Defined Contribution Health Plans: A Primer

For business owners, offering benefits is a key retention and attraction tool, especially health insurance. It can also be an expensive one. Most employers constantly look for ways to cut costs and improve margins. And health insurance benefits have always been hard to predict and to control. Currently employers define health insurance benefits for their employees by offering a predetermined range of healthcare plans in which the employer pays a minimum of 50% of each employee’s premium.

Now, with the Affordable Care Act (ACA) in effect since January 2014, employers have another option when offering health insurance coverage for their employees, such as a defined contribution health plan. (For related reading, see: A Defined Benefit Plan for Small Business Owners.)

What is a DC Health Plan?

With a traditional health insurance model the employer defines the benefit, such as selecting the health insurance carrier and plan, with the employee’s premium being the variable because age and geographic location would be factored in. With a defined contribution (DC) health plan, the employer defines the contribution to the employee’s premium, leaving the employee to research and select their own carrier and plan.

Who Benefits the Most?

Both the employer and employee benefit from DC health plans. However, there are few more advantages for employers, especially small business employers. For one, many smaller employers do not have dedicated human resources departments so the responsibility is left to the business owner, who does not have expertise in healthcare nor the time to properly research different plans. With a DC health plan, the business owner can transfer that responsibility to the employee. In addition, due to the size of small businesses, they have little to no leverage trying to negotiate better rates and benefits as large businesses do when setting up traditional health insurance plans.

How Employers Benefit

  • As mentioned above, DC health plans can free up employers from the administrative time and duties that go along with choosing and managing their employees’ health plans by transferring that responsibility to their employees. (For related reading, see: HSA vs. FSA: Navigating the Alphabet Soup.)
  • With health insurance costs increasing, DC health plans offer more financial predictability because the amount contributed is predetermined.
  • Due to the ability to predict costs, some small businesses who may not have been able to afford offering health insurance benefits can now offer them indirectly.
  • The contributions are a tax-deductible business expense.

How Employees Benefit

  • Instead of receiving a one-size fits all health plan, employees now have the option to customize their coverage based on their medical needs and budget.
  • DC health plans offer employees portability. If an employee leaves their current employer, he or she can keep their current health plan even though they would be responsible for paying the amount the employer contributed.
  • Using the scenario above where an employee leaves their job and keeps their health plan would also add comfort and relieve stress. They would not have to worry about having no coverage or about changing hospitals or doctors during a transition to a new job.
  • DC health plans offer employees flexibility. They can choose to use any carrier they want that offered coverage in their area, or change plans if they were not happy with their current one. (For more, see: 4 Mistakes to Avoid with Your Retirement Plan.)

Affordable Care Act

You may ask yourself why DC health plans haven't been used more in the past. Prior to the Affordable Care Act if an individual were to apply for health insurance, he or she would have been medically underwritten by the insurance carrier. The carrier would have then accepted or declined the individual based on any pre-existing medical conditions. With the Affordable Care Act, individuals can no longer be declined for this reason. The possibility of an employee not being able to get coverage for this reason no longer exists.

A Final Note

Under the Affordable Care Act, businesses with 50 or more employees must offer their employees "affordable" health insurance coverage or be forced to pay a penalty. This requirement does not pertain to businesses with 49 or fewer employees. DC health plans, in terms of the ACA, are not considered to be "providing health insurance." Therefore, DC health plans are better suited for businesses with less than 49 employees. (For related reading, see: Why You Should Have a Roth IRA.