James Kalamas, Gene Kuo, and Drew Ungerman
Web exclusive, June 2005
Senior executives in the United States should be doing everything they can to control the rising costs of health care benefits while maximizing returns on this investment. Benefits costs are increasing three to four times faster than inflation, mushrooming into one of the biggest expenses for companies. Indeed, within a few years benefits costs at some Fortune 500 companies could even eclipse profits. The issue has gone well beyond budgeting discussions by human-resources departments, as suggested by GM chairman and CEO Rick Wagoner's call for a national health policy to address a problem he says threatens the competitiveness of US corporations.
Most companies don't apply the same rigor to managing their health and retirement benefits that they bring to other business investments, such as research and development. Too often, executives consider benefits a fixed cost, with little room for savings. Our experience, however, shows that employers can continue to offer attractive plans while reducing expenses. To achieve this goal, a company should take a product developer's approach to designing benefits packages, by viewing its employees as internal customers and developing plans that closely match their expressed needs. This approach goes beyond offering à la carte plans that allow employees to pick and choose benefits. By measuring expected returns—whether in cost savings or reduced employee absenteeism—on a regular basis, managers can be more certain they are getting what they are paying for.
Redesigning benefits packages should be part of a larger cost-management program that includes more selective purchasing, incentives for health care providers, and centralized accountability, all of which can reduce benefits costs by a total of 10 to 20 percent.1 By taking a product developer's approach when designing a comprehensive benefits and retirement package (see sidebar, "Weighing retirement packages"), employers will be in a better position to offer attractive benefits without going broke.
Define the return on investment
US employers are generally not required by law to offer health benefits to their employees, but many do so because of the tax incentives and because a good benefits package helps them attract and retain talent. Since employees consider health care an entitlement of employment, however, and have been mostly shielded from the reality of rising prices, a gap has developed between the insurance carrier (paid by the employer; employees contribute a portion of the premium—generally around 25 percent) and the employee, who has little incentive to limit consumption or scrutinize costs. With health care costs rising, employers must update their approach, demanding the same rigorous focus on cost constraints and returns on investment as they do for other substantial expenditures.
The experiences at one industrial company are typical. After several mergers and acquisitions and little postmerger management of benefits, the company was left with a number of plans—none of which had been analyzed for value or impact. Senior managers viewed benefits as a necessary expense and realized that packages are not easily changed without causing widespread dissatisfaction among employees. When faced with rising costs that threatened the profitability of the company, however, its executives embarked on a program to redesign its benefits offering and limit the growth of health care costs. They began by defining benefits as an investment in their people and the company and by articulating the program's goal: to maximize savings while maintaining competitiveness in recruiting and employee retention. In administering the plan, they wanted to offer more flexibility and simplicity with minimal disruption.
With these goals in mind, plan managers set out to learn more about what employees valued and how to design benefits packages within the newly defined cost constraints and investment objectives.
The product developer's approach
Just as companies in all industries get more out of sales and marketing efforts by determining what types of products consumers want to buy, so an employer can derive more from its benefits costs by learning how employees feel about the current offering—specifically, what they would like to keep and what they would like to change. Market research tools such as Web-based surveys, focus groups, concept tests, and conjoint analyses can help define employee segments (Exhibit 1).
Ideally, plan managers should begin their research in late autumn or in winter so they can design and test new products in the spring and have the final packages ready for the following autumn's enrollment window. The internal market research will help managers design and test new benefits combinations and communicate to employees the value in the redesigned packages.
Discover employee preferences
The first step is to find out what parts of the benefits package employees are happy with and what improvements they would like to see. Large companies usually buy their health insurance packages from brokers offering a selection of plans: some products feature higher premiums and co-payments in exchange for a greater choice of physicians; others focus on delivering lower-cost care in limited provider networks, such as health maintenance organizations (HMOs).2 Employers often review the historical usage pattern with their insurance brokers, but this type of analysis provides only part of the picture. Companies can get more value out of their health benefits investment if they find out for themselves what employees want.
At one company, the results of an internal, Web-based survey on its entire health, disability, and retirement benefits package revealed that employees who were pleased with the medical and pharmaceutical coverage were generally happy with the entire package—a correlation that was particularly strong for the pharmaceutical benefit (Exhibit 2).
Conversely, those who were unhappy with those areas were less satisfied with the whole offering. Armed with this insight, plan managers improved pharmaceutical benefits—a relatively small but quickly growing category of expense—while cutting back in other areas that were overfunded and underappreciated. This move reduced costs, encouraged the use of pharmaceuticals to treat chronic diseases, and lifted employee satisfaction at the same time. Without a deep understanding of customer needs, managers might have made severe cuts in pharmaceutical costs—to bad effect.
A company can then use tools such as conjoint analysis to categorize employees according to their expressed needs. One corporation found that fully 80 percent of its staff favored low costs over a greater choice of insurance providers—a preference that had significant ramifications, as plan managers had been considering dropping the HMO option. As a result, they decided to continue the HMO coverage and instead reduced the number of plans offered.
If conjoint analysis reveals many distinct segments, plan managers may need to explore more modular, customized health benefits designs. In contrast, the discovery of a few fairly homogeneous segments might lead an employer to pursue only two or three packages. The industrial company in our example found that its employees fell into four discrete segments, ranging from those who valued coverage at nearly any cost to those who cared most about minimizing their monthly out-of-pocket costs (Exhibit 3).
These preferences were the foundation for the company's new benefits packages.
Design and test new packages
Once armed with these insights, employers are better prepared to design benefits packages that deliver the expected return on investment. After discovering that many employees would rather pay more at the time of service than pay a higher monthly payroll deduction, for example, plan managers at one company added the option of a medical plan with higher deductibles and co-payments tied to medical-inflation indexes. These measures helped limit increases to monthly payroll deductions.
Another company found that one group of employees cared less about basic medical coverage than about ancillary services such as eye care, chiropractic, and podiatry—areas to which many other employees ascribed low value. Plan managers decided to offer these services separately so that the group that valued them could choose and pay for them.
Once new plans are conceived, benefits managers can again use tools such as conjoint analysis and targeted concept testing to find out how employees will react to the proposals (Exhibit 4). The perceived value of various benefits combinations can be assessed (by business unit or benefits plan segment) and weighed against other quantifiable measures such as cost and ease of administration. Tools like these can prove especially valuable when companies consider relatively new and unproven solutions such as health savings accounts.3 Since neither employers nor health care experts have a definitive understanding of how these solutions will be received by employees, marketing tools can help gauge the interest in these plans and may provide a stronger rationale for change.
Market the new plans
Good product developers understand that a product's success or failure hinges on execution. Benefits are no different, particularly given how disruptive any changes to an organization's offering can be. Here again, knowledge of what customers value can uncover potential implementation challenges—and tactics—early in the game.
If managers find, for example, that a substantial number of employees spend very little time thinking about health care benefits, the system should be designed to allow them to make decisions with minimal effort. Companies could offer a default option based on last year's choices or could invest in enrollment-support tools that ask employees a series of questions about their risk tolerance and expected consumption patterns and then recommend options accordingly.
Market research can also identify broad themes for internal communication efforts. At one company that implemented a new build-your-own benefits design, communication managers decided to promote the advantages of increased flexibility and control—prominent themes in focus groups and survey responses—as the centerpiece for the preenrollment campaign. Other communications may need to be tailored to address particular hot-button issues (such as access to HMOs, benefits for dependents, or the cost of chronic-illness drugs) of specific employee segments.
Robust internal research and effective marketing are not a panacea for fixing health benefits issues. To ensure that companies are getting the most from their benefits investment, plan managers must also source health care better (by seeking out competitive bids and by negotiating contracts with providers, for example) and collaborate with other players in the value chain to reduce costs. Understanding the employee's perspective on benefits, however, is an essential tool for formulating the entire health benefits strategy.
Weighing retirement packages
Retirement benefits pose an equally vexing issue for employers. Many are reconsidering their obligations to offer retirement plans at all, for a combination of reasons. Career-length employment is less common than it once was, for example, and the costs associated with defined benefits and the litigation risks when plans change can be highly volatile. Here too it is valuable to understand the employee's perspective, which should be considered along with corporate priorities and risk tolerance when crafting a portfolio of retirement benefits.
Retirement plans come in two types. Defined-benefit plans (pensions) promise a certain payout during retirement. Defined-contribution plans, such as 401(k) matching, promise that a company will pay only a specified sum or percentage as the fund accrues. Plan managers who are considering freezing their pensions can use market research tools to determine how employees might perceive a switch to a 401(k) plan—a move that shifts the risk and decision making from employer to employee.
Companies that offer only defined-contribution plans can learn how their employees value the matching contributions as opposed to methods such as profit sharing or fixed employer contributions. At one company, conjoint analysis showed that most of its employees would derive far greater value from a more generous maximum 401(k) match (which encourages them to save on their own) than from a smaller fixed contribution.
Some companies might find that employees value retirement benefits so highly that to make cuts would damage morale. In these cases, the more prudent course might be to preserve the benefits for current employees and adjust the plan for only new hires.
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About the Authors
James Kalamas is a principal in McKinsey's San Francisco office, Gene Kuo is a consultant in the Houston office, and Drew Ungerman is an associate principal in the Dallas office.
Notes
1Lynn Dorsey Bleil, James Kalamas, and Rayman K. Mathoda, "How to control health benefit costs," The McKinsey Quarterly, 2004 Number 1, pp. 104–13.
2HMOs became popular in the 1990s, as employers tried to stem the rising costs of health care. These groups achieved savings by limiting care to provider networks where they had strict control over costs. But when consumers balked at the restrictions, many HMOs loosened the rules. These packages, while often costing employers as much as or more than the alternatives, remain a low-cost option for employees.
3Paul D. Mango and Vivian E. Riefberg, "Health savings accounts: Making patients better consumers," The McKinsey Quarterly, Web exclusive, January 2005.
