Medical Savings Accounts Study: Case Studies
Morris County Hospital Employee Welfare Plan

• Sponsor: Morris County Hospital, Council Grove, Kansas

• Number of employees: 50-60

• Coverage: MSA/catastrophic benefit within comprehensive employee compensation plan.

• Summary effect: Health costs per employee dropped 45%; employee savings increased

• Year of origin: 1983.

• MSA ended 1992: reverted to standard indemnity health plan.

For nearly ten years, a small employer in central Kansas administered a medical savings account coupled with catastrophic health insurance. The person responsible for developing and implementing this plan, Ron Thompson, has documented the story in a monograph, "Employee Benefits - A Tale of Success."18 This medical savings account program satisfied employees and reduced health spending. Despite its success, it succumbed to federal tax policies and workplace regulations hostile to employee benefit innovation.

Morris County Hospital is a twenty-eight-bed rural community hospital in Council Grove, Kansas, population just over 2000. Until 1983, hospital employees were compensated under state and county guidelines. In addition to participating in Social Security, these municipal employees also contributed to the Kansas state retirement plan called KAPERS. Health benefits were a standard Blue Cross indemnity plan with a $100 deductible and 20% coinsurance to a maximum personal out of pocket liability of $1000 for covered charges. Dependents were not included under this plan and employees could elect to decline the health benefit. The hospital projected a $1300 per employee premium for 1983.

After an extensive review, the hospital board authorized a new "Employee Welfare Plan." This plan treated all employee compensation as a total package. Social Security and the Kansas state retirement plans were replaced by a comprehensive defined contribution plan. A "money sharing plan" was created to increase personal savings and encourage individual responsibility. A medical savings account complemented by employer-provided catastrophic health insurance was included as an essential component of the overall plan.

Medical savings accounts allocations were made from which amounts could be spent by individual employees for other available benefits within the overall profit sharing plan. At year's end, unspent funds from individual MSAs were allocated into individual employee-owned retirement accounts. Unspent MSA pretax dollars were channeled into vested retirement accounts in accordance with the hospital's IRS approved profit sharing plan.

In 1985, the Internal Revenue Service issued a private letter approving the Morris County Hospital employee welfare plan.19

The new employee compensation plan was implemented in stages starting in 1979 when a decision was made by the hospital management to withdraw from the Social Security program. The hospital signed a letter of intent to cancel participation to take effect after the required two-year notice period. The state permitted withdrawal from the social security program only if the hospital also canceled participation in the State retirement program, KAPERS. Withdrawal from both plans motivated Morris County Hospital management to develop the integrated employee compensation plan.

The idea of a defined contribution plan as the basis for total employee compensation made it easy to include an MSA health benefit in the plan. The hospital took this opportunity to convert from prepaid comprehensive medical services to catastrophic health insurance. The savings from substantially lower premiums were used to establish individual medical savings accounts to cover up-front medical expenses. In all, 23% of total hospital payroll was allocated for benefits.

"This medical savings account program satisfied employees and reduced health spending."

"Despite its success, it succumbed to federal tax policies and workplace regulations hostile to employee benefit innovation."

Hospital employee total compensation consisted of:

• W-2 reportable wages, salary, bonuses, overtime
• Employer paid retirement fund up to 15%
• $3000 deductible health insurance plan paid in full by the hospital
• Social security replacement pension plan: Employer contribution 10% of wage and employee contribution up to $2000/year
• Workers compensation
• Medicare tax 2.9% of W-2 reportable wages
• Life & Disability coverage (employee contribution only)
• Paid time off (dollar value) for vacation and sick leave per year

What happened with this program over its nine-year life?

In 1982, the final year of the old plan, the fifty employees averaged health care spending of $807 including employee point of service cost for the deductible and coinsurance. Total plan spending was over $40,000. Social Security and KAPERS contributions were just under $90,000. The first year of the new plan for 1983 experienced dramatic change in the amounts distributed for employee fringe benefits. Health insurance premiums for the $3000 deductible policy dropped from $33,698 to $18,698, a $15,000 reduction.

In the first year of the new plan, overall health spending below the new deductible averaged less than $203 per employee. Average total health spending per employee decreased by 33%, and total health spending in this first year went from 7% of hospital payroll to 5%. Sick leave expense dropped almost 50%, from 3.5% of payroll in 1982 to 1.9% in 1983. In subsequent years, paid sick leave dropped even further and stabilized at 1% of payroll.

In 1993, the unspent dollars remaining in individual MSAs went directly into each employee's retirement plan. In 1982, $75,218 went to FICA and $12,086 to KAPERS trust funds. In 1983, a small carry-over of $3,046 went to FICA and more than $100,000 went into vested employee-owned retirement plans—an increase of 14%. Unlike their previous contributions into the Social Security Trust Funds, all of their new retirement contributions became the sole property of the employees.

"Average total health spending per employee decreased by 33% in this first year."

Total health spending in this first year went from 7% of hospital payroll to 5%.

"Sick leave expense dropped almost 50%, from 3.5% of payroll in 1982 to 1.9% in 1983."

This initial year experience was not a fluke. The newly integrated compensation plan worked the first six years exactly as forecasted by its originator. In some ways, it worked as projected through the entire nine years. In the final year of the plan, health spending remained stable at 5.3% of payroll and sick leave costs held at 1.1% of payroll.

Health spending reductions rewarded employees directly with monetary savings channeled directly into employee retirement plans. Throughout the nine years, Morris County Hospital employee fringe benefits remained constant, averaging 23% of payroll. By 1991, the final plan year, total employment increased to sixty. Average wage compensation had gone from $6.10/hour in 1983 went to $9.06 in 1991, an increase of almost 50%. Annual contributions to employee retirement accounts went from $104,000 in 1983 to $193,000 in 1991.

Did problems that emerged in the final three years of the integrated compensation plan affect the MSA program?

In the seventh year of the plan, total workforce increased by 25%, accompanied by greater employee turnover. Medical spending below the deductible took a sharp upturn. Per capita spending within the deductible increased by 44% in just one year and another 27% the following year. The 3.5% annual increase in medical spending over the first six years became annual increases of 8% averaged over all nine years. What happened?

The large increase in spending below the deductible was caused by a failure in employee education. In those last three years, the employees—especially the new ones—viewed the health benefit as something given free by the hospital to the employees. The whys, wherefores, and uses of their medical savings accounts were no longer explained in detail. Many employees viewed the money being spent from the MSA to be the hospital's rather than theirs. Too many employees failed to understand this money was not other people's money but theirs to be saved if not spent.

"Health spending reductions rewarded employees directly with tangible monetary savings channeled into employee retirement plans."

"Annual contributions to employee retirement accounts went from $104,000 in 1983 to $193,000 in 1991."

Still, this large increase of spending had little effect on increases in the insurance premium over the same period. Over the entire nine years, the catastrophic insurance premium increased only 25% averaging 3% per year. In sharp contrast, by 1991, health spending under the deductible increased 300% over the 1983 sum of $9,315. Total 1991 health spending equaled $993 per employee.

Did the Medical Savings Account coupled with catastrophic health insurance work as Ron Thompson envisioned?

On balance, the answer is yes despite emergence of a flaw in the last three years of this incentive-based employee compensation program. Contributions to both non-governmental retirement plans would have been greater had the large increases in spending below the deductible been anticipated and dealt with by active employee education. This flaw was foreseeable and preventable.

What contributed to the success of Thompson's integrated compensation plan?

Based on direct interviews with Morris County Hospital employees, primary care physicians, and plan administrators, the responsible factors are clear. Incentives were generally strong to use medical savings accounts dollars only where and when needed. Dollars not spent were dollars saved. Dollars saved rewarded the saver directly and the employer secondarily.

"Dollars saved rewarded the saver directly and the employer secondarily."

None of the employees questioned could recall any instance when preventive or needed care was ignored or avoided. Employees considered preventive care more important than saving a few dollars. Moreover, they particularly liked not having to pay either deductibles or coinsurance. Employees preferred the MSA program to having to pay out-of-pocket to meet a deductible. In 1992, on the advice of the hospital's employee benefits consultant, Morris County Hospital's "Employee Welfare Plan" using pretax dollars was modified. While retaining the other components of employee compensation, the Medical Savings Account plan, high deductible health plan, and the profit sharing plan were eliminated. They were replaced by a prepaid comprehensive health insurance plan. In 1994, this replacement Blue Cross network plan (PPO) cost the Morris County Hospital per employee a premium of $179/month. The plan has a $100 deductible and 20% coinsurance with a maximum out-of-pocket liability of $1000.

1994 employee wages and salary averaged $11.77 per hour. Not including out-of-pocket payments for the new health plan, health benefit spending as a percent of payroll has increased almost twice the prior 5% cost of payroll. The new health plan covers employees only. Insuring families under this Blue Cross plan would cost 20% or more of payroll. Comparing the new Preferred Provider plan to the prior 9-year experience, two employees declared a strong preference for the MSA program. They liked controlling their own dollars for coverage of services within the deductible. They understood that once the $100 deductible is met there is little incentive to constrain utilization. In their words: "It's not my money."

What would be the effect on employee earnings and savings had hospital management retained MSAs and catastrophic insurance?

Health benefit spending in 1994 might still run 5% of payroll or about $100 per employee per month. The plan savings would continue to flow into individual employee retirement plans at the end of each year. But this is not the case even though some compensation objectives remain intact. Today Morris County Hospital employees continue to receive fringe benefits amounting to the same 23% of paid wages. The difference is that substantially more of their earnings now pay for costly health insurance premiums, deductibles, and coinsurance. Substantially less of their earnings go into individual retirement accounts.

Properly structured, a Medical Savings Account program once again could benefit Morris County Hospital and its employees. The opportunity cost for adopting prepaid medical benefits and canceling the MSA program is the $193,000 that no longer annually flows into employee retirement plans.

"Employees considered preventive care more important than saving a few dollars."

"Employees preferred the MSA program to having to pay out-of-pocket to meet a deductible."

Evergreen Freedom Foundation P.O. Box 552, Olympia, WA 98507 Phone: (360) 956-3482, Fax: (360) 352-1874 Email: effwa@effwa.org