Time for Defined Contribution Health Benefits?
A common thread is presenting the benefit as a set dollar amount
#Joanne Sammer and Stephen Miller, CEBS
By Joanne Sammer and Stephen Miller, CEBS September 25, 2013
When the defined contribution 401(k) plan appeared on the retirement scene in the early 1980s, employers eagerly embraced it as a way to replace or supplement traditional defined benefit pensions, characterized by their higher costs and less predictable expenses. Now, employers are eyeing the defined contribution concept as a way to rein in another costly employee benefit: health insurance.
"Employers want to understand and start to predict what their health benefits costs are likely to be," said John Hennessy, a senior consultant at the Hay Group in Dallas. "They are thinking that the plans and approaches available in the past aren't going to fit in the future."
A New Take on an Old Idea
Defined contribution health care can take many forms, but a common thread is reframing how health benefits are presented. "With traditional employer-provided health care, you are building your benefit around certain plans; with a defined contribution approach, you're building it around a set dollar amount," explained Brad Davis, CEBS, a benefits attorney at Wraith, Scarlett & Randolph Insurance Services in Woodland, Calif. (Davis is also featured in an archived 2013 SHRM webcast, Health Care Consumerism: From a Parenting to a Partnering Approach.)
Basically, "The employer gives the employee a set amount in a virtual gift card—or call it a benefit bank, a wallet or flex credit—and then allows the employee to take that amount and shop for their own insurance off a menu that the employer provides," Davis explained. "The employer negotiates prices and contracts with carriers, and the available options are presented in one comprehensive package."
With the defined contribution approach, the menu can be as simple as the multiple options under a Section 125 cafeteria plan, Davis noted, or can involve a dedicated online platform or, increasingly, use of a private health care exchange, as described below. What's different is that "the employer is now saying, 'This is how much money we are giving you to shop on this menu, and you can pick whatever suits you best.' It's a different style."
Adapting a defined contribution approach does not necessarily mean greater cost shifting or changing the benefits being offered, Davis added. Rather, instead of framing it as the organization and the employee both paying a percentage of the premium each month (which to most employees is far from transparent, as they tend to see just the deductions taken from their salary), companies tell their employees that now they will receive a set dollar amount to go toward monthly premiums.
"Your 'virtual gift card' may be $300 per month, but to sign up for the insurance benefit may cost the employee $360 per month," Davis noted. "The employee will then have to pay $60 out of pocket. When employees see the gross monthly rate of their insurance and the gross monthly contribution that you're making toward that, it's enlightening. They are exposed to the true costs."
Employees see the gross insurance rate
and your contribution toward it;
they're exposed to the true costs.
"If you currently contribute 80 percent of employee premiums, convert that to a dollar amount for year one," Davis explained. "Then in years two and beyond, as premium costs increase, you can increase your contribution based on the dollar amount that you established back in year one. You're still only covering whatever percent you were in previous years."
Moreover, at renewal time, businesses have the option of increasing their contributed amount to cover some or all of the annual premium cost increase. But employees are less likely to view the employer as "cutting back" if it boosts its contribution by $10 a month, for instance, even if the plan premium rises by much more.
Employers won't have to tell their staff, "We have to reduce our share of the premium from 85 percent to 70 percent." That could still mean the company is spending more money (if the premium increase is more than 5 percent), "but it often doesn't look that way to employees," Davis pointed out.
Numerous Design Options
The defined contribution approach can be seen as another form of health care consumerism, Davis added. If employers currently offer plans with health savings accounts (HSAs), health reimbursement arrangements (HRAs) or flexible spending accounts (FSAs)—all of which are funded with pretax dollars and provide workers with financial incentives to be cost-conscious when selecting health care services—"the defined contribution model can go hand in hand with all of those things," Davis noted. "Plans that incorporate an HSA, HRA or FSA can all be options on your menu." (To learn more, see the SHRM Online articles "Misunderstanding HSAs Poses Open-Enrollment Hurdle" and "Consumer-Driven Decision: Weighing HSAs vs. HRAs.")
The selection can be made up of self-insured or fully insured plans, although the coverage must conform to the afforability standard in the Patient Protection and Affordable Care Act (PPACA or ACA).
Employers can choose to offer different amounts for individual and family coverage. Also, amounts contributed to employees who are purchasing coverage in New York, where premium rates are higher than average, could be greater than amounts given to workers in, say, Texas.
"You get to design what the menu looks like," Davis said. When an employee leaves the organization, the employer stops making monthly contributions, just like under a traditional approach. "Remember, it's a virtual gift card," he remarked.
If the employer contribution ends up being more than the employee spends on the health plan, the employee can be steered toward purchasing voluntary benefits with these funds, such as added disability coverage, or the leftover funds can be directed to an HSA or FSA. Another option is to allow employees to cash out any surplus, although they must then pay taxes on these dollars.
Rise of the Exchanges
Health care reform has been a catalyst that's opened up a broader discussion of defined contribution health benefits. The ACA introduced public health insurance exchanges or "marketplaces" for each state, by which individuals without access to affordable employer-provided health coverage can shop for their own plans. Companies must pay penalties when employees purchase subsidized coverage on a public exchange.
At the same time, in the private sector there has been a rush by benefits consulting firms and others to establish private (or corporate) health insurance exchanges that do not involve government subsidies and penalties. These private exchanges are designed to provide a new option to employers that are interested in exploring a defined contribution approach (to learn more, see the SHRM Online article "On Private Health Exchange, Choice Drives Satisfaction").
In fall 2013, Walgreen Co., the nation's largest drugstore chain, announced it will send 160,000 full-time workers to a private health exchange run by benefits consultant Aon Hewitt. According to Thomas Sondergeld, Walgreens' director of health, benefits and well-being, the company has branded its program as "the Live-Well Benefit Store," and will make the same premium contribution for its employees' 2014 plans that it did in 2013. Available plans will vary regionally but all employees will have access to five plan-level options (catastrophic, bronze, silver, gold and platinum) differentiated by premiums, deductibles and networks, offered by three to five competing carriers, along with tools to compare plans based on previous health claims. Dental and vision plans are also on the exchange (Walgreens will provide separate employee credits for medical and dental plans, and pays 100 percent for vision coverage).
Although some private exchanges offer both fully insured and self-insured group plans, Walgreens is shifting from its current self-insured plan options to fully insured plans. According to Sondergeld, "the exchange model provides greater cost predictability," mitigating the need for self-insurance and its associated risks.
Big U.S. companies that have recently moved employee coverage to private exchanges include Walgreen Co., Sears Holdings Corp. and Darden Restaurants Inc., which operates the Red Lobster and Olive Garden chains.
Walgreens' Move to a Private Exchange
Private exchanges could be a game changer when it comes to defined contribution health benefits by providing the platform and technology necessary to facilitate this approach, and some observers see a shift to these exchanges as inevitable. According to research from consulting firm Accenture: "Private exchange participation will approach public exchange enrollment levels as soon as 2017 and surpass them soon thereafter. … In 2017, approximately 18 percent of the American public will purchase insurance through exchanges, radically transforming the health insurance landscape."
Aon Hewitt's 2013 Health Care Survey of nearly 800 large and mid-size U.S. employers covering more than 7 million employees found that 28 percent expect to participate in a private health exchange in the next three-to-five years.
Another factor to weigh: Starting in 2018, health benefit coverage that costs more than $10,200 for an individual employee or $27,500 for dependent coverage will be subject to a 40 percent excise tax. Concern over the "Cadillac tax" on high-value health plans could drive employers to private exchanges, where organizations can ensure they remain under the spending threshold.
One sign that private exchanges are likely to play a major role in providing employees with health coverage is the success this model already has had with retiree-health benefts. Over the past decade a growing number of companies—most recently IBM, Time Warner and GE—have been moving Medicare-eligible retirees off their company-sponsored health plans and giving them an annual contriubtion to buy private supplemental Medicare ("Medigap") and Medicare Advantage plans on exchanges developed to provide a marketplace for competing retiree-health policies. Now, private exchanges want to help companies control health care costs for active employees as well.
Educating Employees
If employers start to embrace a defined contribution approach to health benefits, they should expect a learning curve for both themselves and their employees. As a result, "there is more likely to be an evolution toward the defined contribution approach," said Matthew Kersting, a senior consultant at Sibson Consulting in New York. This is particularly true when it comes to setting up standardized models for defined contribution health plans and getting employees comfortable with the terminology and information necessary for the approach to work. Employers that want to make the switch to a defined contribution benefit should expect a clear and steep learning curve.
"Communication is absolutely critical," advised Davis. "I have employers who started communicating this change 90 days out, and I have employers who started doing so a whole year out. In addition to print, e-mail and online materials, you may want to hold face to face group meetings, and webinars for satellite workers. All through this transition, make sure there is complete transparency."
A defined contribution strategy is also likely to be perceived differently by various employee demographic groups. For example, younger workers might be more willing to embrace such a change than older ones. The same could be true of single vs. married employees, particularly if the defined contribution approach makes it more expensive for people to purchase coverage for their spouses and families (which it needn't necessarily do).
Navigating Forward
Another consideration is how the PPACA changes will play out and affect the insurance market, which is still very much a question mark. Given that uncertainty, no one yet knows how the public or private health insurance exchanges will perform.
Still, employers can start taking steps toward defined contribution health benefits by keeping an eye on the market for potential vendors that are a good fit for the organization. For example, some service providers will build an online portal tailored to your employees. Alternatively, some private exchanges will handle all or most administrative issues related to benefits, which may be attractive to organizations that do not have a large HR and benefits staff or that simply want to offload those responsibilities. Other vendors might be differentiating themselves with the technology they offer to make employee choice and communication easier.
Advised Davis: "Every year you still have to do your due diligence and shop your plans around. You have to make sure you're still getting the best plans and the best price, so that when you put the menu or exchange down in front of your employees, you can be confident it's the best you have to offer."
If companies can find the right defined contribution health benefits model and design options that are attractive to employees, "they could end up with benefit plans that meet more employee needs and create more satisfaction, which is the entire point of offering benefits," said Hennessy.
Regs Limit Purchasing Individual Policies with Pretax Dollars
On Sept 13, 2013, federal agencies issued IRS Notice 2013-54 and DOL Technical DOL Technical Release 2013-03, reiterating that health reimbursement arrangements (HRAs), premium reimbursement arrangements (PRAs) and other employer payment plans cannot be used to pay for individual policy premiums on a pretax basis, such as when individual coverage is purchased by employees through a public health insurance exchange or on the individual market.
[Update: Enactment of the 21st Century Cures Act in December 2016 lets small businesses use "qualified small employer health reimbursement arrangements" (QSEHRAs) to fund, with pretax dollars, employees who buy individual plans on the open market. However, an employer that is considered an applicable large employer (i.e., with 50 or more full-time employees or equivalents) is not permitted to offer a QSEHRA. See New Law Lets Small Employers Use Stand-Alone HRAs.]
The regulations do not limit employers from providing their active employees with a defined dollar amount, on a pretax basis, to purchase group coverage through a private exchange.
Also, for a true "retiree-only plan" under the tax code and ERISA, employers can still sponsor an HRA or PRA and reimburse individual policy premiums on a pretax basis.
Joanne Sammer is a New Jersey-based business and financial writer. Stephen Miller, CEBS, is an online editor/manager for SHRM.
Private Exchanges Evolve with Demand, SHRM Online Benefits, November 2017
Private Exchanges Spur Health Coverage Shift, SHRM Online Benefits, September 2014
On Private Health Exchange, Choice Drives Satisfaction, SHRM Online Benefits, updated September 2013
As Employers Drop Coverage, Retirees Turn to Private Exchanges, SHRM Online Benefits, September 2013
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