Defined contribution as a funding strategy for health care coverage is gaining much attention lately as a cost control concept and driver of deeper health care consumerism. Part of the hope is that more personal responsibility will result in better health care behaviors and outcomes, which could result in a lower cost trajectory. Yet most people recognize that defined contribution is no silver bullet and those employers considering it should be aware of some common myths and the realities.
Myth #1: Defined contribution means non-group medical coverage
Non-group medical coverage will be the norm for retirees and possibly for part-time employees. But for active full-time workers, most employers that consider defined contribution strategies will maintain group health plans both for cost control and tax reasons. We expect group health plan rates, particularly for large and/or self-funded plans, to remain financially advantageous as compared to community-rated non-group health plans. And since recent signals from the Department of Labor indicate that the employer probably won’t be permitted to fund non-group coverage with health reimbursement arrangement (HRA) funding, the cleanest remaining tax strategy that would allow pre-tax payment of non-group insurance is through section 125. It is unclear yet whether employers will be permitted to contribute toward non-group coverage under section 125 without causing the plans to be classified as group insurance, and this could cause those plans to become subject to group rating rules, complicating the strategy. Group insurance will probably remain the best option for employers from both a cost and tax perspective.
Myth #2: Defined contribution will fix employer spend on health coverage cost increases year after year
The prospect of fixing the corporation’s health coverage budget year after year is certainly attractive to the CFO but may not be realistic in the labor market. Let’s say a company decides to offer a defined contribution for health care and plans an annual increase to the defined contribution by a percentage pegged to the consumer price index (CPI) or perhaps a fixed amount of 3 percent. If the cost of health care continues to escalate at a rate higher than the defined contribution increase, the employee will simply bear a greater portion of the burden of the medical inflation. It’s really just cost shifting, and a competitive labor market may demand more from the employer sooner or later. However, national data suggest that employers have continued to increase the employee-only contribution along with medical inflation rates, but are beginning to hold the line on increases in the contribution toward family coverage. Employers have been paying a lower percentage of the total premium toward family coverage in recent years, a trend that is likely to continue. Employers adopting defined contribution may take a similar approach, allowing the self-only contribution to rise along with medical inflation, but limiting future increases toward dependent coverage. Of course, the world of employers and employment markets are diverse, and contribution strategies are likely to be all over the map as well.
Myth #3: Defined contribution fixes corporate cost, but doesn’t affect overall cost in the long run
Fixing the corporation’s cost using defined contribution will have practical limits as described in Myth #2, but that doesn’t mean defined contribution won’t deliver a cost advantage longer term. Consumers vote with their feet. And with more control and ownership of the health care dollar, the consumer will act in his or her own best interest. Affecting cost is not just about adoption of higher risk and lower premium health plan designs, it extends to consumer tolerance to accept lower cost, narrow networks and to try new plans that are based on innovations in payment reform. Coupled with wellness incentives and greater transparency on provider costs, defined contribution offers promise for longer term favorable effects on the health care cost trend.
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