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Small Business Employee Benefits and HR Blog

Using Defined Contribution to Reimburse for Individual Health Insurance Costs

June 17, 2014
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Defined Contribution Healthcare arrangements are on the rise because they allow employers to reimburse employees for individual health insurance costs. With Defined Contribution, small businesses have a way to offer employee health benefits without absorbing the premium and administrative costs of sponsoring a traditional group health insurance plan. Reimburse for Individual Health Insurance Costs with Defined Contribution | Image © igor - Fotolia.com

We recently wrote about the shift to Defined Contribution Healthcare, outlining four reasons small and medium sized businesses are rapidly adopting Defined Contribution arrangements:

  1. Small business health insurance costs are on an unsustainable trajectory

  2. Individual health insurance policies provide greater value to employees

  3. Individual health insurance costs 20 to 60 percent less

  4. Defined Contribution Healthcare arrangements allow employers to reimburse employees for individual health insurance costs

This article looks at how employers can structure and set up Defined Contribution arrangements to reimburse employees for individual health insurance.

How to Reimburse Employees for Individual Health Insurance Costs with Defined Contribution

With Defined Contribution arrangements, employees purchase their own individual health insurance policies and the employer reimburses employees for their out-of-pocket premium cost, often up to a specified monthly healthcare allowance. 

There are two primary ways to set up a Defined Contribution arrangement:

  1. A Taxable Healthcare Allowance, or

  2. A Tax-free Healthcare Reimbursement Plan (HRP)

1. Taxable Healthcare Allowance

With this Defined Contribution approach, the employer reimburses employees for their substantiated individual health insurance costs on a post-tax basis up to a healthcare allowance specified by the company. 

2. Tax-free Health Reimbursement Plan (HRP)

With this Defined Contribution approach, the employer utilizes Section 105 of the Internal Revenue Code to establish a formal self-insured medical reimbursement plan to reimburse employees for their substantiated individual health insurance costs on a pre-tax basis. This type of arrangement is referred to as a Healthcare Reimbursement Plan (HRP), and it must be structured to comply with the Affordable Care Act's Market Reforms.

Defined Contribution and Individual Health Insurance on the Rise

Due to the high cost of group health insurance and the better value of individual health insurance, small businesses have begun shifting employees to the Individual Market and are replacing existing employer-sponsored health insurance premium contributions with a Defined Contribution toward employees’ individual health insurance premiums.

How big of a shift is happening? We predict that 60% of small businesses will eliminate employer-sponsored health insurance by 2017 in favor of individual health plans and Defined Contribution Healthcare arrangements.

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