AOL’s Tim Armstrong Missed the Real Message on Health Care Costs
Business + Economy

AOL’s Tim Armstrong Missed the Real Message on Health Care Costs

Reuters/Brendan McDermid

When AOL chief executive Tim Armstrong blundered in blaming his company's 401(k) cutbacks on "two distressed babies" recently, he missed an epic opportunity to identify the bete noire of employer-sponsored U.S. health care.

Employers who have health coverage for their employees are relying upon a flawed, unsustainable model that's slowly imploding. Although Armstrong later walked back his comments, he could have articulated why this model is a yoke for employers — and employees — that will eventually become a financial burden that's too heavy to bear.

First, though, a little economic history. After World War II ended, Washington policymakers and economists were concerned that, with millions of GIs re-entering a workforce short on labor, wage inflation would go through the roof. So a compromise was struck with employers. In exchange for a generous tax break, they could offer fringe benefits like health care instead of ratcheting up salaries.

Unlike most European countries, which created national health services after the war, the burden of health care largely fell on employers in the U.S. With the exception of federal employees and the military, it wasn't until the 1960s that national programs like Medicare and Medicaid attempted to create a public mandate for health care — at least for the elderly and poor.

With health care costs escalating over the past 70 years, employers have been chafing at their growing bills for medical expenses. Although the tax write-off certainly helps, large employers still have to pick up most of the tab and are increasingly passing the cost along to their employees.

According to the last annual survey by the Kaiser Family Foundation, annual premiums for employer-sponsored health care coverage are more than $16,000 a year, with employees paying more than $4,000 out of pocket. That represents a 4 percent increase over 2012. 

While $16,000 is less than the average price of a new car, consider that it's risen 80 percent since 2003. In the span of a decade, a near-doubling of health premiums can be perilous to a company's bottom line. It certainly was a factor in the bankruptcy of General Motors and other mature companies with "legacy" costs.

A Smaller Pool
Outside of growing costs that are not completely offset by a tax break, employers are hobbled by the fact that private insurers will penalize them if they have a relatively small number of employees. 

Since insurance pricing is based on the size and demographics of the pool of those insured, a spate of high-expense claims can be devastating. Hence Armstrong's initial carping over employees' distressed babies.

The public programs, in contrast, have large pools to spread out costs. There are more than 1 million in the armed forces and more than 44 million in Medicare. Relatively healthy people paying into the pool — and only filing inexpensive claims — offset those who are acutely and chronically ill. 

But those economies of scale are only seen in the largest companies and health systems. The bigger the pool, the more costs can be spread out. Small to mid-sized employers get hammered by ever-increasing premiums while the largest employers are more able to control their costs through in-house health programs, managed care and self-insurance.

The fractured private system favors the biggest employers while those in the middle and lower tiers struggle and pass along more costs every year. Or, as Charles Lane observed in The Washington Post:

"Because health insurance works best with a broad risk pool, and because “everyone” is the broadest possible risk pool, the categorical U.S. system is plagued by obvious yet intractable inefficiencies and inequities."

Employers have danced around the inefficiencies of this system for years. They've shifted employees into health maintenance organizations, preferred provider groups and high-deductible policies. Many have even brought health care providers into the workplace to offer check-ups and wellness services. 

The overriding result of these efforts will be the same: Thousands of employers will have little bargaining power with providers to reduce costs if every company insists on having its own program — and they are subsidized through the tax code for doing so. There are little to no economies of scale and costs will be constantly masked because the employee pays through a third party.  

The faulty link between employer and health coverage begat the Affordable Care Act, which offered universal access not linked to employment.

Although the ACA model is far from perfect — it doesn't provide true universal coverage and does almost nothing to reduce costs — it was one step on the road to provide coverage for those who were self-employed, jobless, poor or not offered a plan through work. Concludes Lane:

"Linking health insurance to work, however, is a bad idea: There’s just no necessary connection between how much you work and your risk of needing care. Eventually, the United States must move from a categorical approach to health insurance to a more universal one, whether through Obamacare or some less-convoluted plan."

What will a more "universal" plan look like? Ironically, it may take the shape of an expanded Medicare-like program with limited out of pocket costs, small premiums and no link to employment. 

Such an idea was recently floated by Donald Berwick, who formerly headed the Centers for Medicare and Medicaid Services under President Obama. Berwick is also running for governor of Massachusetts, where he would like to see a state-run single-payer health system launched.

But outside of New England — Vermont is also considering such a plan — single-payer plans have little or no currency. That may change if major business groups back the idea. And it will take more than “distressed baby” gaffes to gain traction.

Top Reads from The Fiscal Times: