running 20% to 40%.

COSE's performance reflects the realities of an insurance marketplace in which size and power are next to godliness. It negotiated a variety of sophisticated plans with various cost-control features and took over administration of the plans, including centralized enrollment, billing, and reimbursement. Insurers charge between 5% and 15% of the premium for administration costs; COSE charged less than 1%.

"For many small companies, the only hope they have to bring costs under control lies with the formation of purchasing groups," says John Polk, executive director of COSE. But coalitions need not be as big as COSE to be effective. A handful of other purchasing groups flourishes around the country, usually organized by local chambers of commerce. In terms of bargaining clout, a chamber is often more effective than an industry trade association because of its ability to concentrate its power on local providers.

Apart from the advantages conferred by size, a coalition is most effective if it does three things:

* Negotiates the plans as if the coalition itself were the customer.

* Administers the plans itself or uses a low-cost third-party administrator.

* Manages the claims information, which will enable it to identify ways to further cut costs.

How Did You Choose Your Agent?

Chances are good that you went with the insurance agent who sent you a pitch letter and a proposal. And you'll probably dump that person when another agent arrives with yet another promise to lower the cost. But there is a better way: consult with local companies of about your size. Have they used their agent for at least three years? Has their agent been aggressive in incorporating cost-saving mechanisms? Then, of course, interview the agent. Consider your decision as carefully as if you were hiring a key person for your company -- because you are.


In many circles, self-insurance is regarded as a high-risk gambit best suited for poker players with a steady hand. While self-insurance isn't for every company, if you have a good claims record and more than 100 employees, you should at least consider it -- especially if your premiums are climbing steeply. You may be able to do much better simply by paying the claims as the bills come in. (Companies with fewer than 50 employees are beginning to organize into self-insurance cooperatives; see Hotline, December 1989, [Article link].)

Sandmeyer Steel Co., in Philadelphia, found itself in that position five years ago. Its annual claims, or loss ratio, were about 70% of the premiums it was paying, which means that the insurance carrier was keeping 30% of the premiums for administrative expenses and profits. Since an 80-20 loss ratio is usually considered fair, the insurer was keeping more than its share. The company, whose 140 employees make stainless-steel products for manufacturers, decided to self-insure.

President and CEO Ron Sandmeyer reports that the company has saved at least 10% a year on its health-care costs. The biggest saving, 5% or more, comes from the lower cost of administration -- third-party administrators, companies that handle paperwork on self-insured plans, charge up to half the rate of insurance companies. In addition, self-insured companies don't pay state tax on premiums or cover certain state-mandated insurance benefits, such as psychiatric care, though they may elect to have this coverage. Finally, self-insured companies don't have money tied up in reserve accounts with an insurance company; when Sandmeyer Steel self-insured, it got about $100,000 back from its carrier.

No company should self-insure without buying stop-loss insurance, which puts a lid on what it will pay out in claims. A 100-employee company, for example, might buy stop-loss to pay individual claims over $25,000 or the year's aggregate claims above $300,000. To calculate the aggregate, insurers usually add 20% to the prior year's claim record to adjust for industry trends, then another 20% to 25% in margins.

With stop-loss, companies can limit the risks of self-insurance and budget at the start of each year for the maximum possible claims. Experts urge companies to establish their own reserve funds so that an unexpectedly high claim or a drop in cash flow doesn't leave employees waiting months to be reimbursed for their claims.


Employees of The Bank Mart will each tell the personnel department what benefits they want in 1990. Just as they did in 1989.

The mutual savings bank, in Bridgeport, Conn., started a cafeteria plan a few years ago for its 220 employees. Once an option only for large companies, cafeteria plans are now routinely available for companies with as few as 50 employees. In cafeteria plans -- also known as flexible benefits -- the employer's contribution usually comes in the form of a spending credit, which the employees use to "purchase" various options from a menu of benefits. One person might choose more health insurance and less life insurance; another, less health-care and more life and disability coverage.

For employees, this flexibility is attractive because they can tailor their benefits and levels of coverage to their own needs. For companies, it can mean savings on health-care costs. In a survey last year by Hewitt Associates, a benefits consultant in Lincolnshire, Ill., per capita medical costs for cafeteria plans rose 14.3% in 1987, compared with 20.4% for private plans nationally.

The Bank Mart's experience shows how flexible plans can achieve these savings. Under its plan, the number of employees who opted out of medical coverage (because they were covered by their spouses' plans) increased from 10 to more than 30. "Before, 20 people were taking it simply because it was given to them," says Carol Levey, manager of compensation and benefits.

Other employees chose lower-cost medical options, such as higher deductibles and copayments, and used the credits they saved on something else. This brought immediate reductions in the cost of health coverage. And the company will likely see more reductions in the future, since cost-sharing usually reduces overuse of medical services.

Even greater savings could come later because the company, if it chooses, can avoid the full burden of future increases in medical costs. The plan moves it away from the traditional defined benefits approach -- we'll provide certain benefits, no matter what the cost -- to a defined contribution approach. Each year, The Bank Mart will set its level of contribution to the entire benefits package, most of which goes to the medical plan; if the cost of medical coverage increases 20%, for instance, the company might raise its contribution by only 10%, leaving to employees the choice of either spending more of their own dollars or opting for a less expensive plan.

"We know that down the line, costs are increasing," says Levey. "I have a feeling that in 1990, we will be sharing more costs with employees."

Per Capita Medical Cost Increases:

Cafeteria vs. Other Plans

1985 1986 1987

Cafeteria plans 6.6% 8.2% 14.3%

All plans nationally 8.8 11.9 20.4

Source: Hewitt Associates, Lincolnshire, IL, 1989.


The news was bad for Tassani Communications: last April the company's insurer gave notice of a 50% increase for the plan year. Desperate to contain costs, the $25-million, 60-employee company scrapped its indemnity plan for a preferred provider organization, or PPO. The premium increase declined to 30%, still high but several thousand dollars less each month than the indemnity plan.

Tassani joins a growing number of companies offering managed care, which includes PPOs and health maintenance organizations, or HMOs. More than 60 million Americans are enrolled in managed care, most of them in plans offered by large companies. Fewer than a third of the small manufacturers in a National Association of Manufacturers survey offered HMOs or PPOs in 1989.

But they soon will. Insurers that once ignored the small end of the market now are competing to sign up companies with as few as two employees. The reason for small companies to heed the new pitch is compelling -- managed-care plans usually save money. In addition, enrollment in a managed-care plan enables small companies to avoid much of the cost shifting now going on in the market (see Negotiate the Best Deal, page 6).

The traditional medical plan, now slowly fading away, is an indemnity program in which providers are reimbursed on a fee-for-service or a cost-plus basis. Employees are free to choose their own physicians and hospitals. That the cost of these programs has soared should come as no surprise: there are no restraints on use of medical services or on fees charged by providers.

Managed care is supplanting the traditional plan because it is designed to contain costs. Here is a brief guide:

How They Work:
HMOs receive a set annual fee for each enrollee, which gives them an incentive to deliver cost-effective care. Employee payments are limited to about $5 for each visit to a doctor's office. Each patient has a primary physician who controls access to medical services.

Your Savings: This varies widely. Some companies report no savings at all, but generally you can expect a 10% savings over the cost of a traditional indemnity plan. Some companies may save as much as 40% if local HMOs are competing vigorously for market share. Premium increases may also be lower. For example, Cigna Corp. reports that its HMO premiums increased an average of 9% a year between 1983 and 1988, compared with 18% for indemnity plans.

What to Look Out For: Check the HMO's reputation for delivering quality care. Also, check its history of premium increases. Beware, too, of offering a choice of an HMO or an indemnity plan. Younger, healthier employees tend to select the HMO, while older, less healthy people become concentrated in the indemnity plan. Indemnity premiums go up as a result -- often negating any advantage of the lower HMO rates. The solution is to contract with an insurer that offers both an indemnity plan and an HMO and will base rates on the history of all your employees together.

How They Work:
A network of physicians and hospitals agrees to a fee schedule that usually represents a 10% to 20% discount on their usual charges. The physicians may also agree to a set of procedures designed to keep costs down. Employees can use non-PPO providers, but companies provide incentives -- lower deductibles and copayments -- to encourage them to stay within the PPO network.

Your Savings: You can expect to pay 5% to 10% less than the cost of an indemnity program. If you offer very low deductibles and copayments or waive them entirely -- which many companies do when they introduce the program -- you may realize no savings at all.

What to Look Out For: Does the PPO have a reputation for quality care? Does it have broad coverage geographically and by specialty? Check the PPO's history of premium increases, since they usually can't control the use of physician services very well, especially when deductibles and copayments are low. "Utilization can go up like crazy," says Larry Tucker, a partner and benefits consultant with Hewitt Associates. The remedy: raise deductibles and copayments, while still maintaining a financial incentive for employees to use the network.

Manufacturing Companies Offering HMOs/PPOs

Number of employees

20,000+ 85%

5,001-20,000 82

1,001-5,000 63

301-1,000 44

101-300 35

51-100 27

25-50 28

Fewer than 25 22

Source: National Association of Manufacturers Health Care Survey conducted by A. Foster Higgins & Co., New York City, 1989

Growth in Number of Participants* (in Millions) Enrolled in HMOs, 1978-88

1978' '79 '80 '81 '82 '83 '84 '85 '86 '87 '88

8.5 9.5 10 10.5 11 14 15 19 24 29 31

* Excluding dependents.

Source: From a survey of HMO plans conducted by InterStudy, Excelsior, Minn.

Check Your Dependent-Care Policy

If many of your employees have working spouses, you may want to think through your company's dependent-care policy. When dependent coverage is essentially free, employees may be taking it even though their spouses are covered where they work. So the extra $2,000 or so that your company spends in those cases is wasted. In other instances, the employer of the spouse may be charging for dependent coverage -- so if you are providing it free or at a nominal charge, the dependent coverage will end up on your account. The trick is to come up with an amount to curb these problems that is still reasonable for sole breadwinners.


Mark Kaplan is holding two versions of a hospital bill in his hands. Nothing unusual in the first one: tubal ligation, a stay of two days. The hospital wants $3,580.05.

Most companies would pay the bill. Kaplan, director of human resources at Mandel-Kahn Industries Inc., sent it out for an audit instead. The second bill, postaudit, he did pay: $2,696.91. After the cost of the audit, the company saved 16%.

This is routine for Mandel-Kahn, a Houston-based distributor with 800 employees. Every audited hospital bill comes back with savings of at least 15%, and the hospitals don't dispute the new figures. Most of the savings come from reduction of charges that are above the usual and customary, but others are for services that were never performed. "I've had male patients charged for vaginal examinations," says Kaplan. "We've been charged for hospital stays when there wasn't any stay at all."

Auditing the work of health-care providers is part of a broad strategy known as utilization management, which attempts to limit costs by overseeing the length and necessity of hospital stays and many outpatient procedures. The services are provided by many insurance companies and by an array of vendors whose largest player, Intracorp, of Berwyn, Pa., covers 25,000 employers and 11.5 million people. A study published last year by The New England Journal of Medicine found that one insurer's program had slashed medical bills by 8.3% for 222 patient groups. And Mandel-Kahn hasn't had a rise in medical costs since 1985.

Utilization review began in the 1970s when many health plans required second opinions before surgery. Today it includes a variety of initiatives:

* Precertification review. The centerpiece of the strategy, the review takes place before hospital admittance and is an attempt to prevent unnecessary hospitalizations and limit the duration of hospital stays. Where appropriate, it shifts procedures to less expensive outpatient facilities.

* Concurrent review. Once hospital treatment starts, this review controls the length of stay and makes sure the treatment is medically appropriate.

* Case management. Broader than concurrent review, it monitors care throughout a catastrophic illness.

* Mental health and substance abuse-care review. Various strategies are employed to control soaring costs of care in this area.

* Hospital bill audits. This strategy tries to cut the cost of care by finding overcharges.

Many of these services cost a few dollars a month per employee, but they often save multiples of that. Used by big companies for years, they are available now to businesses with as few as 50 people.

Last year a Mandel-Kahn employee was seriously injured in an automobile accident. Not willing to accept the hospital's charges at face value, the company sent the bill to Intracorp, which conducted an on-site audit (see Audit Results, next page.)

Enlist Employees in Your Strategy

Few cost-containment strategies are more effective than frank and frequent communication with employees. Smart managers routinely tell employees how much the company spends on medical care and how costs have gone up over the years. Without such information, many employees probably think of health care as "free" in the sense that some faceless insurance company is paying the bills.

Once employees see the relationship between company savings and the resources available for raises, bonuses, and profit sharing, their health-care decisions can change dramatically. And you can help influence those decisions by pointing out the cost savings of using a primary physician or clinic instead of an emergency room for routine care, buying generic drugs, and examining bills for overcharges.

Read the Fine Print
If you're looking for ways to cut health-care costs, one place to start is by examining your current policy -- something few executives do. Gust Headbloom, owner and CEO of Apex Broach & Machine Co., a tool and machine manufacturer in Detroit with 51 employees and $6 million in sales, was surprised at what he found in his. Headbloom discovered that his insurer had been routinely billing the company for what struck him as an unusual item -- maternity benefits for the company's retirees. His retirees were a lively bunch, to be sure, but Headbloom decided to save the $2,623 a year just the same. "We realized that these rascals just weren't playing around anymore," says Headbloom.

Audit Results
(For explanation of charges, see "Facts Behind the Audit," right)

Total bill $19,612.74


Personal items 1.85

Undocumented items 690.90

Charges more than fair and reasonable 5,281.11

Charges unrelated to carrier's responsibility -0-

Not medically necessary days/services -0-

Mathematical errors -0-


Undercharges 325.30

Savings 5,648.56

Total recommended payment 13,964.18

Less previous payments 15,650.24

Total due $1,686.06 credit

Facts Behind the Audit
1. Total bill

This is what the hospital charged for the patient's stay.

2. Undocumented items

Eliminated charges for 23 separate items and procedures that either were undocumented or not performed at all. One such procedure was a chest X-ray billed at $64; another was for seven wound dressings billed at a total of $173.20.

3. Charges more than fair and reasonable

Reduced charges, often by half or more, for 81 separate entries. For example, the hospital billed five units of anesthesia at $93.20 each, far above the fair and reasonable cost of $37.50 each; it billed crutches at $65.65 when the fair and reasonable was $31.80; it charged $150 for a drainage instrument whose fair and reasonable was $50.75.

4. Undercharges

Picked up items that the hospital failed to charge, and these were added back into the bill. Many of these were medications.

5. Savings

Net overcharges represented 29% of what the hospital billed. Even after the auditing charge of $590, the company saved 26%.

6. Total recommended payment

What the auditor says the company should pay.

7. Less previous payments

The required payment to the hospital of about 80% of the bill before the audit.

8. Total due

In this case, it's the hospital that owes some money.


Raising the cost to employees -- it's the fastest way for a company to reduce its health-care expenditures. And unless it's handled carefully, it's also the one most likely to cause a rift in management-employee relations.

Companies have several ways to pass on costs to employees. One of the more common practices is to require employees to contribute more to the premium, which reduces the company's cost dollar for dollar.

They also can require employees to pay more for each visit to a health-care provider. One way is to raise the copayment -- the percentage that the employee pays for each claim -- from, say, 10% to 20%.

Or they can raise the deductible. Raising the deductible from $100 to $250 will slice 8% to 10% off a health-care premium; raising it to $500 will lop off another 10% or so. Companies often reap additional savings because employees who share the costs are likely to use medical services in a more cost-effective way.

A $100 deductible used to be the standard, and still is in certain parts of the country, such as the Northeast. But that is changing. "We used to have 80% of our business in $100 deductibles, but now, more than half is in $250," says Howard Bolnick, president of Celtic Life Insurance Co., one of the leading small-company insurers. "I would expect to start seeing more and more $500-deductible plans being sold."

The idea behind higher deductibles is straightforward enough: employees should insure themselves for the small claims, as they do with auto insurance, and depend on their insurer to cover the bigger or recurrent claims that might be beyond their ability to pay. But raising deductibles to $250 or $500 could severely hurt many lower-paid employees. Some experts suggest implementing a progressive scale that pegs deductible levels and employee premium payments to the level of compensation.

Any plan that takes more dollars out of an employee's pocket can run the risk, of course, of damaging workplace relations. To help reduce the resentment, companies might consider the following strategy:

* Try other cost-containment measures before looking to employees for a bigger contribution. If you find that you still have to cut down on costs and choose to seek more money from employees, at least you will have established a good-faith attempt to look for other solutions first.

* Lay a careful foundation for any change in contribution levels. Explain to employees how much their health insurance costs, how much premiums are rising, and how those costs affect the company's profitability and competitiveness.

Negotiate the Best Deal
You're probably picking up the tab for someone else's "deal." All you need to do is look at the costs of a day's care in a typical hospital, Tulsa's Hillcrest Medical Center. The hospital's average daily expense was $779 last year. A small company's medical plan, though, probably paid something like $1,278.

Hospitals like Hillcrest cut low-cost deals with many parties, then make up for their loss of revenue by shifting their costs to someone else. Uninsured patients paid only $220 per day of the average $779 cost of care at Hillcrest last year. And the federal government paid only $445 a day for patients on Medicaid and $640 for those on Medicare. To meet its budget, Hillcrest shifted the costs to private employers. Those within networks such as HMOs negotiated rates of $1,050 a day -- far more than the average cost, but still favorable compared with the $1,278 charged to companies with traditional indemnity plans.

One Day's Cost for Patients atHillcrest Medical Center

Uninsured $ 220

Medicaid 445

Medicare 640

Actual cost 779
Network 1,050

No network 1,278

Source: Hillcrest Medical Center, Tulsa, Okla.


Many companies are beginning to see that the personal habits and lifestyles of their employees can have a major impact on health-care costs. That's why more and more now forbid smoking in the workplace or refuse to hire smokers at all.

In a landmark study of its health-care claims from 1980 to 1982, Control Data Corp. found that high-risk employees -- those who smoked, had high blood pressure, were overweight, or rarely exercised -- cost the company hundreds of dollars more every year in medical claims than their low-risk colleagues.

Slowly, health insurers are beginning to believe numbers like these. Now, the Travelers Insurance Co., for one, offers discounts of up to 12% for companies of 10 to 49 employees if they rate favorably on several risk factors. John Alden Life Insurance Co., in Miami, offers similar discounts for companies of 25 or fewer employees in the Southeast. And the Greater Oregon Health Service provides its own wellness program to 25 small businesses in the state; if claims for any of the companies fall below a predetermined level, the carrier returns half of the savings to them. Greater Oregon reports that the average company participating in its wellness program saves about $167 per employee per year in health premiums compared with companies that don't participate.

Wellness programs need not strip the treasury bare. Many companies take advantage of free or low-cost screenings and workshops offered by the community outreach programs of local hospitals and by nonprofit health organizations such as the American Heart Association, the National Cancer Society, and the March of Dimes. A fitness program need be no more than the cost of a VCR and a few tapes, or the purchase of T-shirts for employee sports teams.

Companies can spend much more, of course. Maupintour Inc., a vacation tour company with 165 employees, built a small fitness center at its headquarters in Lawrence, Kans., in 1981, outfitting it with a treadmill, stationary bikes, weights, sauna, and lockers. The company hires only nonsmokers, bans smoking in its offices, and sponsors sports teams. The cost of the entire program last year was about $5,000. Maupintour hasn't studied its return on investment in wellness, but personnel director John Gibson says, "Our health-insurance rates haven't gone up like other companies in the area."

How to Put Together a Wellness Program

Before starting your own, here are some things to consider:

* Be sure employees want the program. They should understand its purpose. Distribute a questionnaire asking for their suggestions.

* Target the right people. "Don't preach to the committed," says Charles Kuntzleman, program director of Fitness F