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How to Use Defined Contribution Health Plans

Use Cases for Defined Contribution Health Plans

The term Defined Contribution is a big buzzword in the health benefits industry. This section provides an overview of what Defined Contribution Health Plans are, and how they are used.

Defined Benefit vs. Defined Contribution

First, let's start with a concept most people are familiar with. In the retirement space, Defined Contribution is a type of retirement savings plan in which the amount of the employer's annual contribution is specified, such as with a 401(k). Compare this to a pension plan where the employer specifies the benefit (a defined benefit).

In healthcare, the same logic is followed. A Defined Contribution Health Plan is a type of health plan in which the amount of the employer's annual contribution to employees' healthcare (Ex: individual health insurance policies) is specified. Compare this to a group health plan where the employer specifies the group health insurance plan (again, a defined benefit).

How Defined Contribution Health Plans WorkDefined_contribution_health_plan

Defined Contribution Health Plans offer an alternative to “defined benefit” group health insurance plans. Just as employers realized the savings associated with moving away from defined benefit retirement pensions and toward Defined Contribution 401(k)s, many businesses are applying this model to their health benefits programs.

The general strategy of a Defined Contribution Health Plan is that:

  • The employer implements a Section 105 Medical Reimbursement Plan to give each employee a fixed monthly healthcare allowance to spend on an individual health plan.

  • Employees select and purchase the individual or family health plan of their choice. Employees may purchase their own policy directly from any health insurance company, through a broker, or from the state Health Insurance Marketplaces.

  • The employer reimburses employees up to the amount of their Defined Contribution allowance.

Defined Contribution Health Plans by themselves are not health insurance plans. Defined Contribution plans give the employer control of benefits, while giving employees choice and a great benefit.

Why Defined Contribution Health Plans Work

Defined Contribution Health Plans work for employers and employees because:

  • Individual health insurance cost 20% - 60% less than comparable group health coverage. The employer’s healthcare dollars go farther.

  • Contributions are tax-deductible to the employer, and employees receive reimbursements tax-free.

  • The employer gains fiscal control and predictability over their health benefits budget.

  • There are no minimum or maximum contribution amounts, and no minimum participation requirements.

  • Employees have choice in health insurance plans and make consumer-driven choices.

  • Employees have access to the federal individual health insurance tax subsidies through the Health Insurance Marketplaces.

Other Variations of Defined Contribution Health Plans

So, how else is the term "Defined Contribution Health Plan" being used? One popular variation is a type of Defined Contribution within group health insurance offerings.

With a group-based Defined Contribution model, the business sets an amount to contribute to employees' health insurance premiums, but provides a limited menu of group health insurance options (for example, employees choose from 2-5 insurance policies). This type of "employee choice" group health insurance offering is common with larger businesses. It is also one of the features that some state small business SHOP Marketplaces offer to small businesses as part of health care reform.

Tip: In this guide on Defined Contribution Health Plans we are focusing on a “Pure” Defined Health Plan model, paired with individual health insurance.

Planning for the Transition to Defined Contribution Healthcare eBook