Pareto Blog

Healthcare for employees and dependents–that thing that actually drives the cost of health insurance–does not span nice, neat 12-month increments. At the end of the 12-month period, the employer doesn’t hit a magic button and exchange all of his/ her employees like a person with a bad set of Scrabble tiles.

Rather,when an employer hires an employee, it tacitly agrees to pay for the majority of future healthcare costs for that employee (and his/her dependents),for as long as that employee remains with the company. This could be 12 months,12 years, or longer. While the employer accepts this liability, they rarely consider the totality of it.

Part of the reason this liability is often overlooked is because it doesn’t appear on their balance sheet.  This is because the employer has not explicitly or legally committed to cover these costs. Since it is just an implicit promise, GAAP doesn’t require its inclusion. But what if that liability was on the balance sheet of the employer?

Consider, for example, an employer with 100 employees. Using a national average of $11,000 per employee, this employer will spend about $1.1M in premium in the next year. What are the future costs that this employer has tacitly agreed to pay? If we assume that the fully-insured premium will increase at a rate of 9% per year, the total payments over the next 15 years are $32,300,000. It we discount that payment stream using a fairly conservative rate of 6%, we can calculate the net present value (in other words, the costs in today’s dollars) of the future liability is $19,100,000. That is a staggering number. Rather than asking how to cut costs next year, employers should be asking, “How do I reduce this massive $19.1M weight tied to my ankle?”

The first instinct of most is to reduce the cost. But that instinct is wrong. The best way to reduce the $19.1M figure isn’t to reduce cost; it’s to reduce TREND. If we take the same original assumptions but change the annual rate of increase from 9% to 7%, the net present value drops from $19.1M to $16.6M.  Said another way, decreasing the trend by just 2% increases the value – in today’s dollars – of the employer’s company by $2.5M.

Interestingly, reducing the upfront costs but not the long-term trend has a much smaller impact. The value of an upfront 5% cost reduction but with equal trend reduces the net present value by less than $1M. So if you’re ever given a choice between equal costs and lower trend, and lower costs and equal trend, you always want to go with the lower trend.

What is the fastest and most reliable way to reduce trend? Self-insure. Self-insured costs rise more slowly than fully-insured because they are not subject to the same level of tax– and those taxes continue to rise, leading to higher rates of trend.

The kicker? Self-insurance typically provides lower initial costs and lower long-term trend. An employer that is fully-insured and moves to self-insurance can typically reduce costs about

5% – due merely to reduced taxes (without factoring in the reduction of carrier profits or effective population health management efforts).

So what is the net present value of initial savings of 5% combined with a trend improvement of 2%? The combination of these things reduces the net present value of future payments by $3,300,000.

Ask any consultant if they think that self-insurance would typically save 5% in taxes and reduce trend by 2 or more percent. The overwhelming majority would tell you that this can be accomplished – probably without much difficulty.

So why are we still talking about 12-month rates when instead the consultant could walk in the door of the above employer and say, “I can add $3,300,000 of value to your company right now.” What employer doesn’t want to increase the value of their company by $3,300,000 with the wave of a hand?

You want a stretch goal? Reduce the costs by 10% and the trend by 4%. This will add $6,000,000 in value to the company!

Pareto’s consultant partners are successful because they’ve put away the 12-month cost comparison spreadsheets and instead focus on reducing trend.