As employers continue their efforts to manage health care cost increases, the defined contribution (DC) approach has captured the attention of finance executives lured by its ability to cap or reduce company costs. Towers Watson's 2014 Health Care Changes Ahead Survey of 379 employers found that half of the surveyed organizations in which the CFO is highly involved in setting the health benefit strategy will implement or consider a DC arrangement by 2017.
What is a DC health arrangement? The employer contributes a fixed dollar amount toward the cost of an employee's health benefit each year. The employee pays the difference between that employer subsidy and the actual cost of coverage, regardless of which plan option the employee selects. The employer subsidy can remain the same from year to year or vary. Some employers make no commitment as to future adjustments. Others commit to revising the subsidy in line with changes in the Consumer Price Index or other external metrics, while others commit only to periodically evaluating the subsidy.
It's not a new concept. Most popular during the heyday of flexible benefits plans, DC health plans have been around in various forms for decades. When health care costs increased slowly, the DC approach was manageable. But as the pace of health care cost increases quickened in the late 1980s, DC approaches led employees' costs to outpace their compensation gains, and the plans began to lose their appeal.
Towers Watson's 2014 Health Care Changes Ahead Survey of 379 employers found that half of the surveyed organizations in which the CFO is highly involved in setting the health benefit strategy will implement or consider a DC arrangement by 2017.
The Return of DC
Now, DC health benefits are getting a second look, as four factors have converged to bring the DC approach to the forefront. The first is the private exchange model for the delivery of health benefits for active employees, which encourages employers to take a DC approach. The second is employers' ongoing concern as health benefit costs continue to rise, albeit at a more modest rate than in prior years. The third factor is the idea of de-risking health benefits, and the fourth is related to the 2018 excise tax on high-cost health plans.
Employers turning to DC health arrangements are considering a variety of approaches beyond a strict DC policy. Some may offer employees multiple plans but define their contribution based on a target plan that's viewed as the company's standard or core plan. If an employee elects another option, the employer subsidy is no greater than the subsidy for the target plan. Rather than being a true DC model, this is considered a one-year DC approach because the subsidy for the target plan typically changes as costs of the target plan change from year to year. But it's clearly different from a traditional approach where, no matter which plan option an employee selects, the employer covers a fixed percentage of plan cost, such as 75%. (The traditional approach is giving way to a more aggressive one that better articulates the employer's commitment and more starkly conveys the relative cost of various plan options.)
DC Benefit Dos and Don'ts
If you plan to adopt a DC arrangement, it's important to define your objectives, consider the multiyear implications, and ensure your strategy is consistent with your total rewards strategy and desired employee value proposition. DC health benefits aren't the best choice for every employer. For example, if your primary objective is to de-risk the health benefit program or avoid the excise tax, a DC approach is not the right solution.
A DC approach doesn't really de-risk health benefits. While the employer may cap its premium subsidy for a given year, the self-funded plan sponsor will absorb unanticipated risk if claims and expenses exceed expectations by year-end. Some employers have considered returning to an insured plan to transfer risk to an insurance carrier. This approach results in higher costs due to health care reform levies on insured plans (these levies don't apply to self-funded plans) and the added costs associated with switching from a more efficient self-funded plan to an insured approach including insurer risk charges, premium taxes, state mandates and the like. Moving to an insured arrangement means you'll have a one-year fixed cost (with significant added expense), but experience rating will mean that the subsequent year's premiums will reflect any adverse loss experience in the next year's cost basis.*
Also, DC approaches won't effectively manage excise tax risk because the employer and employee shares of the premium cost are both included in the excise tax calculation. But if you build a DC strategy that will encourage employees to move to less expensive coverage levels, a DC approach can help you get participants into lower-cost plans.
Before your organization shifts to a DC approach for health benefits, work with HR to conduct a careful assessment and develop a thoughtful strategy. DC arrangements are worth exploring, but they don't address every issue. Problems caused by poorly designed DC health benefits can be difficult to mitigate.
Randall K. Abbott is a North American leader and senior strategist in Towers Watson's Health and Group Benefits practice. He has over 35 years of experience consulting to many of the nation's largest and most complex employer-sponsored health plans. As a consultant active in flexible benefits several decades ago, he's relishing the déjà vu of DC health benefits.