Using Carve-Outs to Shave Health Costs

The cost of health-care benefits is soaring — an astonishing 11 percent last year alone, the Kaiser Family Foundation reports. Not surprisingly, employers are urgently looking at alternatives such as shifting some health costs to employees and cutting benefits. But there is another option: a carve-out.

   When a company “carves out” a portion of its health-care benefit plan, the employer is purchasing that portion of benefits from a specialty vendor. Rather than having, say, United Health Care handle every aspect of benefits, an organization might use United for everything except mental health. Dental plans could be considered carve-outs, though such a practice is so common that deciding whether to have a separate dental plan is often a no-brainer.

   Why consider a carve-out? In some cases, you may find that a certain part of health costs is growing at an unmanageable rate.

   There’s no guarantee that a carve-out will save a company money, and the method hasn’t been the panacea that was anticipated a decade ago. But specialists can sometimes use their connections and bargaining power to net good rates. John Erb, a senior manager at Deloitte & Touche, uses as an example the two major anti-depression drugs, Zoloft and Prozac. A company that manages drug benefits may have negotiated an arrangement to prescribe one or the other of these medicines at a significant discount.

   A carve-out can also potentially improve health-care access for employees. Purchasing all health care through one HMO can mean poorer access to certain specialty care. An employer, for example, may find that only a small number of optometrists in a given area are covered under its HMO. When employees have to drive a long way to see an optometrist each year, not only is it a hassle, but they may also have to go during business hours. By using a vision-care vendor, a company can potentially reduce the time that employees are out of work traveling to an optometrist, and provide more vision-care options.

Big, self-funded companies
   Carve-outs are most often used and most often effective in large companies. The smaller a company, the less willing it may be to handle the paperwork involved in dealing with many health-care vendors.

   A Deloitte & Touche study found that only 31 percent of employers with fewer than 1,000 employees carve out part of their medical plans. This compares with 78 percent of employers with 10,000 or more employees.

   With larger companies, many of which self-fund their health-care programs (claims are paid from company money rather than from the pockets of an HMO), carve-outs can offer substantial savings. If a company is large enough to spend $4 million on annual health coverage, for example, and could save 10 percent through a carve-out, that’s $400,000, a significant amount for any company.

   On the other hand, a company with just 500 employees may find that it can’t generate enough savings through a carve-out to justify the extra administrative work involved.

   Even if a company’s program isn’t self-funded, carve-outs can produce savings. Employers might be temporarily shielded from rising prescription-drug and other costs because they’re being absorbed by the HMO. Still, when the year is up and the HMO announces cost increases, those added costs are sure to be passed on to employers.

   That’s what happened to S. W. Bajus, a property management company with 150 employees on a Blue Cross/Blue Shield health plan. Four years ago, Blue Cross/Blue Shield announced a large increase in drug costs. Bajus sent out RFPs to pharmacy-benefit plans, and ended up switching to one called PharmaCare in 1998. It got worse: the following year, PharmaCare announced a 75 percent increase in drug costs. Bajus switched to another drug-plan product, called TriCast, in 1999.

   “The carve-out benefit to employees is substantial,” says Jessica Clancey, who oversees benefits for S. W. Bajus. She is also trying to limit expenses by educating employees on the advantages of an HMO over a PPO. “If you’re a single person and you go to the doctor twice a year, it’s really ludicrous to be on the best plan.”

Drugs and other targets
   Conventional wisdom has it that it costs more to put people in the hospital than to give them drugs. Chuck Newton, of the reinsurance company Evergreen Re, says that’s not so true anymore. “Pharmacy costs are now either equal to or will be surpassing the average costs of inpatient services,” he says.

   With prescription drugs a quickly growing portion of overall health expenses — about 15 percent of employer health costs — they’re a carve-out favorite. Deloitte found that 19 percent of employers of fewer than 1,000 employees carve out drug benefits. Sixty percent of employers with 10,000 or more employees do so.

   Also ripe for a carve-out are areas of specialty care where future costs are unknown and hard to predict on the basis of a company’s historical patterns of health-care usage. Organ transplants are a good example. Five years ago, transplants were performed on about 7 per 100,000 people. The number has more than doubled to 15 per 100,000.

   The supply-side constraints of organ transplants are quickly disappearing. While the demand for transplants is high, there’s not enough supply. But as transplants become more readily available, employees will get them far more often. This will result in an unpredictable increase in health costs to employers. “An employer’s bottom line is going to be affected tremendously as transplants increase over the coming years,” Newton says.

   A liver transplant can cost a quarter of a million dollars, so even if a company had an increase of just one liver transplant among its workforce over a previous year, it’s big bucks.

   Hospital costs are another potentially good area for carve-outs. Scott Clendaniel, a benefits broker in New Jersey and Pennsylvania, says employers can save thousands by carving out these rising costs. Clendaniel recommends that employers carve out hospital coverage and install a $250 or $500 co-pay for hospital visits. Then, you can self-fund this portion. In other words, when employees spend time in the hospital, they just bring the bill to the company, and the employer sends the hospital the co-pay.

   “The employee maintains a high level of benefit, and the change can result in a 5 to 10 percent savings off the medical premium, resulting in thousands saved in costs,” Clendaniel says.

Problems with carve-outs

• Stop-loss: One of the biggest issues when deciding whether to carve out a portion of your health care is stop-loss coverage. This insurance coverage protects a company if its losses go over a certain barrier during a year.

  
  

  If a company were to purchase prescription drugs through a carve-out, it would likely not have stop-loss protection. Robert Christadore, president of Benefits Planning & Insurance, says a company should do a risk analysis to determine how much it would save by carving out its drug plan, and what the odds are that its costs would be high enough to trigger stop-loss coverage under a general health plan.

• Putting health in boxes: When an employer carves out a portion of its health-care benefits, the manager of the carved-out portion is concerned solely with controlling the costs of those benefits, regardless of how it affects the rest of the company’s health-care costs. This, says The Segal Company’s Stephen Parahus, can give a distorted picture of overall health-program costs, and may not contribute to an overall program that is optimally cost-effective.

  
  

  Carving out drug benefits, for example, may result in reduced drug costs but may give disincentives for some drug therapies that would reduce other types of medical expenses, such as hospitalization or surgery. Dealt with in isolation, then, a carved-out drug plan may or may not help effect overall health-plan cost efficiency.

  
  

  A good rule of thumb is that the easier it is to carve something out, the better the likelihood of success. Parahus says that benefits — such as vision — that have relatively little interrelationship with other health benefits can be carved out easily and are simpler to design and monitor than other types of benefits. Mental health or prescription drugs, by comparison, are more integrated into health-care delivery.

• Administration: As Clancey found out when S. W. Bajus carved out its drug coverage, it meant a lot more paperwork. It’s more work for both the employer and the employee.

  
  

  Craig Smith, who has spent 14 years in the insurance business as both an agent and a sales manager, says carve-outs can be a mess for a small employer. “If you’ve got a drug plan here and a vision plan there and a dental plan here, tracking all your claims could become a nightmare.”

Workforce, December 2001, pp. 40-42 — Subscribe Now!