Defined Contribution Health Plans "For Dummies"

Written by: Christina Merhar
Originally published on July 17, 2013. Last updated August 16, 2018.

Many experts agree that defined contribution health plans will replace traditional employer-sponsored group health insurance.

For example, Economist Peter Orszag, the former Director of the Office of Management and Budget, wrote that the shift to defined contribution health plans would gradually take over the health insurance market over the next decade (source: Bloomberg Businessweek).

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

While many in the health insurance industry are familiar with the defined contribution approach, most employers are not. As defined contribution quickly picks up speed, here is a briefing of the defined contribution health plan approach.

What is a Defined Contribution Health Plan?

With a defined contribution health plan approach, an employer provides employees a fixed health care allowance. Employees may use their health care allowance (often offered through a health reimbursement arrangement, or HRA) to purchase individual or group health coverage that fits the health needs and budget of the employee. There are two main approaches with defined contribution health plans.

The first is a "pure" defined contribution approach, where employees can purchase any policy from any carrier (public exchange or private exchange). With a "pure" defined contribution health plan the employer does not prescribe a specific menu of health insurance plans to choose from. Employees can purchase any eligible policy from an insurance broker, online, through the state marketplaces, etc.

The second approach is a more limited defined contribution approach, where employees can use their allowance to select from employer-defined options on a private health insurance exchange. 

Defined Contribution "Deja Vu"?

To many, the shift in health benefits from defined benefits (group health insurance) to defined contribution health benefits is easily relatable to the shift in the retirement benefits space from defined benefits (pensions) to defined contribution (401(k)s).

After realizing the savings associated with moving away from defined benefit retirement plans, many businesses are also applying this model to their health insurance benefit programs.

Why Transition to a Defined Contribution Approach?

Businesses are trending toward defined contribution health benefits because they offer controllable costs while still providing employees access to quality health insurance. Let's look at this closer.

  • For employers, a major benefit is cost predictability and control. Because the defined contribution approach allows a business to define all health benefits costs accurately, a business can predict and control the costs year to year. There is a time savings factor as well. Using the right administrative software, defined contribution health plans take less than 5 minutes per month to administer.

  • For employees, a major benefit is increased choice of health insurance plans, personalization of benefits, and the ability to take control over their health benefit decisions. Health care reform in 2014 opens up even more benefits for employees including guaranteed-issue health insurance premiums on the individual market, and affordable policies because of the individual health insurance tax subsidies.

Do you agree that defined contribution health benefits reduces the cost and time associated with traditional health insurance, and yet maintains the benefits employees value? Let us know your thoughts below.

The Comprehensive Guide to the Small Business HRA

Originally published on July 17, 2013. Last updated August 16, 2018.


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