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Out-of-control health care costs will continue to slam the corporate bottom line. In addition to costs, employee morale is a major issue. Employees have grown to feel entitled to health care coverage. They may understand that costs arc rising, but they're still inclined to feel their employers are ripping them off when they're required to pay more of the health care tab. There are no easy answers to the crisis, which is the complicated result of an aging wave of baby boomers, increasingly effective but expensive medical technologies that prolong life spans and rising pharmaceutical costs, as well as other cultural and societal factors. Cutting out waste, fraud and abuse in the medical system will go only so far. As if the costs weren't bad enough, another huge issue is hanging over companies' heads: increasing pressure for government mandates. Currently, cost sharing - or, as many employees prefer to call it, cost shifting - is emerging as the most popular approach for employers trying to rein in costs.

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To stay competitive with low-wage, low-benefits Wal-Marts moving into Southern California, Safeway and other supermarket chains earlier this year tried to persuade their unionized employees to start contributing toward their health care benefits. Paying 100 percent of workers' health care bills, the employers argued, was just too much. The request drew a resounding "no" from the union, and the employees promptly went on strike. The strike cost the supermarkets millions of dollars in lost sales, causing them to bend and agree to insulate current employees from the rising costs of health care for the next two years.

That strike was just a taste of what's to come. Of the respondents to the latest CEO Confidence Index, some 48 percent said they expect their companies' health care costs to increase by 11 to 20 percent annually over each of the next three years (see story, page 12). The benefits-consulting arm of Wells Fargo predicts that double-digit increases will continue into the future. That's many times the rate of overall inflation, now hovering around 2 percent. Medicare, already under heavy pressure, is likely to go broke by the end of the next decade without major reform, and the recently passed prescription-drug bill only makes things worse. Employee health benefits on average represent 7 percent of total wages, according to the Bureau of Labor Statistics. If current trends continue, that figure would rise to 25 percent in 10 years and to 60 percent in 20 years. Even if the inflationary trends continue, as they're likely to do, no one expects the gap between wage growth and health care inflation to be anything but vast.

In other words, these out-of-control costs will continue to slam the corporate bottom line. U.S. automakers, for example, say health benefits account for $1,200 to $1,400 of the cost of building each new car. General Motors says it will spend $4.5 billion on health care this year, on top of $67.8 billion in future retiree health care liabilities.

Health care costs are being blamed in part for the trend toward outsourcing; the American Electronics Association recently identified soaring health care costs as a major factor in its members' sending jobs overseas. Before the grocery strike increased the volume of bad blood between management and labor, Ford Motor Co. CKO Bill Ford was very public about his views on health care. "I just think that as a country, if we have a model that isn't working and a model that's driving jobs overseas, then we'd better take another look at it," he said last December.

In addition to costs, employee morale is a major issue. Employees have grown to feel entitled to health care coverage. They may understand that costs arc rising, but they're still inclined to feel their employers arc ripping them off when they're required to pay more of the health care tab. That, clearly, could harm loyalty and productivity.

Push for Government Mandates

There are no easy answers to the crisis, which is the complicated result of an aging wave of baby boomers, increasingly effective but expensive medical technologies that prolong life spans and rising pharmaceutical costs, as well as other cultural and societal factors. Cutting out waste, fraud and abuse in the medical system will go only so far.

The issue is so intense that the next wave of employee and public anger could dwarf the scandals over Enron-style corporate malfeasance and the ongoing controversy over outsourcing. "The issue of health care costs and how to deal with them has moved out of human resources and into not just the executive suite but the boardroom," says Peter Lcc, chief executive of the Pacific Business Group on Health, a consortium of companies including Bank of America, FedEx and Vcrixon Communications.

As if the costs weren't bad enough, another huge issue is hanging over companies' heads: increasing pressure for government mandates. With the number of uninsured Americans at 43 million and rising, "we're moving rapidly toward the tipping point on mandates," says Tom Bcauregard, a consultant at Hewitt Associates, a human relations consulting firm. Already, California has passed a bill requiring businesses to pay into a pool that would provide coverage to more than a million uninsured workers; critics say the law will do nothing to curtail health costs. "If senior executives don't start working more aggressively toward health care reform, we're just running out the clock on mandates," Beauregard says. "The worst scenario isn't even a national solution, but a 50-states solution."

Bill George, former chief executive of the medical device maker Medtronic, says the strategic importance of health care to senior management is sure to grow. "Most CEOs are not spending enough time on it," he says.

So what's a CEO to do? Start with acceptance. The problem is not going away. Look at supply: America's innovation machine continuously turns out wonder drugs, high-tech devices and other medical marvels, most of which, when they reach market, can significantly improve people's lives. On a single day recently, TAe Wbii Street /oimiuZ reported on a new $20,000 deRbrillator, an implant that can prevent heart attacks; a promising treatment that might allow certain cancer patients to bear children; and a major study showing that increasing the currently recommended dosage for the statin drug Lipotor can substantially reduce heart attack risk. "Medical technology has the amazing ability to bring us enhancements daily, monthly, yearly, allowing us to do more and more," says Michael Dowling, chief executive of the North ShoreLong Island Jewish Health System, which runs 17 community hospitals that serve the New York metropolitan area.

Add to advanced technology the burgeoning demand represented by 77 million baby boomers moving into old age. That's a lot of people who hail from a generation that's gotten used to plenty. "This is a consumer-driven culture," Dowling says. "With that comes a massive onslaught of people with high expectations that will drive increased utilization of health care."

And technology will be keeping these same people alive a lot longer. "Our grandfathers and uncles died in their 60s because of heart attacks," he says. "Our bodies arc still getting sick in our SOs and our 60s, but we're living into our 90s."

This demographic bulge increases costs for existing workers, and everyone else, simply by boosting total demand. The current work force, meanwhile, is doing its part by contributing to the porking up of America. Obesity, a major contributor to many varieties of bad health, has become a national epidemic that some public health experts say may soon cancel out the social health gains made by the dramatic reduction in smoking.

And then there's the demand created by all those drug ads on television. Drug companies have to compete, too, of course, but the highvisibility TV ad campaigns arc intended to raise demand for name-brand drugs, which cost far more than generic versions and consequently raise health care plan costs.

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PITCHED BATTLE: Autoworkers picket during GM-UAW contract talks in Detroit.

In Search of Solutions

Currently, cost sharing-or, as many employees prefer to call it, cost shifting-is emerging as the most popular approach for employers trying to rein in costs. Clearly, requiring workers to pay more helps the bottom line. The larger economic idea used to justify cost sharing is that employees, as the end consumers generating the demand, will make better decisions about discretionary spending when more of their own money is at stake. As Scott Serota, chief executive of the Blue Cross and Blue Shield Association, puts it: "When the member has limited economic skin in the game, their assumption is going to be that more is better. If you sent people to a car dealer and they didn't have to pay for the car, most people would go out with a high-end car."

Not surprisingly, companies with unionized workers are feeling the strongest resistance from employees. Unions increasingly are targeting health care benefits as an issue worth striking over. The supermarket workers in California are not alone. In March, Minnesota transit workers were striking over health care benefits, as well. Peter Bell, chairman of the Twin Cities Metropolitan Council, which runs the system, told reporters that the health benefit inflation is "the Pac-Man in our budget that is eating us alive. As with businesses in the private sector and units of government in the public sector, it is allconsuming and unsustainable."

In the move to share costs, companies are getting most aggressive with retirees. Almost three-quarters of 408 employers surveyed recently by the Kaiser Family Foundation say they've begun charging retirees more for health care over the past year. Ten percent said they've cut retiree benefits completely, and another 20 percent said they'd probably do the same by 2007. The result has been howls of protests from retired workers -such as those at United Airlines, struggling to emerge from Chapter 11-who say they were misled into accepting early retirement packages. They say they were told that their health coverage would continue.

Hewitt's Beaurcgard warns, however, that cutting retiree benefits can backfire. "It's easy to understand immediate savings," he says. "But the longer term implication is that you're changing your retirement patterns. Take the 62-year-old who plans to retire at 63. He's done all the right things, but now that he's preparing to retire, he recognizes the gap in health care [before Medicare kicks in . He's highly paid, maybe not so highly productivc. But you've put yourself in a position where you've got people hanging on for health benefits who arc unhappy and unproductive."

Companies may be less aggressive when it comes to cost sharing with current employees, but not by much. Family covcrage is a common target. In the past three years, the average premium charged to employees for family coverage is up by 50 percent, according to the Kaiser foundation. This year, Hewitt estimates, employee costs for family coverage will jump from $1,276 a year to $1,565. Yet the employers' share of health care costs is holding steady on average, at about 77 percent, according to Wells Fargo.

Requiring employees to share the eost of health care inflation may be unavoidable, and some argue that giving consumers more "skin" in making economic decisions will be essential to getting this problem under control. But companies that focus solely on offloading the financial burden to their employees are asking for trouble, says Pacific Business Group's Peter Lee, who believes cost sharing has its limits. "If a strategy is only about getting skin in the game, we arc going to end up with employees who arc skeletons," he says. Blue Cross and Blue Shield's Scrota and other experts strongly agree, saying that companies that hack thoughtlessly at health care costs are likely to invite employee backlash.

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So what to do? James Robinson, a corporate health care expert at the Univcrsity of California-Berkeley, says CEOs had better get ready for "a very painful, nittygritty, disagreeable, dirty process of changing the way people think about health care, and getting them ready for a series of tradeoffs"-some of which, he adds hopefnlly, "arc going to be good."

Understanding trade-offs is the key. Robinson bristles at the notion that requiring patients to dig into their own pockets will, say, encourage them to better understand whether an MRI scan is really necessary for their particular condition. It may even inspire them to haggle with the doctor over the price of a procedure. "When we buy a car, we buy a car; we're not expected to choose the spark plugs," he says. "The manufacturer docs that." Negotiating details of treatment procedures, he says, is like negotiating for the spark plugs in a new car.

An intelligent and streamlined redesign of benefit packages that acknowledges economic trade-offs could move health care toward becoming a more rational market, while softening employee backlash. In health care, the thinking goes, consumers need the equivalent of car models to choose from, an array of benefit packages that offer different levels of service depending on an employee's needs and ability to pay. Those packages exist today, of course, but in a crude form that often boils down to a choice between in-nctwork and out-of-network service. Human resources executives can handle the details, but they're going to require some big help from senior management-most crucially, by working with top executives from other companies and with health care providers to devise widely accepted, standardized and transparent measures of quality health care.

Those measures arc crucial if employers are to design intelligent benefit packages and employees are to choose wisely among them. One of the most promising approaches to standards and quality is what's known as "evidence-based medicine," which conceptually isn't much different from the best-practices approach in business. Treatment methods in large populations are studied for statistical evidence on what works best to treat a particular malady. That evidence is made available to physicians, and updated as new evidence is produced.

Consumers As Gate-Keepers

Maybe those treatments require the use of expensive equipment, devices and drugs. Maybe they don't. Rut human nature won't bow to statistics when good health or a life is on the line. If a $25,000 drug cures only 5 percent of a population with a life-threatening disease, the patient understandably is still going to want that drug.

Designing intelligent benefit plans mat take evidence-based medicine into account, however, offers the opportunity to put the gate-keeping function in the hands of consumers. And consumers, according to Robinson, are the only player in the U.S. health care system with the "social legitimacy" to make such decisions. Government is considered inept. Most health care providers are profit-oriented businesses with their eyes on the bottom line. Ditto for the insurance companies. Doctors would much rather lay out options for patients man deny them care.

A tiered-price menu of health benefit packages, from basic transportation to highend luxury-say, from a Mazda 3 to a Mercedes-Benz S Class -subsidized to some degree by the employer, could keep basic health care affordable to all workers while giving consumers the option to buy more if they are willing to pay for it. The barebones plans would offer a narrower choice of providers and more closely resemble the managed-care HMOs of the early 1990s. If employers make sure the plans are tailored well, denial of care decisions would be less arbitrary than under the old HMO regime, more often based on scientific and statistical evidence transparent and available to all parties. Organizations such as the Leapfrog Group and the National Quality Forum arc among those working to develop such standards.

Employees need to take personal responsibility for their health as well. There's plenty of evidence to show that "lifestyle" behavior modifications proven to keep people healthy and slow the progression of existing disease. That's familiar, if not sufficiently heeded advice about eating less, exercising more, not smoking, limiting alcoholic consumption and putting on a seat belt. Evidence-based "dis ease -management programs" arc proving their worth in some benefit plans. Blue Cross and Blue Shield offers what it calls the BlueWorks program, which works not only with patients, but with their spouses and children as well to help them manage their own chronic diseases. There is plenty of data on the most expensive maladies-diabetes, cancer, heart disease -to guide the way. Employer-sponsored wellness programs that offer education and opportunities for on-the-job exercise and stress reduction are becoming more popular again as the evidence shows they pay off in the long run.

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Companies can't force employees to live healthier lives, of course. Medical evidence can stack up and fill a stadium but a couch potato culture won't do much to rein in health care costs. "We don't have a system where people take responsibility for their own health," says former Medtronic GKO George. "They think the doctor and the health care system is responsible for their health. Basically, we have sick care, not health care. In the worst of cases, people get Medtronic stents and they go back and live the same artery-clogging lifestyle they were already leading." A recent example of what he's talking about: A union official scheduling pickcters in the Minnesota transit strike puffed away on a cigarette.

Berkeley's Robinson says that making health care less of a frcebie is key to sealing back costs. But, he adds, it would be easy for chief executives to misconstrue his point. It isn't about turning consumers into financial negotiators. Instead, he says, shifting economic incentives closer to the end customer "sets the framework for a change in the culture of medicine away from entitlement and toward the concept that health care is a very valuable, very expensive, precious social resource."

It's a subtle distinction, but GKOs who make the effort to develop smart health care benefit strategies, and who communicate with their employees about the need for change, arc far more likely to achieve the cooperation they need to avert the impending health care meltdown.

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ACTION PLAN

Steps to take with:

Employees

* Develop tiered benefit packages tailored to employee needs.

* Begin or expand well ness programs, which can lower health costs and worker's comp claims while improving employee morale.

* Communicate directly with employees to emphasize the importance of health care costs to the company's future.

Suppliers

* Demand transparency on cost and quality.

* Insist on evidencebased health plans.

* Analyze total cost of care; cheap services might cost more in the long run.

Government

* Closely follow proposed legislation. Key issues: Medicare reform, tort reform, more government research into drug efficacy.

* What's most important, says former Medtronic CEO Bill George, is motivation. "Most (CEOs) do lobbying on their own self interest," he says. In health care, "we need them to look at the whole problem."

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"If we have a model taht isn't working and that's driving jobs overseas, then we'd better take another look at it."

-BILL FORD, CEO, FORD MOTOR