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Small Business Employee Benefits and HR Blog

Defining Defined Contribution Health Plans

The term defined contribution is a big buzzword in the health benefits industry. So what is the definition of defined contribution health plans? This article goes "back to basics" to define defined contribution (yes, that's a lot of "defines"...). This is a high-level, executive summary to concisely explain this emerging health benefits strategy.

define defined contribution

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 health care, 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' health care (and 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 Work

Defined contribution health plans offer a new alternative to the defined benefit group health insurance plan. Just as employers realized the savings associated with moving away from defined benefit retirement pensions and toward 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 dollar amount.

  • Employees choose how to spend the funds, within the parameters of the employer's plan. For example, employees purchase their own individual policy directly from any health insurance company, or from the new 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, rather they are a health benefits strategy that allows the employer to realize cost-savings.

Why Defined Contribution Health Plans Work

Defined contribution health plans work for employers and employees because:

  • The contributions can be tax-free to the employer, and employees receive pre-tax dollars.

  • 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.

  • In 2014, employees will have access to the federal individual health insurance tax subsidies through the new health insurance marketplaces (ie: individual policies that are affordable and guaranteed issue). 

Bottom line?

With guaranteed-issue policies starting in 2014 and the massive premium tax subsides through the health insurance marketplaces, defined contribution health plans will have all the same benefits of a defined benefit (group health insurance plan), often at a much lower cost for the business and employees.