How's this for pointing out the obvious? Health-care costs are out of control. Just ask any company owner who provides employees with health insurance, and you'll hear a tale of woe.

According to a recent study by human-resources consulting firm William M. Mercer, employers saw their health-care costs go up by an average of 11.2% in 2001. At the time of the study, those employers were expecting an average increase of 12.7% for 2002. But the news is actually worse for many small companies, some of which are burdened with premium hikes of as much as 40%.

For Peak6 Investments, a Chicago-based options-trading firm with 60 employees, the rising costs have been particularly galling. For each of the past two years the company got socked with 20% to 25% premium increases, which were all the more painful because the company pays for 100% of its employees' coverage. "Typically, employees in this field get very low salaries and make most of their income from bonuses or commission," says Karen Day, Peak6's human-resources manager. "So when we're recruiting, a strong benefit package is a great way to get talent in the door."

Day usually seeks alternatives when she's renewing the company's coverage, and last year her research turned up Destiny Health, an insurance provider servicing the metro-Chicago area, which was offering something called a defined-contribution plan. Such plans represent the first major shift in health-care coverage since the onset of managed care. They feature what observers, providers, and participants say is a killer combo of better choices for the employee and greater cost control for the employer.

Peak6's coverage through Destiny Health is a typical defined-contribution plan, characterized by "personal-care accounts" for employees' medical expenses. The employer contributes a given dollar amount to the employee's personal-care account for use on any standard medical procedure, after which the employee is responsible for payments up to a preset ceiling, whereupon the insurance will cover any further expenses. The dollar amounts that companies and employees give to defined-contribution plans vary from company to company.

At Peak6, each single employee receives $600 in a personal medical fund (PMF) to pay for day-to-day medical expenses. The employee pays for the next $300 out of pocket, and any amount over that initial $900 is covered through a conventional preferred-provider-organization (PPO) policy. (Catastrophic and emergency situations are processed separately through a standard indemnity policy.) But here's the key point: any of the first $600 that the employee doesn't use will be rolled over to the next year. And if the employee should leave the company, he or she gets that money, including any accrued interest.

The goal of the plans is to disabuse employees of the notion that everything costs $10 (a standard copayment amount) and to give them an incentive to make cost-effective choices -- for instance, avoiding expensive trips to the emergency room. "Other plans basically hand people a credit card with no limit," says Day. "The Destiny approach was our only hope for getting employees to understand the cost of the benefit so that we can continue to pay for it in full."

Defined-contribution plans generally include a wellness component, exemplified by Destiny Health's Vitality program. Participants who take certain steps toward a more healthful lifestyle -- such as quitting smoking -- receive "Vitality points," which they can apply toward a health-club discount or even an increased interest rate on their PMFs. (The interest rate starts at 3%, but through the Vitality program employees can push it as high as 10%.)

As for Peak6's costs, Day admits she could get similar coverage elsewhere for about the same money. But she anticipates significantly lower -- probably single-digit -- premium increases in the future, mostly due to the incentives for employees to conserve. "We're already seeing employees really becoming consumers, questioning and negotiating with doctors and preserving their PMF balances," she says.

Innovation often arises from the efforts of start-ups, and the defined-contribution concept is no exception. Now large insurers like Aetna and United HealthCare have begun getting in on what many consider to be the future of health insurance. Ken Linde, president and CEO of Destiny Health, is also chairman of the Consumer Driven Healthcare Association (CDHA), a consortium of six emerging health-care companies that was founded to help promote awareness of the consumer-driven-health-care alternative. And awareness is indeed building. According to an April 2002 survey by the Kaiser Family Foundation, 35% of small businesses say they are likely to switch to a defined-contribution plan within the next year.

That is, if they can find one.

Before you call your broker, you should know that the programs are as yet limited by geography. For example, Destiny Health has so far created plans only for Illinois-based employers, although the company was recently cleared to sell to customers in Wisconsin and Washington, D.C. And Linde is looking to expand into three to five more states over the next few years.

For now, some upstart providers are teaming up with established insurers, as is the case with MyHealthBank and Regence BlueCross BlueShield of Oregon. Larry Thompson is human-resources manager at @Once, a permission-based E-mail-marketing company in Portland, Oreg., which has 65 employees. To get better customer service and to combat consecutive premium increases of more than 25%, Thompson switched the company from a health maintenance organization plan to a MyHealthBank plan. At a cost equivalent to the company's previous HMO plan, @Once can now offer employees three options: an HMO, a PPO, and a traditional indemnity plan. The company pays 100% at the HMO level. Employees who select the indemnity plan pay a bit extra for the privilege. And for the PPO, the least expensive option, the company puts its savings into employees' flexible spending accounts, which they can then use to offset expenses.

On-line administration is another significant source of savings in defined-contribution plans. Participants typically have access to a password-protected site where they can educate themselves about the program. Employers can usually take care of their side of benefits management on-line as well.

Some critics fear that defined-contribution plans will prevent genuinely sick employees from seeking necessary health care because they might choose to pocket the money instead. Depending on the plan, employers can restrict not only how employees use their medical funds but also the percentage of the money that they get to take with them if they leave the company.

Cynics might view the plans as a smoke screen to disguise a reduction in health-care benefits. "We don't generally sell this as a cost reduction, rather as cost containment. The hope is, it will improve the quality of benefits and health care in the long term," says David Cowles, cofounder of Benemax, a benefit-management company in Medfield, Mass.

As far as Karen Day of Peak6 is concerned, the defined-contribution sector appears to be off to a good start. Destiny Health, she says, has taken a very active role in educating Peak6 employees about the program. "They even give them a welcome call, asking, 'Do we need to walk you through the plan?' " she says. "How many insurance companies do that?"

Christopher Caggiano is a senior associate editor at Inc.

Healthy Choices

Think a defined-contribution plan might work for your company? Depending on which insurer you want and which version of the plan you'd prefer, you may have to wait awhile for your first choice to come to your region. But the good news is that as of this writing there are options available in all 50 states. Here's a list of vendors that currently offer plans to small companies.

Benemax ( Available in all 50 states. Currently has subscribers in 40 states, including Massachusetts, New York, and California.

Destiny Health ( Now in Illinois. Has recently been cleared to sell in Wisconsin and Washington, D.C.

HealthMarket ( Currently available in Georgia, Indiana, Missouri, Ohio, Pennsylvania, Texas, Virginia, and Washington, D.C.

MyHealthBank ( Currently offering plans in Idaho, Oregon, Utah, and Washington State. Available only through the Regence Group (BlueCross BlueShield), at

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