In a sluggish economy, most large employers can tighten their belts, lay off a few hundred or thousand employees, and muddle through. Employee benefits-at least for the workers who don't get pink slips-remain essentially intact.

But small companies that operate lean and mean even during the good times turn a critical eye to fringe benefits. The result: Innovation on the part of the providers of health, retirement and other benefits products, and a lot of scrambling on the part of those who advise and sell them to the small-business community. But when survival is on the line, even non-fringe benefits such as health insurance can get the heave-ho. And that is precisely what has been happening. A recent Kaiser Family Foundation study reveals that the percentage of small employers (companies with three to 199 workers) offering health benefits has fallen to 61% from a high-water mark of 67% in 2000.

U.S. Census data released recently revealed the first up-tick in three years in the percentage of the total population lacking health coverage. (The percentage rose to 14.6% in 2001 from 14.2% in 2000.) "This is a forerunner of much larger increases to come," warns Ron Pollack, a Washington-based lobbyist for expanding health coverage.

And the increase wasn't just a reflection of employers ditching coverage, but of employees' personal decisions to drop coverage because they couldn't afford their rising share of the health-benefit cost.

Meanwhile, eroding 401(k) account balances stemming from the carnage on Wall Street since the onset of the bear market are causing high anxiety and new investment patterns among small companies and their employees. But, as the old adage goes, in crisis there is opportunity.

Shopping For Plans

"Our activity level is rising every month," reportsDavidHuntley,afounderof 401Konnect.com, a Web-based 401(k)-selection tool for commission-based financial advisors. "I believe it's because more people are shopping for plans. The brokers who are going out and talking to small-business owners about the issues, giving them some ideas and not simply avoiding them because they don't want to deal with the unhappiness, are doing well."

On the health-plan front, what small employers want to talk most about is skyrocketing costs. A recent reader survey by Employee Benefit News, a trade magazine, found that health-plan costs were by far readers' biggest worry, with 71% assigning it the maximum anxiety rating. That issue far outranked others, such as "retirement planning education," which only about 14% of the 1,507 survey participants ranked as a "very important" concern. (Retirement planning was rated "important" by 38% of survey respondents.)

The survey found that 83% of respondents are experiencing double-digit increases in health-plan costs. And the hit for smaller employers (defined as those with fewer than 200 employees) is more brutal. For example, 43% of employers in that group sustained increases exceeding 15% this year, compared with 35% for all survey respondents. The disparity reflects a traditional pattern in the health insurance market in which buyers with greater purchasing leverage effectively shift rising costs to buyers with less.

Passing The Buck

Although some small employers are simply dropping health benefits altogether, most are pursuing less Draconian strategies. In general, the approach among small companies-as well as large ones-is to pass the buck to employees: reduce benefit levels and ask workers to pay for a greater share of the remaining benefits.

For example, the Kaiser Family Foundation says the average deductible for "preferred providers" in PPO plans rose this year to $276, a 37% increase. And the percentage of workers in HMO plans facing a $20 co-payment rose to 11% from a paltry 2%. "The rise in employee costs is likely to continue," the survey concludes.

In many cases, the increases already have been huge, reports Eric Wurzel, a partner of Travers O'Keefe, a New York-based regional insurance and benefits brokerage. "Many are switching to enormously high deductibles, like $1,000 with 70/30 coinsurance up to as high as $10,000 or $20,000."

In response, carriers like AFLAC and Colonial-major players in the "voluntary" or payroll-deduction employee-paid market-have introduced policies designed to help cash-strapped employees meet these deductibles. The supplemental insurance that responds most directly to reductions in group-health-benefit levels is medical gap policies.

"I find these most attractive to my clients who have a lot of blue collar workers," says Richard Harlow, a Reston, Va.-based broker who specializes in the small-employer market. The lower-wage workers have a tougher time dealing with the rising deductibles, he adds.

Colonial, for example, sells its Medical Bridge policy that "supplements existing major medical coverage by helping employees pay the medical and non-medical expenses associated with a hospital stay or outpatient surgery, such as deductibles, co-payments, child care or transportation to or from the hospital," according to spokeswoman Jeanne Reynolds.

The policy is available with guaranteed-issue underwriting, assuming minimum participation levels are achieved. As an individual policy, it's portable and guaranteed renewable.

Also generating a lot of interest is AFLAC's "Personal Sickness Indemnity Plan," which provides physician-visit coverage varying from $15 to $25 per visit, and hospital-confinement benefits varying from $50 to $200 per day based on the level of coverage and duration of the hospital stay. The policy also contributes to the cost of other services, including diagnostic exams, surgery, hospital-based rehab and ambulance transportation.

Yet another player in this market, Houston-based Manhattan Insurance Group, offers its MedChoice Plan with similar features.

Patient-Directed Health Care

A very different approach to attacking rapidly escalating health-benefit costs that is getting attention is "patient-directed health care." The idea is based on giving employees financial incentives to spend health dollars prudently and the information they need to make health-care decisions.

The concept was given a large boost by the Internal Revenue Service this year, when it laid the basic ground rules for health-care reimbursement accounts (HRAs), a funding device that can be incorporated into a high-deductible health plan. "What the IRS allowed was phenomenal," says Fred Hunt, president of the Society of Professional Benefit Administrators. "The flexibility and tax advantages are tremendous."

In a nutshell, funds accumulated in an HRA can pay for employee health expenditures, and unlike a flexible spending account, unspent HRA funds can roll over into the next plan year. But a crucial distinction is that HRA accounts are funded by employer dollars, not employee deductions as flexible spending accounts are.

Hunt acknowledges HRAs won't generate immediate huge savings for employers. The hope is that over time, by taking advantages of the financial incentive to limit utilization of health-care services (i.e. to bank annual savings), employees will ultimately be more careful about health-care spending. It is hoped that this eases inflationary pressure on the system. To a lesser extent, HRAs may reduce insurance costs because their design makes them look like a high-deductible plan to an underwriter.

The shift for employees, says Ken Harvey, president of Corporate Benefit Services in Charlotte, N.C., represents a transition from "being guests in a doctor's office" to "acting like they're shopping in a grocery store" for medical services. And that, he says, requires that employees be given "value-added support tools."

One such tool built into his company's plan is "E-doc," an Internet-based service that gives employees a direct link to physicians. Using that resource, one of his own employees learned that the pain in her back that she thought would require a trip to the doctor was a kidney stone that could be resolved with patience at home.

Harvey's company is a TPA, or third party administrator, and generally works with employers with at least 200 employees. But insurers that distribute group products to smaller companies through brokers also are jumping on the HRA bandwagon. For example, last May Principal Financial laid out a blueprint for what it called the "next generation of health-care options" for self-funded plans, featuring the HRA, 100% coverage of preventive routine care, a catastrophic deductible and catastrophic coverage (with specific and/or aggregate excess loss insurance arranged by Pd Principal Financial). That product came on the heels of another offering by Principal aimed at small employers-its "minimum premium funding option."

"Through this arrangement, each month employers are allowed to pay part of their group medical insurance premium and deposit an amount for incurred claims, which is withdrawn from the employer's separate bank account only as claims occur," the company says. The idea is to give employers "the opportunity to not only cost-effectively provide quality health-care benefits to employees, but keep their company assets fluid for continued growth."

While perhaps not a silver bullet, the plan represents at least a recognition of the pain small employers are feeling when confronted with whopping rate increases-a pain compounded by the hurt caused by the decimation of 401(k) accounts thanks to the bear market.

No More No-Brainers

On the 401(k) front, small employers have shifted their focus away from the kinds of funds that are clearly not the no-brainer they may have once thought. "Three years ago, plan sponsors focused almost exclusively on large-cap growth," says Laura Bartlett, senior vice president and retirement plans practice leader for ABD Insurance and Financial Services in Redwood City, Calif.

"We have always advocated offering a full array of funds across the spectrum of risk and investment styles," she says. "Today we're seeing a lot more interest in value funds, bond funds and stable value products."

In addition, she's hearing a lot more calls for employee education programs. Demand for 401(k) investment advice services-in which plan participants are given specific recommendations on which funds to use and in what proportions-may be somewhat spottier. On the one hand, some surveys suggest employees want advice. For example, 89% of 750 workers at 200 companies nationwide polled over the summer for CIGNA Retirement & Investment Services said they would "welcome personalized financial planning advice."

Yet according to ABD's Bartlett, "investment advice services are underutilized by participants; many do not even know they are there." That suggests a job-and opportunity-for financial advisors to be more valuable to their small-business clients. "People like us," she says, "need to do a better job promoting these services."

Typically, bundled 401(k) products lack a built-in investment advice component. In addition, cost may make it impractical for an employer to pay a planner directly to provide advice to employees, who also may not be willing to pay for the help themselves. In those cases, advisors still can make themselves valuable to small-business owners by helping with the analysis of the cost and quality of packaged 401(k) plans, says Huntley of 401Konnect.com.

"The brokers who are serious about growing in this market will develop a consultative relationship and be an advocate for their client," rather than simply recommending only the 401(k) products with which they are already familiar and comfortable, he adds.

The array of competitive 401(k) products on the markets has grown, Huntley says, because "insurance companies are becoming more like mutual fund companies in terms of the fee structures and investment products they're offering."

At the same time, he adds, "mutual funds are beginning to look more like the insurance products" because many no longer limit plan sponsors to their own roster of funds.

More competitive choices should be good news for small employers and present more opportunities for advisors to help companies sort through the options, Huntley concludes.

Richard F. Stolz, the former editor and publisher of Employee Benefits News, is a financial writer based in Rockville, Maryland.