Retiree Health Insurance: Erosion in Employer-Based Health Benefits for Early Retirees

Published by the Government Accountability Office on 1997-07-11.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

                  United States General Accounting Office

GAO               Report to the Honorable
                  Jerry Kleczka, House of Representatives

July 1997
                  RETIREE HEALTH
                  Erosion in
                  Health Benefits for
                  Early Retirees

          United States
GAO       General Accounting Office
          Washington, D.C. 20548

          Health, Education, and
          Human Services Division


          July 11, 1997

          The Honorable Jerry Kleczka
          House of Representatives

          Dear Mr. Kleczka:

          In August 1996, the Pabst Brewing Company notified about 750 retirees of
          its Milwaukee plant that it planned to terminate their health benefits
          within a month. Concerned about this abrupt cancellation, especially for
          early retirees—those who are not yet eligible for Medicare, you asked us
          to examine a number of issues related to the private sector’s provision of
          health benefits to retirees:

      •   Has the number of private sector early retirees with health coverage
          declined since the late 1980s?
      •   How are retirees affected by an employer’s decision to terminate health
      •   Do federal laws (1) prevent employers from reducing or terminating
          retirees’ health benefits or (2) provide for continued group health
          coverage for retirees under age 65 years whose health plans are

          Beyond the specific questions raised by Pabst’s termination of retiree
          health benefits, you expressed concern about the fragility of the current
          system for providing retiree health coverage. Several factors suggest that
          retiree coverage is becoming an important national issue. These factors
          include the downward drift in employers’ commitment to retiree coverage,
          the need to trim Medicare cost growth, and the dramatic near-term
          increase in the number of retirees as millions of baby-boomers approach
          retirement age.

          To address your specific questions, we reviewed (1) available private
          sector and government surveys of changes in retiree access to and
          participation in employer-based health coverage; (2) the Pabst health
          benefit plan in effect during 1996; (3) data from health insurance carriers
          on the cost of alternative sources of coverage for early retirees in
          Wisconsin, where Pabst is located, and other selected states;
          (4) applicable federal and state laws and legal precedents; and (5) earlier
          GAO work. Appendix I contains a discussion of the sources of data on
          employer-sponsored coverage, the patchwork nature of the evidence on
          retiree health care trends, and a cautionary note on the strict

          Page 1                                   GAO/HEHS-97-150 Retiree Health Benefits

                   comparability of the data. We performed our work during April and
                   May 1997 in accordance with generally accepted government auditing

                   The available data on employer-based retiree health benefits paints a
Results in Brief   limited but consistent picture of eroding coverage. The data, primarily
                   from employer or retiree surveys, demonstrate a steady decline in the
                   number of retirees with coverage through a former employer—both for
                   early retirees and those who are Medicare eligible. Foster Higgins, a
                   benefit consulting firm, reported in 1996 that only 40 percent of large
                   employers with more than 500 employees offered health benefits to early
                   retirees—a 6 percentage point decline since 1993. Even fewer small and
                   medium-sized firms offered retiree coverage. Earlier employer survey data
                   suggest that since 1988 the decline in the number of large employers who
                   offer retiree coverage has been significant. It is important to point out that
                   the decline in the availability of employer-based coverage has not resulted
                   in as large an increase in early retirees without private health insurance.
                   Among the reasons are that (1) the decision to retire is often predicated on
                   the availability of health coverage and (2) access to other sources of
                   private coverage appear to be filling a significant portion of the gap
                   created by fewer employers offering retiree health benefits. For example,
                   if employer-based coverage is not available, early retirees may purchase
                   coverage themselves or obtain insurance through a working or retired

                   Retiree surveys provide another important perspective on the erosion in
                   retiree health coverage. Comparing 1988 and 1994 data for all retirees aged
                   55 and older, the Labor Department reported that the number of
                   individuals who continued to receive employer-based health benefits into
                   retirement declined by 8 percentage points; in addition, the number still
                   covered sometime after retirement dropped by 10 percentage points.
                   There are several explanations for the erosion in coverage during
                   retirement. First, some employers, much like Pabst, have ceased to offer
                   retiree health benefits. Escalating health care costs have spurred
                   employers to look for ways to control their benefit expenditures. Among
                   the cost-control techniques adopted by employers are eliminating retiree
                   coverage, increasing cost sharing, and requiring those covered to choose
                   more cost-effective delivery systems. In addition, a new financial
                   accounting standard developed in the late 1980s has changed employers’
                   perceptions of retiree health benefits and may have acted as a catalyst for
                   reductions in retiree coverage. The new rule makes employers much more

                   Page 2                                    GAO/HEHS-97-150 Retiree Health Benefits

aware of the future liability inherent in retiree health benefits by requiring
them to account for its estimated value as a cost against earnings. A
second contributor to the erosion in employer-based health coverage
during retirement is retirees’ responses to changes in their coverage.
According to the Labor Department, fewer retirees are choosing to
participate in employer-based coverage when offered because firms are
asking them to shoulder more of the costs. At the same time, retirees who
decline employer-based benefits may have access to less expensive
coverage through a working or retired spouse.

Losing access to employer-based coverage poses three major challenges
for retirees: (1) higher costs in purchasing individual coverage on their
own; (2) a related problem, the potential for less comprehensive coverage
because of higher premiums; and (3) until recently, the possibility that
coverage will be denied or restricted by a preexisting medical condition.
The impact of the termination of health benefits on retirees varies from
state to state, depending on the nature of state laws governing the
purchase of insurance by individuals. The cost impact is starkly illustrated
for affected Pabst early retirees by the nearly $8,200 annual cost of
purchasing standard family coverage in the individual insurance
market—an enormous increase given that the former Pabst plan required
no contribution on the part of the retiree for most plan options. Beginning
July 1, 1997, the implementation of the Health Insurance Portability and
Accountability Act (HIPAA) will provide uniform federal standards to
ensure that individuals leaving employer-based group plans can purchase
insurance on their own if they can afford to do so.

A key characteristic of America’s voluntary, employer-based system of
health insurance is an employer’s freedom to modify the conditions of
coverage or to terminate benefits. While federal law (the Employee
Retirement Income Security Act of 1974 or ERISA) requires that the terms of
an employee’s health benefits be in writing, the intent was not to prevent
an employer from changing or terminating those benefits for either active
workers or retirees. In cases involving the termination of health benefits
by an employer, federal courts have turned to the nature of the written
agreements and extrinsic evidence covering the provision of retiree
benefits. In essence, the issues before the court often come down to a
matter of contract interpretation. If the employer has explicitly reserved
the right in plan documents to modify health benefits, the courts have
generally upheld the termination of coverage. On the other hand, if the
contract leaves some doubt, courts will look to evidence such as collective
bargaining agreements and other written and oral representations to

Page 3                                    GAO/HEHS-97-150 Retiree Health Benefits

             determine the rights and obligations of the parties. Today, most companies
             have reserved the right in plan documents to modify health benefits for
             current and future retirees. Finally, the right to purchase continuation
             coverage from an employer is only guaranteed to workers in certain
             circumstances, for example, if an employee is fired, laid off, quits, or
             retires. Individuals who are already retired when an employer terminates
             coverage are not eligible to continue that firm’s health plan at their own

             Although some Americans purchase health insurance individually for
Background   themselves or their dependents, most receive coverage as a benefit
             through their employer. The former is commonly referred to as individual
             coverage and the latter as employer-based group coverage.
             Complementing these two types of private insurance1 are public programs
             including Medicaid for the poor and Medicare for the elderly and disabled.2
             With the exception of the long-term disabled, Medicare is only available to
             individuals aged 65 and older. The lack of affordable health insurance for
             older Americans—either employer based or purchased individually—was
             a key factor leading to the establishment of Medicare in 1965.3

             The availability of employer-based health benefits is of particular concern
             to older Americans approaching or at retirement age—individuals who
             consume a higher level of medical services and whose health care costs
             are commensurately more expensive. For those under age 65 and not yet
             eligible for Medicare, the decision to retire may turn on the continuation of
             health benefits by an employer. For those 65 or older living on a fixed
             income, employer-based benefits may help fill coverage gaps in Medicare
             such as deductibles and copayments or the lack of a prescription drug
             benefit. (See app. II for a description of Medicare benefits and how they
             differ from employer-based coverage.) In 1994, about 75 percent of retirees
             were over age 65 and thus employer-based coverage supplemented
             Medicare benefits; the remaining 25 percent were ineligible for Medicare

              A significant portion of employer-based private insurance is provided by the public sector. The federal
             government covers civilian workers through its Federal Employees Health Benefit Program, while the
             Department of Defense operates a health care system for military personnel. Similarly, state and local
             governments also provide employee health benefits. About 17 percent of workers aged 18 to 64 have
             coverage provided though a public sector employer.
             Other public sources of health services include the Indian Health Service, the Department of Veterans
             Affairs, and public clinics and hospitals.
              Insurance coverage as part of a retirement benefit was the exception, not the rule, and private
             insurance companies had shown a reluctance to offer coverage to older persons even when these
             individuals could afford it. See Marilyn Moon, Medicare Now and in the Future (Washington, D.C.:
             Urban Institute Press, 1993), p. 25.

             Page 4                                                  GAO/HEHS-97-150 Retiree Health Benefits

because they were between ages 55 and 65. For the latter group,
employer-based benefits were a particularly critical source of coverage.
Overall, about one-third of retirees 55 years and older received health
benefits from a former employer. While Bureau of the Census data show
that the number of retirees increased from 18.5 million to 23.4 million
between 1988 and 1994, the first members of the baby boom generation
are age 51 and poised to enter retirement, an event that will begin to
dramatically increase the number of retirees.

Before 1980, most employers that provided retiree health coverage did so
on a lifetime basis. The trend, especially for firms with labor unions, was
to continue to improve retiree health benefits with each successive labor
contract. Beginning in the 1980s, however, sharply rising medical costs,
heightened foreign competition, corporate takeovers, the declining
bargaining power of labor, and a change in accounting standards gave rise
to attempts by some employers to modify or even eliminate retirees’ health
benefits. New accounting standards announced in 1990 changed
employers’ perception of retiree coverage by making them more aware of
the magnitude of their liabilities.

ERISA established safeguards governing the creation, operation, and
administration of most employer-based health benefits.4 In addition, ERISA
requires group health plans covering 20 or more workers to offer 18 to 36
months of continued health coverage in certain circumstances, such as
when an employee is fired, laid off, or quits.5 The mandate to offer such
continuation coverage does not oblige employers to share in its cost.
Finally, HIPAA has an impact on those who are seeking to transition from
employer-based group benefits to individual coverage. Effective after
June 30, 1997, the law provides uniform federal safeguards to ensure that
individuals who lose group health benefits and can afford to purchase
individual coverage have the right to do so.6

 P.L. 93-406, 29 U.S.C. 1001 et seq.
 This provision was added to ERISA by the Consolidated Omnibus Budget Reconciliation Act of 1986
(COBRA), 29 U.S.C. 1161 et seq. For this reason, continuation coverage is known by the acronym
 P.L. 104-191.

Page 5                                               GAO/HEHS-97-150 Retiree Health Benefits

                           Since the late 1980s, retiree access to and participation in private
Decline in Access to       insurance through an employer has declined. The drop in coverage—both
and Participation in       for those who retire early (before they are eligible for Medicare) and to
Employer-Based             individuals who are Medicare eligible—has been reported in periodic
                           surveys sponsored by benefit consulting firms and by the federal
Retiree Coverage           government. The erosion in coverage has been influenced not only by the
                           discontinuation of employer-based health benefits but also by the trend to
                           require greater retiree cost sharing—a factor contributing to lower
                           participation rates. Survey data indicate that employers are more likely to
                           offer coverage to early retirees than to those who are Medicare eligible.

Fewer Employers Offering   Data from an annual survey conducted by Foster Higgins suggest a
Retiree Coverage           significant decline between 1988 and 1996 in the availability of retiree
                           coverage from large employers with over 500 workers.7 The data appear to
                           be consistent across the entire period, but the pre-1993 data should not be
                           viewed as authoritative because of a change in the survey methodology,
                           described in appendix I. The data distinguish between early retirees and
                           those who are Medicare eligible. Since 1993, coverage for both groups has
                           declined by 6 to 7 percentage points, a continuation of a trend evident
                           since 1988. As shown by figure 1, early retirees at large firms are more
                           likely than those who are Medicare eligible to be offered health benefits by
                           a former employer. In 1996, for example, only 33 percent of
                           Medicare-eligible retirees were offered health benefits compared with
                           40 percent of early retirees.

                             National Survey of Employer Sponsored Health Plans 1996 (New York: Foster Higgins, 1997). The
                           Foster Higgins survey included both public and private employers but only reported aggregated data
                           on the two sectors.

                           Page 6                                                GAO/HEHS-97-150 Retiree Health Benefits

Figure 1: Percentage of Large
Employers Offering Retiree Medical   100      Percentage of Covered Retirees
Coverage, 1988 and 1992-96










                                               1988                1992         1993   1994    1995     1996

                                                        Retirees Under Age 65

                                                        Medicare-Eligible Retirees

                                     Note: Data from 1988 and 1992 are not strictly comparable with data collected after 1992.

                                     The two primary reasons cited for the decline in employer-based retiree
                                     health coverage are (1) new accounting standards, which highlight the
                                     magnitude of this liability over time; and (2) rapidly rising benefit costs.
                                     Since employers typically cover retiree health costs as they are incurred,
                                     the liability represented by a commitment to provide benefits to current
                                     and future retirees is largely unfunded. In 1990, the Financial Accounting
                                     Standards Board announced the introduction of a new rule, referred to as
                                     FAS 106, regarding these unfunded obligations. Beginning in 1993,
                                     employers were required to include the present value of future costs for
                                     retiree health benefits as a liability on their balance sheets. The new
                                     standard does not require that employers set aside funds to pay for these
                                     future costs and thus it does not affect their cash flow. However, many
                                     financial experts are concerned because these long-term liabilities erode
                                     equity positions and will become current obligations in future years.8 On
                                     the other hand, by dropping retiree coverage, a company can immediately

                                      For additional information on the impact of FAS 106, see Retiree Health Plans: Health Benefits Not
                                     Secure Under Employer-Based System (GAO/HRD-93-125, July 9, 1993).

                                     Page 7                                                   GAO/HEHS-97-150 Retiree Health Benefits

improve its balance sheet. As shown in figure 1, a sharp drop in
employer-based retiree coverage occurred between 1992 and 1993. It is
difficult to determine the extent to which this 6 percent decline in a single
year stems from the expected response to the FAS 106 rule or from the
change in the survey methodology. In responding to benefit consultant
surveys, many companies cited the fact that FAS 106 results in reductions
in reported income and shareholder equity as a reason for modifying
retiree health benefits, including the phasing out of such coverage.

The late 1980s was also a period of double-digit health care inflation.
Although the growth in premiums has slowed dramatically in the past few
years, the percentage of large firms offering retiree health benefits has
continued to drop. The decline between 1994 and 1996 was especially
sharp for Medicare-eligible retirees. Among the reasons cited by Foster
Higgins for the slowdown in the growth of employers’ health care costs are
that more workers moved into managed care plans—including
retirees—and the fact that some employers dropped retiree coverage. The
Medicare program is also facing cost pressures. In 1997, the Congress and
the President reached a tentative agreement to cut about $115 billion from
the program over a 5-year period in order to reduce the program’s rate of
growth. The effect on those eligible for the program will become clearer as
legislation is debated and signed into law. Although higher beneficiary
premiums have been discussed, they may be balanced by a wider variety
of managed care plans and increased preventive care benefits.

There are several potential explanations for higher levels of employer
coverage among early retirees. First, individuals are not as likely to seek
early retirement unless they are able to continue employer-based health
benefits. A RAND study of the effect of access to post-retirement health
insurance found that the offer of continued coverage had a positive effect
on the likelihood of retirement for men aged 55 to 62.9 Second, those who
retired early through buyouts may have been guaranteed health benefits as
an enticement to do so. Third, COBRA provides 18 months of coverage,
allowing individuals to retire at age 63-1/2 and continue with
employer-based group coverage until Medicare eligibility kicks in at age
65. Fourth, because of higher managed care enrollment among early
retirees, cost may be a less important factor in an employer’s decision to
offer or withdraw health benefits to this group. While just over one-half of
early retirees are enrolled in a managed care plan, the corresponding
figure for Medicare-eligible retirees is only 29 percent. Finally, employers

 Lynn Karoly and Jeannette Rugowski, The Effect of Access to Post-Retirement Health Insurance on
the Decision to Retire Early, RAND Reprints: 94-13E (Santa Monica, Calif.: 1995).

Page 8                                               GAO/HEHS-97-150 Retiree Health Benefits

                         know that coverage is available to retirees aged 65 and older through
                         Medicare, an option not open to younger retirees.

                         Other sources of private insurance appear to be filling a significant portion
                         of the gap created by the fact that fewer employers offer retiree health
                         benefits. If employer-based coverage is not available, early retirees may
                         purchase coverage themselves or obtain insurance through a working
                         spouse. Thus, between 1989 and 1995, the percentage of early retirees with
                         private coverage fell by only 7 percentage points compared with a much
                         larger drop in the number of employers offering retiree coverage.10

Coverage Influenced by   While Foster Higgins surveys employers about the health benefits they
Factors Other Than       offer, CPS data emanate from interviews with individuals, in this instance,
Availability             retired workers. As with the Foster Higgins survey, CPS data include both
                         the private and public sectors. Analysis of CPS data by the Labor
                         Department’s Pension and Welfare Benefits Administration revealed a
                         significant erosion between 1988 and 1994 in the number of individuals
                         who retain employer-based health coverage upon retirement.11 As shown
                         in table 1, only 42 percent of retirees aged 55 and older continued such
                         coverage into retirement in 1994, a decline of 8 percentage points since
                         1988. Moreover, the percentage of individuals with employer-based
                         coverage continued to decrease throughout retirement. Only 34 percent
                         still retained coverage several years after retirement, and an even smaller
                         percentage believed that their employer-based health benefits would be
                         available until they die. Although a smaller percentage of retirees from the
                         private sector have employer-based benefits at or sometime after
                         retirement, the decline in coverage between 1988 and 1994 can be seen in
                         both the public and private sectors in a roughly proportional manner.
                         Appendix III replicates the data in tables 1 and 2 for the private sector

                          GAO estimate based on Current Population Survey (CPS) data from the Bureau of the Census. See
                         Private Health Insurance: Continued Erosion of Coverage Linked to Cost Pressures
                         (GAO/HEHS-97-122, July 1997).
                          U.S. Department of Labor, Pension and Welfare Benefits Administration, Retirement Benefits of
                         American Workers: New Findings from the September 1994 Current Population Survey (Washington,
                         D.C.: Department of Labor, Sept. 1995), p. 25.

                         Page 9                                              GAO/HEHS-97-150 Retiree Health Benefits

Table 1: Percentage of Retirees With
Employer-Based Coverage, 1988 and                                                                              All retirees (aged 55
1994                                                                                                                 and older)
                                                                                                                   1988          1994
                                       Active employees with coverage at time of retirement                           69%          65%
                                       Workers who continued coverage into retirement                                 50           42
                                       Retirees currently covered by employer’s plan                                  44           34
                                       Retirees who believed their employer-based coverage could
                                       be continued for life                                                          32           30
                                       Source: Department of Labor, Pension and Welfare Benefits Administration.

                                       Factors other than the actual availability of coverage are responsible for
                                       an undetermined portion of the decline in retirees with employer-based
                                       health benefits. According to the Labor Department, the propensity for
                                       retirees to enroll in employer-based plans when they are offered has
                                       dropped because of the increased costs retirees are being asked to
                                       shoulder by employers. In both the 1988 and 1994 surveys, individuals who
                                       declined employer-based coverage at retirement were asked to articulate
                                       the reasons for their decision. Of the approximately 5.3 million retirees
                                       who discontinued employer-based benefits in 1994, 27 percent cited the
                                       expense as a factor—an increase from 21 percent in the earlier survey.
                                       Moreover, there was a 6 percentage point increase over the same time
                                       period in the number of such retirees who indicated that they still had
                                       health insurance through a plan other than that of their former employer.
                                       For example, a retiree may have access to health benefits through a
                                       working or retired spouse.

                                       Table 2 summarizes changes in employer/employee cost sharing for retiree
                                       coverage. Compared with 1988, in 1994, more employers were requiring
                                       retirees to share in the cost of coverage, a fact reflected in (1) the drop in
                                       the percentage of firms paying the entire premium and (2) the increase in
                                       those sharing some of the premium costs. Overall, the employee’s
                                       contribution to premiums rose about 10 percent faster than the inflation
                                       rate over that 6-year period. While this amount reflects the cost increase
                                       for both single and family coverage, there was considerable variation
                                       between the two. The inflation-adjusted employee share for family
                                       coverage increased by almost 23 percent, while the share for single
                                       coverage decreased by about 9 percent. Employers appear to be
                                       encouraging retired employees to sign up for single coverage while hoping
                                       that spouses will choose alternative sources of coverage if they are
                                       available, for example, single coverage from their own former employer.

                                       Page 10                                             GAO/HEHS-97-150 Retiree Health Benefits

                                        Appendix IV summarizes changes from 1988 to 1994 in costs paid by
                                        retirees for both single and family coverage from a former employer.

Table 2: Costs Paid by Retirees for
Employer-Based Coverage, 1988 and                                                                                   1988          1994
1994 (Includes Both Single and Family   Employee pays nothing                                                          42%              37%
                                        Employee pays some costs                                                       33%              42%
                                        Employee pays all costs                                                        21%              19%
                                        Don’t know/no response                                                          4%              2%
                                        Median annual cost to retirees (1994 dollars adjusted for
                                        inflation)                                                                  $874          $960
                                        Source: Department of Labor, Pension and Welfare Benefits Administration.

                                        CPS data also contain insights on the characteristics of individuals more
                                        and less likely to have employer-based coverage. Those characteristics are
                                        summarized in table 3.

Table 3: Characteristics of Retirees
More and Less Likely to Have            MORE likely to have coverage                      LESS likely to have coverage
Employer-Based Health Benefits          Work for larger firms                             Work for smaller firms
                                        Have higher preretirement earnings                Have lower preretirement earnings
                                        Belong to union                                   Are nonunion
                                        Work in manufacturing or                          Work in retail sector or service industries
                                        communications/public utilities
                                        Work for public sector                            Work for private sector
                                        Are men                                           Are women
                                        Are white                                         Are black or other race
                                        Source: Department of Labor, Pension and Welfare Benefits Administration.

                                        If available, employer-based group health insurance provides two
Employers’ Decisions                    important advantages to retirees: (1) more affordable health benefits and
to Terminate                            (2) access to benefits for those retirees whose health status might
Coverage Subjects                       otherwise impinge on their ability to obtain coverage in the individual
                                        insurance market. Such insurance is affordable because many employers
Retirees to New Costs                   continue to finance all or a significant amount of their retirees’ health
and Risks                               insurance costs, even though over the last decade retirees have been
                                        required to pay an increasing share of these costs. In addition, the overall
                                        premiums for employer-based health plans are generally lower than those
                                        in the individual insurance market because the premiums charged to

                                        Page 11                                             GAO/HEHS-97-150 Retiree Health Benefits

                                         employers are based on risks spread over an entire group of workers. In
                                         contrast, premiums in the individual insurance market reflect the risk
                                         characteristics of each applicant. These characteristics include not only
                                         age and coverage type but also gender, health status, and geographic
                                         differences in health care costs.12 Unless there is a state law prohibiting
                                         price differences by age, most carriers charge higher premiums to older

                                         Consequently, retirees no longer covered by their former employer’s group
                                         health plan are likely to encounter higher premiums to obtain similar
                                         coverage in the individual insurance market. For example, before its 1996
                                         decision to terminate health benefits to retired employees at its Milwaukee
                                         plant, Pabst financed the total cost of practically all of the health plans it
                                         offered to its retired workers. With the elimination of these benefits,
                                         affected Pabst retirees who want to obtain health coverage must now
                                         absorb its full cost, which can be a significant amount of money.
                                         Individual retirees may be affected differently by the varying methods
                                         insurance companies use to determine price and eligibility. Table 4
                                         provides an example of the premiums Pabst retirees might face if they
                                         purchase comprehensive coverage from a Wisconsin carrier to replace the
                                         benefits terminated by Pabst.

Table 4: Comparison of Costs to
Retiree Under Age 65 Before and After                                                                Annual cost to     Potential annual
Pabst’s Termination of Health Benefits                                                             retiree for Pabst   cost to retiree for
in 1996                                                                                             health benefitsa individual coverage
                                         Family coverage (retiree and spouse)                              $0-$1,444                 $8,186.96b
                                         Single (male applicant)                                                    $0               $4,502.76
                                          Pabst offered its workers eight different plans and paid their full cost with the exception of one of
                                         four plans that provided family coverage. Few employees selected the family option requiring
                                         cost sharing. The workers who did only had to pay the difference between what Pabst paid for the
                                         other family plans and the cost of this particular plan. This difference was about $1,444 a year.
                                          Premium rate charged by one carrier in Milwaukee, Wisconsin, for a standard plan for a
                                         nonsmoker with a $250 deductible. Covering an additional dependent would bring the cost to
                                         about $9,300. A retiree who smokes and also covers a spouse would pay about $11,000 for

                                         Premiums in other states could be higher or lower given the high
                                         geographic variability of health insurance rates in the individual market.
                                         For example, in 1996, a major carrier in New Jersey offered family

                                          For details on the individual health insurance market, including its structure, premium prices, the
                                         effect of demographic characteristics, and health plans offered, see Private Health Insurance: Millions
                                         Relying on Individual Market Face Cost and Coverage Trade-Offs (GAO/HEHS-97-8, Nov. 25, 1996).

                                         Page 12                                                 GAO/HEHS-97-150 Retiree Health Benefits

coverage with a $250 deductible at an annual price of $11,825.13 The price
of similar family coverage in Maricopa County, Arizona, was only $6,264 in
1996. However, retirees in Arizona with preexisting conditions can be
denied coverage altogether, be charged a premium much higher than the
standard, or have a condition excluded from coverage.

Before the July 1, 1997, implementation of HIPAA, consumers, including
retirees entering the individual insurance market, often discovered that
they were not eligible for insurance or that their coverage was conditioned
upon the permanent exclusion of an existing health problem. Many with
specific health problems found coverage only at prohibitive prices. For
example, health insurance carriers often declined coverage for Acquired
Immune Deficiency Syndrome (AIDS) and diabetes; offered coverage but
excluded conditions such as asthma, ulcers, and glaucoma; and charged
higher premiums for plans that covered problems like anemia and
arteriosclerosis.14 Although HIPAA does not address the cost of health
insurance, it will help guarantee access to the individual market by those
with qualifying coverage from a former employer—regardless of their
health status—and will provide for the renewability of individual coverage.
Although HIPAA offers no protection to Pabst retirees whose health benefits
were terminated in 1996 or to any retiree who lost employer-based health
benefits before July 1, 1997, it will protect future retirees. Wisconsin law
requires insurers to accept individual applicants who previously had
employer-based insurance if such insurance is not self-funded,15 but it
does not apply to Pabst retirees because the firm self-funded its health

Many states, including Wisconsin, offer a high-risk program, or “pool,” for
people who have been denied coverage or have one of a number of
specified health conditions. However, this safety net option often has very
limited coverage and lower lifetime limits. The cost of a high-risk pool can
be 50 percent more than the average or standard rate charged in the
individual insurance market for a comparable plan. The annual premium
for a single male aged 55 to 59 in Wisconsin’s high-risk pool averaged
$5,122 in 1996—over $500 more than the cost in the individual insurance

 This amount is for nonsmokers aged 55 to 59 with one child. Moreover, New Jersey restricts carriers’
premium rating practices and generally requires all carriers to set the same rate for all plan
participants within a community.
 See GAO/HEHS-97-8, Nov. 25, 1996, for a discussion of the evaluation process that health insurance
companies have used in providing access to the individual insurance market.
 Self-funded plans are those in which employers bear much of the financial risk for health claims.
Employers that self-fund are not subject to state insurance regulation. See Health Insurance
Regulation: Varying State Requirements Affect Cost of Insurance (GAO/HEHS-96-161, Aug. 19, 1996).

Page 13                                                GAO/HEHS-97-150 Retiree Health Benefits

                  market, as shown in table 4. Wisconsin offers subsidies to families with
                  incomes of less than $20,000.

                  ERISA covers both the pension and health benefits of most private sector
Limited Federal   workers. The voluntary nature of these employer-based benefits as well as
Protection of     the manner in which coverage is funded have important regulatory
Employer-Based    implications. Consistent with the lack of any mandate to provide health
                  benefits, nothing in federal law requires an employer to offer coverage or
Retiree Health    prevents cutting or eliminating those benefits. In fact, an employer’s
Benefits          freedom to modify the conditions of coverage or to terminate benefits is a
                  defining characteristic of America’s voluntary, employer-based system of
                  health insurance.16 Moreover, employer-based health benefits are funded
                  on a pay-as-you-go basis. In contrast, the sheer magnitude of accumulated
                  employer-employee contributions to retirement funds necessitates a
                  greater degree of regulation of pension benefits. Thus, ERISA not only
                  requires employers to fund their pension plans but gives employees vested
                  rights upon meeting certain service requirements. Health benefits, on the
                  other hand, were excluded from such funding and vesting requirements.17

                  Although ERISA was passed in response to concerns about the solvency and
                  security of pension plans, some of its provisions, including federal
                  preemption of state regulations, also apply to employer-sponsored health
                  coverage. The preemption effectively blocks states from directly
                  regulating most employer-based health plans, while allowing states to
                  oversee the operation of health insurers.18 ERISA, however, does impose
                  some federal requirements on employer-based health plans. For example,
                  employers must

                    The demise of traditional fee-for-service indemnity coverage and the growth in managed care
                  enrollment exemplifies the ability of employers to modify their health benefit programs. Between 1987
                  and 1996, employer-based managed care enrollment rose from 27 percent to 74 percent as employers
                  (1) altered the type and mix of health plans offered, sometimes eliminating the traditional
                  fee-for-service indemnity option; (2) changed employee financial incentives; and (3) used the
                  information provided to employees to influence their selection of health plans. See Health Insurance:
                  Management Strategies Used by Large Employers to Control Costs (GAO/HEHS-97-71, May 6, 1997) for
                  a discussion of the flexibility of large employers as well as the constraints they face in modifying their
                  health benefit purchasing strategies.
                    GAO/HRD-93-125, July 9, 1993.
                   Federal preemption is valued by employers who self-fund their health benefit plans because they can
                  avoid taxes, are exempt from mandated state benefits, and can offer a uniform benefit plan to
                  company employees located in different states. Because of the sometimes obscure distinction between
                  prohibiting states from directly regulating employer health coverage but allowing them to set rules for
                  health insurers, the courts have had to determine many of the actual implications of ERISA
                  preemption. See Employer-Based Health Plans: Issues, Trends, and Challenges Posed by ERISA
                  (GAO/HEHS-95-167, July 25, 1995).

                  Page 14                                                  GAO/HEHS-97-150 Retiree Health Benefits

•   file annual Summary Plan Descriptions (SPD) with the Department of
•   provide participants and beneficiaries access to information about the
•   have a process for appealing claim denials,
•   make available temporary continuation coverage for former employees
    and dependents, and
•   meet specific fiduciary obligations.

    While ERISA protected the pension benefits of retired workers at the Pabst
    Brewing Company, it offered only limited federal safeguards to retirees
    participating in the firm’s health benefit plan. ERISA requires companies
    such as Pabst to make an SPD available to health plan participants within
    90 days of enrolling. For retirees, the SPD that was in effect at the time of
    retirement is the controlling document. The SPD must clearly set out
    employee rights, including “. . . information concerning the provisions of
    the plan which govern the circumstances under which the plan may be
    terminated.” Employers must file these documents with the Department of
    Labor, the agency responsible for enforcing ERISA. According to Labor,
    unless employers have made a clear promise of specific health benefits for
    a definite period of time or for life and have not reserved the right to
    change those benefits, they are free to cut or terminate health care
    coverage. Appendix V contains an excerpt from a Labor brochure outlining
    employer responsibilities/employee protections under ERISA.

    Because of the federal preemption of state regulation, the rights of active
    and retired employees under ERISA are determined in federal courts. In
    reviewing cases involving changes to health benefit plans by employers,
    several federal courts have focused on the actual language used in plan
    documents and, if applicable, in collective bargaining agreements.
    Virtually all employers have reserved the right to modify health benefits
    for current and future retirees in such documents. However, if the
    language leaves some doubt as to the nature or duration of benefits, or if
    there are conflicts in the plan documents, the courts have examined
    significant written and oral representations made to employees to
    determine whether the employer has the right to modify retiree health

    The temporary availability of health care coverage guaranteed by COBRA to
    an individual who is fired, laid off, or leaves a job is not available to
    retirees whose employer terminates their health care coverage. However,
    COBRA does allow covered individuals, upon retirement, to continue

    Page 15                                  GAO/HEHS-97-150 Retiree Health Benefits

                  employer-based coverage for 18 months if their company does not offer
                  health benefits to retirees. Those eligible for COBRA coverage may have to
                  pay the entire premium plus an additional 2 percent. For many individuals,
                  the cost of COBRA coverage represents a rude awakening, considering that
                  under employer-based coverage large companies typically pay 70 to
                  80 percent of the premium.

                  Retirees whose former employers terminate coverage are ineligible for
                  COBRA  and they also may be too late to purchase a supplemental Medigap
                  policy to replace any lost employer coverage. In 1994 and again in 1996, we
                  brought this “catch 22” situation to the attention of the Congress. An
                  individual turning 65 has a 6-month open-enrollment window in which to
                  buy supplemental Medigap insurance to cover Medicare deductibles and
                  coinsurance and certain uncovered services. (See app. II for a description
                  of Medicare benefits.) Medicare enrollees who seek a Medigap policy after
                  this 6-month period may be denied coverage because of a preexisting
                  condition. For example, a diabetic might not be able to buy supplemental
                  prescription drug coverage, a benefit not available under Medicare.
                  Similarly, if termination of employer coverage occurs after the
                  open-enrollment period, a retiree may be unable to obtain alternative
                  Medigap coverage. We suggested that the Congress may wish to consider
                  amending the law to provide a mechanism for retirees to obtain Medigap
                  insurance under these circumstances.19

                  We sought comments on a draft of this report from private sector experts
Agency Comments   and the Department of Labor’s Pension and Welfare Benefits
                  Administration. The reviewers generally agreed with our presentation of
                  the information but provided technical suggestions that we included
                  where appropriate.

                  As agreed with your office, we will make no further distribution of this
                  report until 30 days after the date of this letter. At that time, we will make
                  copies of this report available to interested parties who request them.

                    Health Insurance for the Elderly: Owning Duplicate Policies Is Costly and Unnecessary
                  (GAO/HEHS-94-185, Aug. 3, 1994). See also Medigap Insurance: Alternatives for Medicare Beneficiaries
                  to Avoid Medical Underwriting (GAO/HEHS-96-180, Sept. 10, 1996).

                  Page 16                                               GAO/HEHS-97-150 Retiree Health Benefits

Please call either Michael Gutowski, Assistant Director, at (202) 512-7128
or me at (202) 512-7029 if you or your staff have any questions concerning
this report. Major contributors to this report included John Dicken,
Carmen Rivera-Lowitt, and Walter Ochinko.

Sincerely yours,

Jonathan Ratner
Associate Director, Health Financing and
  Systems Issues

Page 17                                 GAO/HEHS-97-150 Retiree Health Benefits

Letter                                                                 1

Appendix I                                                            20

Limited but
Consistent Data on
Trends in
Retiree Health Care
Appendix II                                                           22

Comparison of
Medicare Benefits and
Group Coverage by
Large Firms
Appendix III                                                          23

CPS Data on Private
Sector Retiree
Coverage and Cost
Appendix IV                                                           24

CPS Data on Costs to
Retirees for Single
and Family Coverage
Through a Former

                        Page 18   GAO/HEHS-97-150 Retiree Health Benefits

Appendix V                                                                                        25

Excerpt From
Department of Labor
Brochure on
Tables                Table 1: Percentage of Retirees With Employer-Based Coverage,               10
                        1988 and 1994
                      Table 2: Costs Paid by Retirees for Employer-Based Coverage,                11
                        1988 and 1994
                      Table 3: Characteristics of Retirees More and Less Likely to Have           11
                        Employer-Based Health Benefits
                      Table 4: Comparison of Costs to Retiree Under Age 65 Before and             12
                        After Pabst’s Termination of Health Benefits in 1996
                      Table III.1: Percentage of Private Sector Retirees With                     23
                        Employer-Based Coverage, 1988 and 1994
                      Table III.2: Costs Paid by Retirees for Private Sector                      23
                        Employer-Based Coverage, 1988 and 1994
                      Table IV.1: Single Coverage—Costs to Retirees for                           24
                        Employer-Based Health Benefits, 1988 and 1994
                      Table IV.2: Family Coverage—Costs to Retirees for                           24
                        Employer-Based Health Benefits, 1988 and 1994

Figure                Figure 1: Percentage of Large Employers Offering Retiree                     7
                        Medical Coverage, 1988 and 1992-96


                      AIDS       Acquired Immune Deficiency Syndrome
                      COBRA      Consolidated Omnibus Budget Reconciliation Act of 1986
                      CPS        current population survey
                      ERISA      Employee Retirement Income Security Act of 1974
                      FAS        Financial Accounting Standards
                      HIPAA      Health Insurance Portability and Accountability Act of 1996
                      HMO        health maintenance organization
                      SPD        Summary Plan Description

                      Page 19                                 GAO/HEHS-97-150 Retiree Health Benefits
Appendix I

Limited but Consistent Data on Trends in
Employer-Based Retiree Health Care
               Despite the existence of a number of public and private surveys that touch
               on the issue of employer-based retiree health coverage, only limited trend
               data are available. Two surveys that include data from the late 1980s
               through the mid-1990s both demonstrate a downward trend in such
               coverage, but the evidence was collected from different vantage points
               and the survey methodologies were not consistent across the entire time
               period. The results are not strictly comparable since one survey focused
               on employers, while the other was based on retiree responses. The former
               asks employers if they offer coverage to retirees; the latter focuses on the
               decisions of individual retirees, who may choose not to participate even
               when employer-based insurance is available because of cost or the
               availability of alternative coverage. In addition, changes in the
               methodologies used to conduct the surveys suggest that individual
               numbers should be used cautiously even though the trends appear to be

               Employer Survey by Foster Higgins. Although the Foster Higgins survey
               dates from 1986, the survey methodology was changed in 1993 so that the
               results could be representative of all U.S. employers rather than just those
               who responded. In addition, the survey was expanded to include smaller
               employers with between 10 and 500 employees, an important group that
               provides health insurance to about one-third of Americans with
               employer-based coverage and a group on which there were little or no
               credible data. As a result of the revamped methodology, pre- and post-1993
               data are not strictly comparable even though the resulting trend line
               appears to be consistent. According to a Foster Higgins official, the earlier
               data are not as “authoritative” as that collected after 1992. Foster Higgins
               focuses on large public and private sector employers, that is, those with
               more than 500 workers. Such large employers are more likely than smaller
               firms to offer health benefits. While Foster Higgins reports separately with
               respect to early retirees versus those who are Medicare eligible, it does not
               (1) provide an overall estimate of the extent to which large employers
               provide retiree coverage or (2) differentiate between the extent to which
               public versus private sector employers provide benefits. Finally, the Foster
               Higgins data are considered proprietary, and only the data it chooses to
               release in summary form are generally available.

               Retiree Survey Analyzed by Department of Labor. In contrast to the annual
               Foster Higgins surveys, data from public sources are more sporadic and
               not as up to date. In 1995, the Pension and Welfare Benefits Administration
               in the Department of Labor released a comparison of 1988 and 1994
               Current Population Survey (CPS) data on retirees. The report is based on

               Page 20                                  GAO/HEHS-97-150 Retiree Health Benefits
Appendix I
Limited but Consistent Data on Trends in
Employer-Based Retiree Health Care

special supplements, sponsored by the Labor Department, to the
August 1988 and September 1994 CPS surveys. These supplements focused
on retiree health benefits. The resulting data only provide a limited picture
of employer trends because (1) they are based on interviews with retired
workers and (2) they do not always clearly distinguish between the
availability of coverage and a worker’s decision not to participate in
employer-based retiree coverage. In addition, no 1988 to 1994 trend data
were reported on an important subset of workers—early retirees. Finally,
questions about reasons for discontinuing coverage were expanded in the
1994 survey, making a precise comparison across the period difficult.

Page 21                                    GAO/HEHS-97-150 Retiree Health Benefits
Appendix II

Comparison of Medicare Benefits and
Employer-Based Group Coverage by Large
              Medicare benefits are more convoluted and contain more gaps than those
              generally offered by large employers. For example, standard
              (fee-for-service) Medicare has separate benefits for hospitalization (part
              A) and physician/outpatient services (part B), with different copayments
              and deductibles. Those eligible for Medicare are automatically enrolled in
              part A but must pay a premium to elect part B coverage. Part A has a
              relatively high deductible for each hospitalization and requires
              copayments for stays longer than 60 days;20 part B has a separate
              deductible, requires 20 percent coinsurance for physicians’ bills, and does
              not cover prescription drugs. Neither part A nor part B has a limit on
              out-of-pocket costs. In order to cover some of the gaps in Medicare
              coverage, beneficiaries may purchase so-called Medigap supplementary
              insurance or may enroll in a health maintenance organization (HMO)
              offered through Medicare if one is available in their area. In contrast to
              Medigap, some HMOs do not even charge a premium for the benefits
              otherwise not covered by Medicare, but generally require beneficiaries to
              use plan doctors and hospitals. Large employer coverage, on the other
              hand, generally offers a single, comprehensive benefit with an associated
              deductible and copayment. Normally, annual out-of-pocket costs are
              capped, and health services beyond that point are reimbursed at
              100 percent. In addition, benefits provided by large employers typically
              include prescription drugs.

               The current deductible is $760. The copayment of $190 per day for more than 60 but fewer than 91
              days of hospitalization rises to $380 per day for the 91st though the 150th days.

              Page 22                                               GAO/HEHS-97-150 Retiree Health Benefits
Appendix III

CPS Data on Private Sector Retiree
Coverage and Cost Sharing

Table III.1: Percentage of Private
Sector Retirees With Employer-Based                                                                               All retirees (55 and
Coverage, 1988 and 1994                                                                                                   older)
                                                                                                                      1988         1994
                                          Active employees with coverage at time of retirement                          65%              60%
                                          Workers who continued coverage into retirement                                42               35
                                          Retirees currently covered by employer’s plan                                 37               27
                                          Retirees who believed their employer-based coverage could
                                          be continued for life                                                         27               24
                                          Source: Department of Labor, Pension and Welfare Benefits Administration.

Table III.2: Costs Paid by Retirees for
Private Sector Employer-Based                                                                                         1988         1994
Coverage, 1988 and 1994 (Includes         Employee pays nothing                                                         50%              42%
Both Single and Family Coverage)
                                          Employee pays some costs                                                      28%              36%
                                          Employee pays all costs                                                       22%              21%
                                          Don’t know/no response                                                          0%              1%
                                          Median annual cost to retirees (1994 dollars adjusted for
                                          inflation)                                                                  $778         $840
                                          Source: Department of Labor, Pension and Welfare Benefits Administration.

                                          Page 23                                             GAO/HEHS-97-150 Retiree Health Benefits
Appendix IV

CPS Data on Costs to Retirees for Single and
Family Coverage Through a Former
Table IV.1: Single Coverage—Costs to
Retirees for Employer-Based Health                                                                                 1988      1994
Benefits, 1988 and 1994                Employee pays nothing                                                        42%        34%
                                       Employee pays some costs                                                     37%        39%
                                       Employee pays all costs                                                      27%        25%
                                       Don’t know/no response                                                        4%         2%
                                       Median annual cost to retirees (1994 dollars adjusted for
                                       inflation)                                                                  $753      $684
                                       Source: Department of Labor, Pension and Welfare Benefits Administration.

Table IV.2: Family Coverage—Costs to
Retirees for Employer-Based Health                                                                                 1988      1994
Benefits, 1988 and 1994                Employee pays nothing                                                        42%        40%
                                       Employee pays some costs                                                     38%        44%
                                       Employee pays all costs                                                      17%        14%
                                       Don’t know/no response                                                        3%         2%
                                       Median annual cost to retirees (1994 dollars adjusted for
                                       inflation)                                                                  $979    $1,200
                                       Source: Department of Labor, Pension and Welfare Benefits Administration.

                                       Page 24                                             GAO/HEHS-97-150 Retiree Health Benefits
Appendix V

Excerpt From Department of Labor
Brochure on Employer Responsibilities
              “Can the Retiree Health Benefits Provided by Your Employer Be Cut?

              “You should know—coverage can change.

              “If your employer has reserved the right in the SPD and controlling plan document to change
              the terms of the plan, you may lose coverage at any time during your retirement. If your
              employer made a clear promise that you will have specific health care benefits for a
              definite period of time or for life, and did not reserve the right to change the plan, you
              should be covered.

              [Text omitted.]

              “—Do the SPD or other plan documents promise that health benefits after retirement will
              continue at a specified level for a certain period of time?

              “—If there is no specific language describing retiree health benefits in your plan
              documents, it is unlikely that you have coverage.

              “—If there is such language, how specific is it?

              “Sometimes language covering retiree health benefits is included in the documents, but it is
              too vague to stand up to a test in the courts. Conversely, there is language on employee
              health benefits that has held up in court. Here is an example:

              “ ‘Basic health care coverage will be provided at the company’s expense for your lifetime.’

              “—Even if a specific promise is made, is there also language that gives your former
              employer the right to change or terminate that specific promise or to amend or terminate
              the entire plan?

              “Typical language giving the employer that right might read:

              “ ‘The company reserves the right to modify, revoke, suspend, terminate, or change the
              program, in whole or in part, at any time.’

              “This is an actual example, but other similar language may be found anywhere in the plan

              “If you are an employee reviewing the current plan, it is important to remember that it can
              change in the future. The documents in effect when you retire are the ones that will
              determine your health benefits, if any, in your retirement.”21

               U.S. Department of Labor, Pension and Welfare Benefits Administration, Division of Technical
              Assistance and Inquiries.

(101553)      Page 25                                               GAO/HEHS-97-150 Retiree Health Benefits
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