SURGICAL STRIKES

SN Staff / Contributing: Elliot Zwiebach / David Ghitelman / Mark Hamstra

Supermarket companies are trying to find a cure for the rising cost of health insurance.

Now that the growth economy of the 1990s is history, many food retailers, like companies in other industries, have found that they are less able to absorb large annual increases in health-insurance premiums.

Supermarket operators are trying several different approaches to mitigate the impact of these costs, including seeking concessions from unions, lobbying for legislation to reduce medical costs, taking steps to increase preventative care, and eliminating other benefits.

While insurance costs are showing the fastest rates of growth among non-salary benefits, other such costs are also on the rise. Pension plans, once funded through the growth in their investments in the stock market, have required increased contributions from employers in the last two years. The cost of workers' compensation, like health insurance, also has increased significantly in the last few years, especially in California.

"Historically, things like rising health care and pension costs just got passed on to the consumer, and that's not happening right now because of the competitive and economic environment," said Meredith Adler, analyst, Lehman Bros., New York. "It's not that costs are going up, because costs have gone up in the past. The problem is this is the first time we've seen significant increases in certain kinds of costs without any ability to pass those increases on."

One of the primary drivers that led Kroger to reduce its earning guidance for 2003 earlier this year was the realization that it would not be able to pass its increasing benefit costs on to consumers, she said.

In its 10-K annual financial report for 2002 filed with the Securities and Exchange Commission, Kroger said its health care benefit costs increased 15 basis points as a percentage of sales in 2002 compared with 2001, while pension plan costs increased nine basis points as a percentage of sales. Total operating, general and administrative expenses, which are comprised primarily of labor costs, were 18.58% of sales in 2002.

Jack Brown, chairman, president and chief executive officer, Stater Bros., Colton, Calif., said his company's non-salary benefit costs now total 50% of the total compensation package, up from about 40% three years ago.

One recent study indicated that health-insurance premiums increased by 12.7% in 2002, following an 11% increase in 2001, and some supermarket retailers are reporting costs that are even higher.

"They just raised our rates about 40%," said Joe Azzolina, president and CEO, Food Circus Supermarkets, Middletown, N.J. "We're in a very competitive area, so you can't just raise prices to offset it."

According to a survey currently being conducted by Food Marketing Institute, Washington, most supermarket companies are absorbing the increases, which are generally in double-digit percentages.

"They are beginning to take steps to do more premium-sharing with employees," said Ernie Monschein, senior director, education and human resources, FMI. "They are doing things like raising deductibles and raising co-pays. You can see the sharing process is beginning to go on, where employers are feeling that they need to push more of the cost onto employees."

He said companies have been shedding other benefits like tuition assistance, career counseling and referral bonuses to preserve employees' medical coverage. He also said that "health benefits are more and more on the table than they've ever been" in labor negotiations with unions.

"The time is going to come where something's got to give," he said. "Are we approaching a crisis? We're not approaching a crisis. We're in a crisis."

At Food Lion, a division of Delhaize America, Salisbury, N.C., health care costs remain the fastest-growing of the company's non-salary benefit costs.

"The drivers are prescription drug costs continuing to increase and the continuing specialization of health care," said Jeff Lowrance, spokesman, Food Lion. "What we're seeing is that patients are increasingly referred to specialists, and specialized services."

For example, he said, it's not uncommon for a doctor to order a CAT scan instead of a traditional X-ray. "CAT scans cost more, and specialized services cost more as well."

An Ounce of Prevention

Food Lion has been taking some steps to reduce medical costs by working with its insurer to monitor prescription drug use "to make sure patients aren't receiving multiple prescriptions for similar drugs from different doctors, and also to make sure that if they are being prescribed, that there's not potential for an adverse reaction that can lead to health problems or even worse," Lowrance said.

The company also about a year ago launched some preventative health care programs for its employees, including a prenatal care program for expectant mothers and a health management program for people with diabetes.

In the prenatal care program, the company focuses on identifying those expectant mothers that might have problems leading to premature birth to make sure appropriate medical care is given to prevent premature births whenever possible. According to one recent study, the average hospital cost for a premature birth is about $58,000, vs. about $4,300 for a regular birth.

"We try and head off problems before they crop up," Lowrance said.

Save Mart Supermarkets, Modesto, Calif., which is largely unionized, participates in two collective health and welfare funds that cover unions for several regional and national chains that operate in the region. Since signing a contract for its Northern California region in 2001, Save Mart has seen its health care coverage costs rise from about $4.25 per hour per union employee to more than $6 per hour, said Mike Silveira, vice president, human resources and law, noting that rates are expected to increase to $7 per hour within a year.

In Southern California, where Silveira said the medical market is much more aggressive, the company pays $3.50 per hour per union employee, up from $3.25 two years ago.

The Northern California agreement expires in the fall of 2004, Silveira said, and "insurance costs are a big item on the agenda. The union knows we can't have an unending stream of increases because we can't pay more per hour in benefits than we do in wages."

When the 2001 contract was negotiated, Save Mart made some efforts to moderate costs, including the implementation of co-payments for drugs -- from no cost to $5 for generics and $10 to $12 for branded drugs; $5 co-payments for office visits and a requirement that spouses take coverage at their place of employment, when it was available.

To help keep health care insurance costs down at Stater Bros., the company encourages the use of generic drugs.

"We pay all costs on generics, but over the last year we've installed a new program where an employee that wants the brand has to pay extra, to help employees recognize how expensive these benefits are and to work with us to help control the costs," said Brown.

"Like any other expense, we're always addressing non-benefit areas to improve efficiencies," he said. "Unfortunately, none of the controls lie in the hands of the employer. While we can try to cut costs to manage the increases and the impact on profits, it will take outside lobbying with the state and federal governments to impose controls and limits on unfair profits by the pharmaceutical and medical industries."

Seeking Regulatory Relief

Ahold USA, Chantilly, Va., which said its own health care costs are increasing about 14% per year, has begun working with national business coalitions to approach health care costs from a legislative perspective, said Barry Scher, spokesman for Ahold.

Among the coalitions are Washington Business Group on Health and Business for Affordable Medicine, or BAM.

"Those are strong coalitions that we're working with to seek ways through regulatory relief to save on health care costs," said Scher. "The goal of our involvement is to minimize cost increases for our company as well as for our associates."

BAM, Washington, has focused primarily on reducing prescription drug costs by lobbying for less restrictive patents on brand-name drugs, which would allow for the substitution of cheaper generic drugs.

Bradley Cameron, executive director, said BAM has helped convince Congress to close some loopholes in the Hatch-Waxman Act of 1984. New rules that will make it easier for generic drugs to get to market are included in the Medicare reform bill that recently passed both houses of Congress and is expected to be signed by President George W. Bush.

Cameron said that on average, BAM member companies -- all of which are self-insured -- spend about $1.2 billion per year on prescription drugs, and that amount is rising at a rate of 20% annually. Generic substitutes can reduce the price for individual prescriptions by as much as 90%.

The Washington Business Group on Health, another coalition to which Ahold belongs, has been battling escalating health care costs on two fronts. The coalition works on a national legislative level, testifying before Congress and the administration about the high costs of health care. At the same time, WBGH also has developed a strategy for employers to reduce their health care costs on their own by restructuring their health plans.

"One of the things that has been driving costs up is that when the economy was booming, most employers did not pass on cost increases for health care [to their employees]," said Helen Darling, president, WBGH. "As a consequence, without having any financial stake, employees and their families started using health care in significantly higher amounts."

She said when employees have little or no co-payment required for doctor visits and they have little or no deductible, they are more apt to make liberal use of their medical benefits. "One thing to do to change that [is having] employees pay at the point of care, so that they have some financial stake in the outcome," she said.

She said employers will pay about $12,000 per employee next year for health care, and that figure is rising at a rate of about 14% per year.

Jonathan Ziegler, principal, PUPS Investment Management, Santa Barbara, Calif., said there does not appear to be any hope in sight for a reduction in benefit costs.

"Right now, it looks like these costs are escalating at a higher rate than the Consumer Price Index in the U.S.," he said. "So the question is: Does the government get involved?"

Jason Whitmer, analyst, Mid-West Research, Cleveland, said, "It doesn't look like it's getting better anytime soon." Yet he did note that Albertsons, Boise, Idaho, has had some success in its effort to cut costs.

"Some of the bigger companies can defray costs better than the little guy, but a lot of these costs have to be addressed by the government rather than by companies specifically," he said.

WORST STATE SCENARIO: CALIFORNIA

Last week, Costco Wholesale Corp., Issaquah, Wash., lowered its earnings guidance for the year, citing, among other factors, the high cost of workers' compensation benefits in California.

It is a phenomenon that is echoing throughout the retailing community in the state, as California employers have had to dramatically increase their payments into the state system. Workers' compensation costs have tripled at Stater Bros., Colton, Calif., in the last year, according to Jack Brown, chairman, president and chief executive officer.

"The increase in workers' comp costs are driving some employers to leave the state," Brown said, adding that the skyrocketing costs are among the factors leading to the effort to impeach Gov. Gray Davis.

"At some point, the rate of increase has to slow before it can ever start to decline, and we see no indication of any slowing," he said.

Stater Bros. tries to keep workers' comp in check by conducting immediate follow-ups on employees who are collecting and trying to get them back to work as soon as possible.

"We used to wait a week to look into an injury, but now we call immediately and find out how they are and let them know we need them," he said.

Stater Bros. now employs two people whose sole responsibility is to stay in contact with people who are collecting and work to prevent similar injuries from happening again.

Out of 14,000 employees at Stater Bros., Brown estimated that up to 100 are out at any given time with workers' compensation claims.

Save Mart Supermarkets, Modesto, Calif., also has been working aggressively to rein in its workers' compensation costs. "We've had reasonably good success keeping costs flat at our company, because we've put more focus on prevention," said Michael Silveira, vice president, human resources and law. After goods and labor, workers' compensation is the largest single cost the company has, he said.

The company has focused in particular on reducing strains and sprains, he said. It also uses a third-party administrator to help handle claims more efficiently.

"The better you set your system up, the more you can do, because the law mandates what has to happen," he said.

While workers' compensation costs have risen along with the cost of health care, Save Mart also has been victimized by some employee fraud, he said. As a result, the company has become more aggressive in pursuing such cases.

According to Jim Pucci, Save Mart's director of risk management, the company's cost of workers' compensation averages $5.85 per $100 of payroll, which he said compares to about $7 per $100 throughout the industry.

Like Stater Bros., Save Mart also takes steps to prevent injuries, such as assigning four employees to monitor worker safety and imposing weight limits on lifting.

The result, Pucci said, is that workers' comp claims dropped 20% last year.

At Safeway, Pleasanton, Calif., the company said in its annual report that the majority of its workers' compensation liability is from claims occurring in California, where it operates about a third of its U.S. stores. The company's costs, however, are mitigated by the high number of part-time employees and the reduced level of benefits they are eligible to receive.

Supermarket companies in California, through the California Grocers Association, also are pushing for legislative reform to reduce their workers' compensation costs.

"The workers' comp system is not a train wreck waiting to happen," said Peter Larkin, president, CGA. "It's a train wreck that has already happened."

He said the problem is not necessarily that the benefits are too generous, but that the system itself is too inefficient. Although employers' costs of workers' comp in California are among the highest in the country, the benefits consumers receive are among the lowest.

In a recent letter to members of the California State Senate Conference Committee on Workers Compensation, Larkin suggested several fixes to the system. Among them are reducing the employer liability for chiropractic care and limiting the number of treatments allowed; setting new standards for determining permanent disability; revamping the penalty structure for late payments by insurance companies and employers; and alternative dispute resolution programs to lessen litigation and reduce attorney fees.