Q. What are the benefits of “defined
contribution” in a private insurance
A. The term “defined contribution” is nothing new. Most of us recognize it
as an approach employers utilize when funding a 401(k) or other similar
retirement plan. The employer simply contributes a set amount of
money into an employee's retirement plan. While some employers use a
“defined contribution” approach when it comes to health insurance, most still
base their contributions as a percentage of the overall cost. That appears to
be changing, however, with the proliferation of private exchanges.
Not to be confused with federal or state run exchanges, a private exchange is an on-line insurance marketplace provided by the employer. A typical exchange will offer a wide array of major medical plans and other supplemental insurance such as accident, auto, dental, disability, home and life. Private exchanges also provide decision support in order to help employees assess their needs and will even make plan recommendations.
How does it work? The employer decides how much money or “credits” to allot employees towards the cost of insurance purchased through the private exchange. The employer must contribute the same amount for all employees in the same class, e.g. all full time employees. The employer could vary contributions between full-time and part-time employees or based on whether the employee selects single or family coverage. If the total cost of coverage exceeds the “defined contribution”, the employee pays the difference through payroll deduction.
For example, let’s say an employer offers a choice of 10 different health insurance plans and provides up to $5,000 annually to an employee who elects “single” coverage and up to $7,500 annually to employees who elect to cover themselves and dependents. The employee electing “single” coverage selects a plan that costs $4,000 annually. In this instance, the employee has enrolled in a plan that requires no contributions through payroll deduction. The entire premium is paid by the employer. This leaves a balance of $1,000 which could be used to purchase other types of coverage such as dental or vision. For an employee who elects coverage for himself and his dependents, let’s say the plan selected costs $10,000 annually. In this example the employee has exhausted all of the “defined contribution” funds. The employee will pay the difference of $2,500 annually through payroll deductions.
When paired with a private exchange, the “defined contribution” model can be very effective.
Benefits for the employer:
- Costs are predictable
- Flexibility in determining what types of insurance can be purchased with the funds, e.g. health and dental but not auto and home
- Any funds or “credits” not used by the employee can revert back to the employer
- Less administrative burden
- Employees see the true cost of coverage
- Ability to offer more health insurance options in order to address everyone’s needs
- Shifts decision making responsibility to employees
Benefits for employees:
- Ability to use employer funds as they see fit
- More options from which to choose
- Decision support tools to help make the best choice
- Feeling of empowerment
- Personalized buying experience
With the emergence of private exchanges in conjunction with “defined contribution” employees now have an opportunity to make better decisions than ever before when it comes to purchasing a plan. It puts employees in the driver’s seat which is where they should be when it comes to selecting health insurance. The fact of the matter is that there is no one-size fits all and even a few choices are not enough. If you offer 1 -3 health plan designs, can you say for sure that everyone’s personal situation is addressed? You may not either with 8 – 10 choices but the gap closes fast, especially when employees have meaningful decision support tools at their disposal.
The way we buy health insurance is evolving. Employers will be well served by taking time now to evaluate whether a defined contribution model within a private exchange makes sense.