(FORTUNE Small Business) – To look at its offices, you would not expect RD Systems to be the site of one of the most far-reaching social and economic experiments in the country. Housed in a featureless metal box in an industrial office park about 20 miles north of Rockford, Ill., the 30-year-old manufacturing company is the very picture of old-fashioned, traditional business. It has also been the picture of stability: Half of its 40 employees have worked there for more than five years.

So it came as a shock to president Jo Ribordy-Christofferson, 41, when four years ago Blue Cross & Blue Shield of Illinois, her insurer of ten years, announced that the premium for the plan she offered employees was going to shoot up 60%. RD Systems had always paid 100% of its employees' premiums, and Ribordy-Christofferson knew that she risked losing her highly sought-after engineers if she offered less. To cut costs, she switched from her preferred-provider organization, or PPO, to a high-deductible plan from another insurer, but found that its customer service was unacceptable. Something else had to be done.

That's how old-economy RD Systems came to offer an innovative, newfangled kind of coverage. Known as "consumer driven" health insurance, it gives her employees more responsibility for managing their spending and will save the company $49,000 this year, a reduction of about 30% from what she estimates it would have paid under the old arrangement. And while Ribordy-Christofferson no longer pays all of her employees' costs, the new plan offers perks to keep her workers happy and healthy. "There just isn't a downside," Ribordy-Christofferson says. "This is health insurance pushing in the right direction."

It's easy to see why small businesses are looking for new answers. Health insurance premiums for all companies went up 14% on average last year, continuing a trend of double-digit annual increases. For small businesses, the problem is particularly acute: In 2003 almost half saw hikes of more than 15%, according to the Kaiser Family Foundation's 2003 Employer Health Benefits Survey.

Desperate for solutions, some small businesses have turned to government- or nonprofit-sponsored programs (see the companion story on page 48) or pursued self-insurance (see the box on page 53); some have even dropped health insurance altogether (see the box below). But more and more entrepreneurs are turning to consumer-driven plans, which typically combine a high-deductible health insurance policy and a tax-advantaged, employee-managed medical account that covers some or all of the deductible. Any money left in the account at the end of the year generally rolls over to the next year, an incentive for employees to spend prudently.

Consumer-driven plans are controversial; critics say that they simply shift more costs to employees, especially sicker ones. But proponents argue that not only are they good for individual businesses but they also may help fix our nation's broken health-care system.

"Right now, if a company's employees are in a PPO, there's no upside for them in saving money and using it wisely," says Ray Herschman, national practice leader for consumer-driven health care at Mercer Human Resource Consulting. Why worry about whether you really need to go to the doctor when all you're ever responsible for is a $20 co-payment? By giving employees a pot of money of their own to spend on health care, consumer-driven plans aim to make them smarter and more cautious health-care users. The hoped-for result: They'll spend less, and premiums will finally begin to come under control.

Last year about 500,000 employees were covered by consumer-driven plans. Up from 100,000 in 2002, that was still a minuscule percentage of the 175 million who had health insurance. But health policy experts expect that health savings accounts, which were created in January under the new Medicare law, will give consumer-driven plans an enormous boost. The accounts, in which contributions and interest are tax-free, must be paired with a health plan that has a deductible of no less than $1,000. "We're getting lots of calls," says Jeremy Claeys, spokesperson for the National Small Business Association, an advocacy group based in Washington, D.C. "People are saying, 'I want to know more. How do I get one?'"

By day Larry Johnson works as an assembler at RD Systems, building and installing the automation equipment designed by the company's engineers. But after work hours, he's South Beloit's version of Body by Jake. Over the years Johnson, 41--a man of medium height with a pinched waist and powerful shoulders--has become something of a gym ambassador to his fellow employees. "I teach them how to use the weight machines," he says.

So why are RD Systems' employees getting so interested in pumping iron? Because they like movies, for one thing. Their health plan from Destiny Health includes a "wellness" program called Vitality, under which employees accrue points when they visit a gym (25 points a visit), quit smoking (3,000 points), or maintain a healthy weight (5,000 points). Ribordy-Christofferson, a longtime distance runner, earns 2,000 Vitality points every time she competes in a race. The points can be redeemed for movie tickets, airline miles, and special deals at hotels. The hope is that the program will make employees healthier and help keep premium costs low.

RD Systems' plan encourages employees to share responsibility for managing health costs. Here's how it works: For a single employee, RD Systems deducts $25 every two weeks to help cover the premium on a plan with a $1,000 deductible. Every year the company contributes $600 to the employee's "personal medical fund," or PMF; it can be spent on medical expenses, or rolled over to the next year if it isn't used. That leaves employees responsible for paying $400 out of pocket to meet the rest of the $1,000 deductible after they've spent the $600 in the PMF. (Family plans have higher deductibles and PMF amounts.) RD Systems' plan is unusual because it lets employees keep the money they've accumulated if they leave the company. "It's how we sold it to employees," says Ribordy-Christofferson. "It helped soften the blow" of higher costs.

Since 2002, when RD Systems signed on with Destiny, based in Oak Brook, Ill., its health-premium increases have slowed. Before the company renewed in February, its human resources director got insurance quotes from eight vendors for 22 plans. Destiny quoted a 23% premium rise for the new year. (The company trimmed that upsurge to 14% by doubling the deductible for hospitalization coverage to $2,000.) If a 23% jump seems high, consider that the other plans' quotes were 30% to 40% higher than even that price.

Many employees of RD Systems seem pleased with the plan. Consider Nevagay Abel, 39, a controls engineer. A year ago Abel, then six months pregnant, started feeling unusually tired. Fortunately, she had signed up with the health plan's Future Footsteps Maternity Program--earning 5,000 Vitality points--which assigned a nurse to call her every few weeks to discuss her pregnancy. The nurse called her that night, and after Abel described her symptoms, told her to contact her doctor right away because it sounded as if she was going into premature labor. The nurse was right. Abel was put on immediate bed rest, but doctors were unable to stop her from delivering her son, Justin, three months early. Although he weighed just 2 1/2 pounds at birth, he's doing fine now. Abel gives the program high marks. "I think it made a big difference in Justin's health," she says.

But not everyone loves the arrangement. "When I started here, it was a better plan," says Kevin Hufford, a mechanical engineer who returned to RD Systems in 2002 after working elsewhere for a few years. "Now we're paying more for less coverage." Hufford buys single coverage. His wife's employer's plan covers her and their daughter for $160 a month; coverage for the three of them at RD Systems would cost $395. The Vitality Program, he adds, is not a great selling point, noting that he already works out at a gym and planned to get his first-aid certification even without the enticement of 2,000 Vitality points.

Critics of consumer-driven plans argue that programs like RD Systems' push more expenses onto employees. Of particular concern is the size of the gap that companies leave between where the employee's PMF ends and insurance begins. The higher the deductible, the lower the premiums, but the more money employees may have to pay out of pocket if they become sick. Determining how large that gap should be can have a significant impact on the bottom line and on employee health and morale.

That's just one of many decisions an employer must make that affect coverage and costs. Among the most important: who pays first, employer or employee, for initial medical expenses, and what types of care can be paid for out of the PMF. Pioneer Motor Bearing Co. in Kings Mountain, N.C., offers a plan through Assurant Health (formerly Fortis Health) with a $3,000 deductible. Pioneer covers the first $2,250 of medical expenses up-front, and the employee pays nothing until that money is spent. Then the employee covers the $750 gap before the insurance kicks in. Rick Dunham buys insurance for employees at Dunham & Co., his Dallas-based marketing consulting company, through HealthMarket, a health insurance carrier based in South Norwalk, Conn. Rather than requiring clients to fund their employee medical accounts, HealthMarket provides the $1,000 accounts for employees as part of the premium Dunham pays. The money can be used for routine and preventive care like checkups and mammograms. By paying that first dollar, employers hope that their workers will maintain their health, potentially eliminating the need for more costly care later.

Do consumer-driven plans reduce employer costs by changing behavior, or do they simply shift more costs onto employees' shoulders? The answer would appear to be both, but the plans are so new and varied that useful conclusions will not be clear for a while. "There is a chance that people in these plans will really use less health care," says Gary Claxton, a vice president at the Kaiser Family Foundation. "But I think we have to be skeptical until we know whether lower costs are just a function of the kind of people who sign up for these plans, people who wouldn't use many health-care services anyway."

Those criticisms may prove valid. But at least one entrepreneur--Rick Rogy, co-owner of Rogy's Learning Place, a chain of 15 child-care centers based in East Peoria, Ill.--says that he and his family have kept their health-care expenses down since moving to a consumer-driven plan a little over a year ago. When Rogy's daughter had a sinus infection, he says, her doctor wanted to write a prescription for $50 worth of antibiotics. Instead, his wife asked for a few free antibiotic samples, which cured the problem. And now Rogy says he's more likely to treat a cold with over-the-counter medications than go to the doctor. Thanks to such strategies, the family was able to roll over $1,000 of their $1,500 personal medical fund in the new year.

And at RD Systems, which with two years' experience under its belt is considered an old hand in this business, the plan seems to be changing the way people spend money on health care. The first year under the Destiny plan, four out of five employees used up all the money in their personal medical fund by the end of the year. The second year, however, three-quarters of employees had money left in their accounts to roll over into the following year. "That's a tremendous change in behavior," says Ness Sebek, the company's human resources director. "It's a domino effect, but in a good way."