About a decade and a half ago, defined contribution health plans were the wave of the future for employer-sponsored benefits. In the late 90s, more than 62 percent of healthcare leaders predicted employers would switch to such an arrangement by 20101 Then,they fell out of fashion.
In the age of Obamacare, however, defined contribution plans seem to be making a comeback, especially among small business owners.
What is a defined contribution health plan?
Defined contribution health plans are not really health plans, at least not in the traditional sense. Essentially, defined contribution health plans are a form of employer reimbursement for employee health insurance coverage.
Employers contribute a defined amount toward their employees’ healthcare benefits. Rather than providing these benefits through a group health insurance plan, employers offer a variety of individual health plan options through a private exchange.
How does defined contribution work?
Employers decide how much they will contribute toward health insurance coverage for employees and their dependents. They may pay employees extra money that is designated for health insurance benefits or reimburse them for a certain amount. Employers may manage defined contribution arrangements themselves or use special software or a third-party company.
As mentioned before, businesses may offer employees access to a private health insurance exchange. Through a private exchange, employers may offer a wide variety of health plans from multiple carriers—typically three to five insurance companies and up to 25 plan options. They can also contribute different allowance or reimbursement amounts to different employee classes. This can be especially helpful to employers with a variety of employee types—part time, hourly, salaried, seasonal, etc.
Many companies, including Walgreens and Sears, offer their employees coverage through a private exchange.3 Consulting firm Accenture estimated 1 million people would enroll in private exchanges in 2013, according to The New York Times. The number is expected to increase to 40 million in 2018. S&P Capital IQ recently predicted that 90 percent of workers with employer-sponsored coverage will be moved to exchanges by 2020, according to Kaiser Health News.4
Employers may also opt for a defined contribution arrangement that involves paying employees extra, taxable income that is intended to pay for health insurance premiums each month. Employees may then shop for health insurance coverage through Obamacare’s state-based and federally facilitated health insurance exchanges or the private marketplace.
However, certain rules and restrictions may apply. Companies with 50 or more full-time employees are subject to the Affordable Care Act’s employer responsibility provision and could face financial penalties for failing to provide access to health insurance coverage. Additionally, it is important to consider that the additional money paid to employees may push them into a higher tax bracket and make them exempt from Obamacare subsidies.
Why would employers offer defined contribution health plans?
With Affordable Care Act provisions that prohibit denial of coverage or higher rates based on health history, income-based subsidies available to those who buy health insurance through the state-based and federally facilitated exchanges, and group health costs on the rise, defined contribution health plans can be appealing for many reasons.
- Tax breaks – Employer contributions are a tax-deductible business expense.
- Streamlined process – Small business owners wear many hats, and managing employee benefits is among them. A defined contribution health plan can reduce employer involvement and free up time.
- Choice – It goes without saying that not all employee healthcare needs are the same. A defined contribution health plan arrangement allows employees a wider selection of health plans to choose from based on their personal healthcare needs and budgets.
- Transparency – Employees put a dollar amount to their employer’s health insurance contribution. As a benefits attorney pointed out to the Society for Human Resource Management, “When employees see the gross monthly rate of their insurance and the gross monthly contribution that [the employer is] making toward that, it’s enlightening. They are exposed to the true costs.”5
- Savings – Employees who qualify for financial assistance and purchase from the state-based and federally facilitated health insurance exchanges can reduce their monthly premiums and out-of-pocket expenses through tax credits and cost-sharing subsidies.
- Flexibility – If the employer’s defined contribution arrangement means paying employees extra, taxable money each month and the amount exceeds their actual premium costs, that money can be placed into a health savings account (HSA) to help pay for qualified medical expenses tax-free or used to purchase supplemental coverage such as critical illness insurance. The employee may also use it any other way he or she sees fit.
- Satisfaction – Ultimately, gaining greater control over their healthcare coverage decisions can improve employee satisfaction and retention.
What else should employers know?
Obamacare has coverage rules for businesses, too. The Affordable Care Act’s employer mandate, which is formally called the employer responsibility provision, will soon take effect. Employers of a certain size must provide their employees with access to qualified health insurance plans. Those who do not comply may have to pay a penalty—the employer shared responsibility payment—of $2,000 per employee above 30 employees. The mandate applies as follows:67
- Starting in 2015, employers with 100 or more full-time employees or a number of full- and part-time employees that equals 100 or more full-time employees.
- Starting in 2016, employers with 50 or more full-time employees or a number of full- and part-time employees that equals 50 or more full-time employees.
- In 2015, employers must offer health insurance coverage to 70 percent of their full-time employees, and by 2016 they must offer it to 95 percent.
Yet, approximately 96 percent of employers are small businesses with 50 or fewer employees, and they are exempt from the employer responsibility provision.
It is also important to note that the IRS prohibits the practice of giving employees pre-tax money to purchase health plans through the Obamacare exchanges or private marketplace. Those who do could face a $100 per day excise tax per applicant.
How can small businesses set up defined contribution health plans?
Small business owners who want to move to a defined contribution health plan arrangement should consult a licensed health insurance agent.
For more information on health insurance options and the Affordable Care Act, visit HealthCare.com.
American Academy of Actuaries. “Understanding Defined Contribution Health Plans.” Issue Brief. June 2002. Retrieved fromhttp://www.actuary.org/files/dc_june02.4.pdf/dc_june02.4.pdf.
Andrews, Michelle. “Defining What ‘Defined Contributions’ Mean For Work-Based Health Insurance.” Kaiser Health News. May 13, 2014. Retrieved fromhttp://www.kaiserhealthnews.org/Stories/2014/May/13/Andrews-Defined-Contributions.aspx.
Fronstin, Paul. “Private Health Insurance Exchanges and Defined Contribution Health Plans: Is it Déjà vu All Over Again?” EBRI Issue Brief, no. 373. July 2012. Retrieved fromhttp://www.ebri.org/pdf/briefspdf/EBRI_IB_07-2012_No373_Exchgs2.pdf.
Morris & Reynolds Insurance. “Defined Contribution (Tax Free) Health Insurance.” N.D. Retrieved from http://morrisandreynolds.com/health-reform/defined-contribution-tax-free-health-insurance/.
1 Fronstin, Paul. “Private Health Insurance Exchanges and Defined Contribution Health Plans: Is it Déjà vu All Over Again?” EBRI Issue Brief, no. 373. July 2012. Retrieved from http://www.ebri.org/pdf/briefspdf/EBRI_IB_07-2012_No373_Exchgs2.pdf
2 Andrews, Michelle. “Defining What ‘Defined Contributions’ Mean For Work-Based Health Insurance.” Kaiser Health News. May 13, 2014. Retrieved from http://www.kaiserhealthnews.org/Stories/2014/May/13/Andrews-Defined-Contributions.aspx
3 Carnns, Ann. “Private Exchanges Rise as Health Care Options.” The New York Times. Nov. 19, 2013. Retrieved from http://www.nytimes.com/2013/11/20/your-money/private-exchanges-rise-as-health-care-options.html?pagewanted=all&_r=2&
4 Andrews, Michelle. “Defining What ‘Defined Contributions’ Mean For Work-Based Health Insurance.” Kaiser Health News. May 13, 2014. Retrieved from http://www.kaiserhealthnews.org/Stories/2014/May/13/Andrews-Defined-Contributions.aspx
5 Sammer, Joanne, Miller, Stephen. “Time for Defined Contribution Health Benefits?” Society for Human Resource Management. Sept. 25, 2013. Retrieved fromhttp://www.shrm.org/hrdisciplines/benefits/articles/pages/defined-contribution-health-benefits.aspx
6 U.S. Treasury Department. “Fact Sheet: Final Regulations Implementing Employer Shared Responsibility Under the Affordable Care Act (ACA) for 2015.” N.D. Retrieved from http://www.treasury.gov/press-center/press-releases/Documents/Fact%20Sheet%20021014.pdf
7 Internal Revenue Service. “Questions and Answers on Employer Shared Responsibility Provisions Under the Affordable Care Act.” IRS.gov. Last reviewed May 13, 2014. Retrieved fromhttp://www.irs.gov/uac/Newsroom/Questions-and-Answers-on-Employer-Shared-Responsibility-Provisions-Under-the-Affordable-Care-Act