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Small Business Employee Benefits and HR Blog

The Tipping Year for Pure Defined Contribution Healthcare

Industry experts and economists agree that defined contribution healthcare is on the rise. Not only on the rise, but that defined contribution healthcare is the future of how employers will offer health benefits. This trend is not brand new. Defined contribution healthcare has been increasing the past few years. But with health reform's new advantages to the individual health insurance market, 2014 will be a tipping year for defined contribution healthcare. Tipping Point for Defined Contribution

Here's a review of defined contribution healthcare and why it is the future. Are you ready for the next big trend in health benefits? 

What is Defined Contribution Healthcare?

Defined contribution healthcare is a strategy for offering health benefits.

Instead of offering a defined benefit (i.e. a specific group health insurance plan), companies provide employees a fixed healthcare allowance (a defined contribution) to spend on health insurance. Employees then use their healthcare allowance to purchase individual or group health coverage. There are two main approaches with defined contribution healthcare.

The first is a "pure" defined contribution approach paired with individual health insurance. With pure defined contribution healthcare, employees purchase individual policies from any carrier. With pure defined contribution the employer does not prescribe a specific menu of plans to choose from. Employees can purchase any eligible policy from an insurance broker, online, through the state exchange, etc.

Using a restaurant analogy, employees would receive a "gift card" from their employer and could choose any restaurant to eat at, and which menu items to order. 

The second is a group-based defined contribution approach, where employees can use their allowance to select from employer-defined plan options on a private health insurance exchange. This type of defined contribution is common with larger businesses but is growing in popularity with small and mid-size employers as well. With this approach, employers offer a set allowance to employees, and employees select a plan from a set menu of options. 

Using the restaurant analogy, employees would receive a "gift card" from their employer and could choose from a prix-fixe menu from one or two restaurants.

How does this compare with traditional group health insurance?

Using the restaurant analogy, employees would be told by the employer where they will be eating, what they will be ordering, and how much they will pay.

The Tipping Year for Defined Contribution

There are numerous reports and studies that point to 2014 being the tipping year for defined contribution healthcare.

Economist Peter Orszag, the former Director of the Office of Management and Budget, wrote in 2011 that the shift to defined contribution health plans would gradually take over the health insurance market over the next decade. In a Bloomberg Businessweek article Orszag argues that:

  • The health benefits market is currently dominated by “defined-benefit” health plans that will shift to "defined contribution" health plans similar to the shift from retirement pensions to 401(k)s.

  • The primary driver of this shift is that U.S. employers need to limit exposure to health-care costs (i.e. the cost of traditional group health insurance is unsustainable)

  • The health reform law will accelerate the shift. 

Bruce Brussard, the CEO of Humana, recently stated that "health insurance will go the way of pensions," also comparing the shift from defined health benefits to defined contribution health plans to the shift from retirement pensions to 401(k)s. Brussard argues that:

  • Rather than offering a health plan, employers will begin offering specified payments and telling their employees to buy their own insurance.

  • Change may take a decade to fully kick in, but is starting now.

Perhaps the most widely cited report is the McKinsey & Company survey that found these major trends:

  • Cost-shifting brings companies closer to defined contribution health benefits: The move toward employers shifting more health care costs to employees is driving defined contribution healthcare. 

  • Health care reform accelerates defined contribution healthcare: Health care reforms, coupled with rising costs, has employers of all sizes concerned. According to McKinsey & Company, up to 60% of educated employers plan to "definitely" or "probably" pursue alternatives to offering health insurance such as dropping employer-sponsored coverage, offering employee health benefits using a defined contribution model, or offering health benefits only to certain employees.

  • Technology and education are a big part of defined contribution healthcare: One of the primary changes to the health benefits landscape is the move toward more electronic communication, which means that employees will be required to educate themselves and enroll in their own health insurance plans. Private health exchanges and individual health insurance quoting/enrollment technology are expected to be a large component of defined contribution healthcare. 

Lastly, a July 2013 survey commissioned by Alegeus Technologies found too that by 2015 there would be mass familiarity and adoption of defined contribution and private exchanges. Their national survey of 500 health benefit decision-makers found that:

  • There is a high level of familiarity and interest in exploring defined contribution and private exchanges – with strong evidence that 2014 and 2015 will be a ‘tipping point’ for adoption. 73% claimed to be familiar with defined contribution healthcare and 55% claimed to be familiar with private insurance exchanges. And, 90% expressed interest in exploring defined contribution and 85% expressed interest in exploring private exchanges for their own organization. Of those that expressed interest in exploring/adopting defined contribution programs, 36% indicated they would make the switch in 2014, 39% predicted 2015 and another 17% indicated 2016 or further out.

  • Education and support will be needed to ease the transition for employers and consumers. 

  • Defined contribution represents a logical next step in the evolution towards a consumer driven health/benefit marketplace.

Conclusion

While larger businesses have been early adopters of group-based defined contribution, it's the small businesses and non-profits who are driving the trend of pure defined contribution healthcare paired with individual health insurance. Because of the changes in health reform that favor the individual health insurance market, and because of the unsustainable cost of group health insurance, more and more businesses of all sizes will look at pure defined contribution as a viable health benefits strategy. Likewise, more and more health insurance brokers are adding defined contribution healthcare to their offerings.

Do you think we're approaching the tipping point for defined contribution healthcare? Leave a comment below.

Related articles on defined contribution health care:

 
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