Rather than paying the costs to provide a specific group health plan benefit (a "defined benefit"), employers fix their costs on a monthly basis by establishing a Defined Contribution Health Plan.
The general concept of a Defined Contribution Health Plan is that a company gives each employee a fixed dollar amount (a "Defined Contribution") that the employees choose how to spend. Typically, employees are allowed to use their Defined Contribution allowance to reimburse themselves for individual health insurance costs.
Defined Contribution Health Plans are an affordable alternative to employer-sponsored group health insurance plans. Defined Contribution Health Plans by themselves are not health insurance plans.
Defined Contribution Health Plans are programs that allow employees to be more involved in their health care choices. With a Defined Contribution Health Plan, employees are responsible for selecting an individual health insurance plan and making payments out of their own finances.
The sections outlined on our navigation bar provide more information about 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 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' 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 Work
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. Depending on the employee's plan documents, employees may also purchase a number of other health care products and services that qualify as eligible HRA expenses.
- 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.
- Depending on the plan . employees may 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.
Design Requirements for Defined Contribution Health Plans
There are three key questions to ask when designing your Defined Contribution Health Plan. These three questions will help you customize a plan that achieves your employee health benefit goals (and meets your budget).
- When will the plan year start?
Your company will decide when your Defined Contribution Health Plan will start.
- What monthly allowance amounts will you provide?
You probably already have a budget in mind for health benefits. Within this budget, how will you divide up employees' monthly allowances?
You can provide the same monthly allowance amount to all employees, or you can provide different monthly allowances to different types of employees. This is also called employee classes. Classes must be based on bona-fide job criteria such as job title, location, etc. You can also vary the allowance amounts by family status (single, married, etc.) within an employee class.
Using employees classes this way is most commonly seen in the individual coverage HRA (ICHRA).
See: The individual coverage HRA (ICHRA)'s employee classes: How do they work?
- When are employees eligible for the plan?
What criteria makes employees eligible to participate in the Defined Contribution Health Plan? For example, do they need to work a certain amount of hours weekly, have a certain job title, or be employed for a certain number of days? (Note: the maximum waiting period is 90 days). These criteria will set employee eligibility for the Defined Contribution Health Plan.