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Price of Promises: Health care costs rise, the state considering trimming employee benefits

Keith Brainard of the National Association of State Retirement Administrators says states tend to accumulate the largest long-term costs for retiree benefits by offering open-ended promises of providing health services.

Health insurance for public retirees used to be considered a throw-away benefit, according to Keith Brainard, research director for the National Association of State Retirement Administrators. It used to be OK to say, "Yeah, we'll throw that in too."

But nationwide, the annual cost of providing public retiree health insurance now hovers around $25 billion, making states reconsider the promises they'll make to future public employees.

"When most of these retiree medical benefit structures were enacted 10, 20, 30 years ago or longer, medical benefits were not nearly as expensive," Brainard says. "And medical inflation was not nearly as high as it is now."

In Illinois, this benefit carries a nearly $2 billion price tag. The long-term cost of providing health, dental, vision and life insurance options to its public employees and retirees has jumped 7.4 percent over last year's $1.8 billion liability, according to the Illinois Department of Healthcare and Family Services. The bipartisan Commission on Government Forecasting and Accountability estimates that increase at 8.9 percent. 

The 346,000 Illinoisans enrolled in the health benefit include state employees, their dependents and retirees. Teachers, university employees, lawmakers and judges have their own separate health systems with similar benefits. Gov. Rod Blagojevich's main administrative agency, Central Management Services, handles all the paperwork and administrative support for the benefits, but the Illinois Department of Healthcare and Family Services manages the contracts with the health insurance companies.

But no agency — as in most states — really knows how much money Illinois should set aside to satisfy the state's promises of providing health benefits to retirees. That's because, until this summer, the state has relied on a pay-as-you-go system by calculating only the benefits claimed in that fiscal year. That has relieved the state from having to set aside revenue to cover the cost over the long term of retirees' health benefits.

Starting in July, however, new accounting standards will pressure state and local governments to disclose their actuarial liabilities, which is the current value of benefits already earned by employees and the benefits they're expected to earn in the future. The rule was issued by the Governmental Accounting Standards Board, a nonprofit, nonpartisan organization created to improve the rules for governments' accounting of finances and reporting to the public.

Disclosure of the costs related to retiree health benefits and other nonpension benefits could put more pressure on state and local governments to figure out how to curb those long-term obligations.

The timing of the national accounting rules coincides with the onset of Baby Boomer retirements. As more public retirees start drawing on their Illinois pensions, they will be able to take advantage of "premium-free" health benefits. They have been promised 100 percent of their monthly premiums as long as they have spent at least 20 years on the state payroll. The state's share drops to 5 percent for retirees who put in between eight and 20 years of service.

Paying for these past promises will force the state to think twice about future promises. In other words, Illinois may need to weigh whether it should revise the benefits offered to new employees long before they retire.

One solution might be to mimic the private sector by offering less generous health benefits in retirement and requiring new employees to pay more of their own health care costs. Both tactics would be politically challenging because making those changes wouldn't pay off for another few decades.

Currently, the state pays much more of the cost of employee health benefits than the private sector does, a point highlighted in a foreboding report issued late last year by the Civic Committee of the Commercial Club of Chicago. 

The business group warns the cost of employee and retiree health benefits have grown by about 14 percent a year since 2000, far exceeding the 4 percent revenue growth during the same time.

The committee suggests Illinois should scale back subsidies and require state employees to enroll in a type of health insurance plan called managed care, which is expected to cost the state less. Managed care, because it requires everyone to have a primary care physician who serves as a gatekeeper for referrals, reduces the chance of redundant — and expensive — tests or procedures. Further, managed care sets boundaries with a preferred network of providers who are under contract with the state.

"Managed care programs tend to be less expensive because you're getting some control over medical care interaction," says Stephen D'Arcy, a John C. Brogan Faculty Scholar in Risk Management and Insurance and a finance professor at the University of Illinois at Urbana-Champaign. "[HMOs] have incentives for keeping people healthy, for intervening early on in the disease in order to have a minimal amount of treatment."

Most of Illinois' state employees, not including teachers or university workers, are enrolled in managed care plans, but another 40 percent, or 135,000 people, choose an option that is more expensive for the state. These patients can see any doctor, and the state uses a different way to pay the providers. Unlike managed care plans, D'Arcy says, such "fee-for-service" systems provide an incentive for doctors to prescribe more tests or procedures because their payment is based on the number of services rendered.

The Commission on Government Forecasting and Accountability says the state could save money by encouraging more employees to enroll in managed care options. The commission's March 2007 report says, on average, each managed care patient costs the state $4,367, compared to about $5,939 per person in the indemnity plan, in which patients can see any doctor they choose.

But switching a few thousand more state employees to managed care wouldn't really solve the state budget crisis, says Sen. Christine Radogno, a Lemont Republican and commission member. She's also a one-time candidate for state treasurer and the GOP budget negotiator for her chamber.

There are other factors that help drive up costs for the state. For instance, about 325,000 former teachers are enrolled in the Teachers' Retirement System with its own health benefit plan, according to that system's 2006 financial report. In fiscal year '05, more than half of teachers who retired took an early retirement option that allowed them to work their final days before they turned 60. They had to work between 20 and 35 years to qualify. That's expensive for the state, Radogno says. 

"To have folks retire at age 55 and then live to be 85, 90, is probably not something that was envisioned when these plans were set up. It's just becoming a huge problem."

A longer life span and 15 years of health-care inflation contribute to the state's ballooning costs, a problem the Blagojevich Administration says it has taken steps to solve.

The administration already has mimicked the private sector and prioritized efficiency, says Becky Carroll, the governor's deputy chief of staff for budget policy and communications. "We are always looking for new and efficient ways to save the state money: better, faster, cheaper, without compromising on the benefits owed to our state employees or to the public."

Shortly after taking office, Blagojevich issued an executive order that consolidated the state's health-related functions, including contracts for the state employee health insurance, under the Department of Healthcare and Family Services.

"It increases our purchasing power and procurement power," Carroll says. "Having it all under one roof with one set of experts is a more efficient way of managing."

Blagojevich also banned stockpiling of vacation days, meaning state retirees can no longer cash in more than $100,000 in unused vacation days when they leave state service. They're limited to carrying over five vacation days a year.

The state also expanded the availability of the managed care plans to more regions of the state and renegotiated health care contracts, including adjusting health benefits for members in bargaining units of AFSCME Council 31, which represents state, county and municipal employees. The new AFSCME contract alone saved $34 million and was part of $216 million saved by revising health care procurement and employee benefits, according to an October 2005 report by Deloitte Consulting LLC commissioned by the governor.

Most of the low-hanging fruit has been plucked and squeezed for savings, says Carroll. "There's much slimmer pickings these days."

However, she adds, the new federal accounting rule could help focus the debate on ways to do things more efficiently without compromising the quality of services. The state might get more bang for its buck, for instance, by honing in on the types of promises it makes to future employees.

Brainard of the National Association of State Retirement Administrators says states tend to accumulate the largest long-term costs for retiree benefits by offering open-ended promises of providing health services. He says it would be cheaper to offer a close-ended "defined contribution" plan, in which the state vows to pay a specific amount toward an employee's medical premium each month.

There also are plenty of other ways to tweak public retiree medical benefits. States could require higher deductibles, higher co-payments or even a lifetime limit on the benefit.

Radogno says she supports looking into higher co-pays and the concept of health savings accounts, which are high-deductible plans that put the consumers in charge of the way they spend their health care dollars. The minimum deductibles cost $1,100 for coverage of an individual and $2,200 for family coverage, but the federal government offers a tax incentive.

"[Higher co-pays and health savings accounts] are good because it makes people connect that whatever they're doing has a cost to it," says Radogno. "It may even impact, ultimately, behavioral choices."

Smoking, being overweight or not exercising, for instance, could cost the consumer more money. "I think anything to bring the consumer into the whole payment mix, along with the insurance companies and the hospitals, is a good thing," Radogno says.

In the past, however, health savings accounts haven't been practical for the chronically ill. Some of the most prevalent diseases tend to be the most costly for employers because patients are more likely to have hospital stays, sick days and expensive prescription drugs. 

The Center for Studying Health System Change, a nonpartisan policy research group in Washington, D.C., issued a report in February that lists other "innovative" ways to get the consumer more involved in his or her health care. Instead of discouraging employees with chronic conditions from using their health benefits, some companies are giving incentives to enroll in "self-funded" medical plans and to practice preventive health.

One is Connecticut-based Pitney Bowes Inc., which employs 35,000 people worldwide and helps businesses manage their physical and electronic mail with "mailstream technology." 

Its U.S. employees who have asthma, diabetes and high blood pressure pay only 10 percent of the cost of refilling their prescription drugs each month, as opposed to the 20 percent to 50 percent under other insurance plans. Pitney Bowes has seen a decrease in costs for emergency room visits and the use of sick days as a result, says company spokeswoman Elizabeth Pytka.

New for 2007, she adds, is that Pitney Bowes will provide free medication that research has shown helps lower bad cholesterol and triglycerides for people who have diabetes or who have had a cardiac event.

But the Health System Change report says expanding similar changes to more diseases could face industry barriers. 

There isn't enough evidence for more companies to follow suit. Though the federal government loosened requirements for health savings accounts late last year, the so-called consumer-directed accounts still aren't flexible enough to appeal to more employers, the report says.

State Sen. Jeff Schoenberg, an Evanston Democrat and co-chair of the Commission on Government Forecasting and Accountability, says mimicking the private sector may not be the answer for reducing the state's various health care costs.

"The fundamental difference between the private sector and the public sector is that we have an obligation not to throw people off the side of the boat," he says.

Still, as pressure increases for Illinois to expand health care to all, lawmakers might need to take a closer look at the long-term promises that are made to the state's own employees.

Illinois Issues, April 2007

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