Number 78 December 12, 2001

How to Improve the Federal Employees Health Benefits Program

As the system that has provided federal workers with a choice of health plans since 1960, the Federal Employees Health Benefits Program (FEHBP) is the oldest, most successful example of “defined contribution” health insurance. The program serves as a model for broader health care reform, but the future success of the FEHBP is being threatened.

The FEHBP, in which all plans provide coverage for prescription drugs, covers nine million federal employees, retirees, and their families at an annual cost to the federal government of about $20 billion. By comparison, the 40 million people covered under Medicare will cost the government about $246 billion this year, without coverage for prescription drugs or catastrophic expenses. The program garnered increased political attention in 1999, when a majority of a bipartisan commission voted to reform Medicare by turning it into a FEHBP-like system.

The FEHBP has recently been criticized for rising premium costs. The average premium is set to rise by 13.3 percent in 2002, but that figure assumes no one will change plans. The actual average increase will be less, depending on how many federal employees switch their coverage to lower-cost plans.

The FEHBP has also experienced an exodus of plans in recent years. In addition to 17 national fee-for-service plans, there are a large number of health maintenance organizations (HMOs) that serve local areas. But the number of HMOs has dropped precipitously, from almost 400 in the mid-1990s to about 165 next year. HMOs have experienced more aggressive government regulation, which has increased their costs, and they have seen a decline in popularity.

According to a May 2000 report by the U.S. General Accounting Office, insufficient enrollments and noncompetitive premium rates have been the most frequently cited reasons for HMO withdrawals from the FEHBP. As a result, more federal employees have coalesced into higher-cost plans. Yet, other important factors are exacerbating the rise of costs in the program.

Health plans in the FEHBP are financed through a modified version of a defined contribution, called “premium support.” The federal government contributes a maximum of 72 percent of the weighted average premium toward the federal worker’s chosen plan, but the amount decreases for low-cost plans because the government contribution is not allowed to exceed 75 percent of the premium for any particular plan.

At first blush, the 75-percent limitation sounds like a sensible cost-saving measure, but it reduces the incentive for federal employees to choose low-cost health insurance. Table 1 shows the 2002 FEHBP premium support schedule for self-only enrollees. For each $100 decrease in premium for a less-costly plan, the employee only realizes a $25 savings. This reduced incentive has become more prominent in recent years. The Balanced Budget Act of 1997 increased the maximum government contribution from 60 percent to 72 percent, with the result that the 75-percent limitation now kicks in for premiums that are just below the average. Since this change took effect in 1999, the average premium in the FEHBP has increased by 9.5 percent in 1999, 9.3 percent in 2000, 10.5 percent in 2001, and 13.3 percent in 2002. By comparison, the average annual premium increase over the years 1989–1997 was 3.7 percent.

The FEHBP is also hurt by the imposition of defined benefits. The Office of Personnel Management (OPM), which oversees the program, and federal legislators have moved away from their previous hands-off approach by specifying benefits that all plans must cover. Examples since 1990 include mammography coverage for women over age 35, coverage for a large array of transplant procedures, and full mental health and substance abuse parity. Disagreements exist about how much mandated benefits add to premiums.

An OPM estimate released this year put the cost of the FEHBP’s mandated benefits at less than four percent of total program costs. But for employer-based plans in the private sector, where mandated benefits have been around longer, they account for a much larger percentage of costs. This suggests that mandated benefits will be a driving force behind future premium increases.

Aside from their cost, mandated benefits work against the basic strength of the FEHBP. Forcing all employees to pay for a benefit that they may not want undermines consumer choice, which has been the FEHBP’s hallmark. It blocks market signals that would tell insurers which benefits are demanded by consumers. The program works best when federal employees decide for themselves if a benefit is worth the additional cost. If, like prescription drugs, it is, insurers will voluntarily cover it.

Claiming that the recent increases in insurance premiums are hitting federal workers too hard, Rep. Steny Hoyer (D-MD) has introduced a bill, HR 1307, which will increase the government’s maximum contribution to 80 percent of the weighted average premium, with a limitation of 83 percent for any particular plan. This change would throw gasoline on what is now a small fire. Table 2 shows how the FEHBP premium support schedule would look in 2002 for self-only enrollees under the Hoyer bill.

By increasing the government contribution across the board, the bill would do nothing to stem the rise in insurance premiums. In fact, it would allow plans to increase their premiums even more, but the enrollees would initially see their contributions lowered. Under the Hoyer bill, there would be even less incentive for enrollees to switch to low-cost plans because the reward to the enrollee would be only $17 for each $100 premium decrease. If the Hoyer bill passes, premiums and government spending would increase at a faster pace and the program would become less stable.

The FEHBP would benefit greatly from a few simple changes. Repealing the 75 percent limitation would inject renewed price competition into the program. By making the government contribution the same for any plan, federal employees would have the strongest incentive to shop wisely for their health plan. Table 3 shows the FEHBP schedule for self-only enrollees in 2002 under a simple defined contribution, where the defined contribution is equal to 72 percent of the weighted average premium. For each $100 decrease in premium, federal employees would save the full $100 off their contribution to the plan. If the premium were less than the government contribution, then the worker would retain the difference to cover out-of-pocket medical expenses.

Although the government contribution would initially be greater for low-cost plans, the federal government would save money down the road. By encouraging the purchase of lower-cost plans, average premium increases would be reduced, resulting in lower costs for both the federal government and its employees.

In conjunction with repealing the 75 percent limitation, Congress should open up the FEHBP to any new health plan that wants to participate. Currently, the program stipulates that any new plan must be an HMO. This policy is anachronistic and should be ended, allowing new fee-for-service plans to participate. High-deductible, catastrophic health insurance plans, for instance, are already emerging in the private sector as a low-cost alternative to HMOs.

Finally, legislators and the OPM should abolish mandated benefits, allowing federal employees to choose the benefits package that they find to be the best value. These changes will reestablish the FEHBP as a successful example of high-quality health care coverage based on consumer choice.

Table 1:	The 2002 FEHBP Premium Support Schedule, Self-Only Enrollees
Note: The federal government contribution is equal to the lesser of: (1) 72 percent of the program-wide weighted average of premiums, or (2) 75 percent of the total for the particular plan an enrollee selects. The program-wide weighted average premium is $3,534 for self-only enrollees in 2002.

Table 2:	2002 FEHBP Schedule Under Rep. Hoyer's Proposal   Self-Only Enrollees
Note: The federal government contribution is equal to the lesser of: (1) 80 percent of the program-wide weighted average of premiums, or (2) 83 percent of the total for the particular plan an enrollee selects. The program-wide weighted average premium is $3,534 for self-only enrollees in 2002.

Table 3:	2002 FEHBP Under a Defined Contribution Schedule   Self-Only Enrollees
Note: The federal government contribution is equal to 72 percent of the program-wide weighted average of premiums. The program-wide weighted average premium is $3,534 for self only enrollees in 2002. Negative federal enrollee contributions represent excess government contributions that can be put into a medical savings account.

Chris Middleton is senior health and tax policy analyst at the Pacific Research Institute.