“Defined Benefit” and “Defined Contribution” are terms that have historically been used in conjunction with retirement plans. Defined benefit retirement plans afford employees with a pre-defined monthly benefit at retirement; however the employer assumes the market risk in meeting the obligation to the employee.
History of Defined Contribution Retirement Plans
Defined benefit retirement plans became less common in the 1980’s as defined contribution plans rose to the forefront. In the mid-80’s, about 80 percent of full-time employees in the United States were enrolled in some sort of defined benefit plan for retirement. And by 2006, this percentage had dropped to only around 20%. (Miller, 2011)
As defined contribution plans grew in popularity the employer realized greater control of retirement plan costs by making a contributing payment to supplement the employee’s retirement plan in lieu of the guaranteed benefit payable under the defined benefit plan model.
Expansion into Healthcare
The concept of defined contribution for employee health insurance was first introduced in the 1990’s. In the business climate of today, the topic of defined contribution has again become a frequent subject of discussion for the funding of employee health plans.
As with retirement plans, defined contribution health plans are being recognized for allowing the employer greater control of expenses by dedicating a certain dollar of contribution to an employee’s health plan funding instead of a specific health plan benefit offered under the defined benefit approach.
In its simplest form, the defined contribution health plan gives the employee a specific dollar amount to use in the purchase of health insurance. This may sound like a reasonable way for employers to control skyrocketing health care costs, however the actual implementation in the real world brings its own set of unique challenges which will be discussed later in this article.
As discussed in “Shifting Responsibilities – Models of Defined Contribution” produced for The Robert Wood Johnson Foundation, it is important to understand that defined contribution in health care is not a single arrangement, but instead a general approach presented across a continuum of models. (Martin, 2002)
On one end of the spectrum, the employer pays a specific dollar amount to the employee who alone becomes responsible for choosing their coverage. This has been referred to as the “voucher” approach. The employee chooses an insurer to provide health coverage and there is no formal accountability on behalf of the employer. In this scenario, the employee is at a higher financial risk and the employer has very little involvement in the administrative component of the employee’s health coverage.
On the opposite end of the spectrum, the employer and health plan work together to package a pre-determined set of benefits that will be made available to the employee. The employer chooses the health plan and decides upon the dollar amount that will be paid to the employee. Risk is spread between the employer, the employee and the health plan. The health plan and the employer bear most of the administration of the plan.
An example of this model can be illustrated by the employer selecting one or more insurance carriers to offer a multi-option plan arrangement with employee funding geared around a base plan typically with a high deductible. The employee is given the opportunity to “buy-up” to higher levels of coverage in the optional plan(s) that are available.
Approaches
As with the shift in retirement plans of the 1980’s, the defined contribution approach can afford businesses the opportunity to reduce health care costs with Health Care Reform likely to hasten the implementation.
Real world application of this implementation has the potential to take shape in a variety of arrangements which mirror the continuum of models discussed above. Examples include:
- The State-level health insurance exchanges which are coming online as part of the Patient Protection and Affordable Care Act (PPACA). The implementation of these exchanges could partner well with and speed along the basic idea of the employer contribution component of the defined contribution health plan (Meulemans, 2012).
- Plans marketed as “Consumer-Driven Health Plans” (CDH Plans) combining a high deductible or catastrophic insurance plan with an account-based reimbursement component. This account-based reimbursement has potential to be shared by the employer and employee and is designed to cover some of the costs of the deductible, coinsurance or other claims.
Advocates of the defined contribution model promote the concept of being “Consumer-Driven” thereby making the healthcare consumer more proactive in selecting their own services given the greater level of financial interest in the outcome. However, the success in shopping for the best price in healthcare currently presents challenges which make it impractical or impossible in today’s healthcare market.
Some challenges and criticisms to the approach include limited cost control of only small to mid-dollar claims with high-dollar claims remaining unchanged. Another is the possible increase in adverse selection as younger, healthier employees opt for lower cost plans while older and sicker populations gravitate toward richer benefits.
Conclusion
In summary, the defined contribution approach to health care will undoubtedly continue to evolve and expand in partnership with the implementation of healthcare reform. The road to expansion will undoubtedly be marked by an extended period of adjustment for both the employer and employee alike.
As the landscape of healthcare continues to be re-shaped we will learn if the defined contribution model is effective in controlling the upward spiral in healthcare costs or be a shift toward the employee becoming increasing responsible for paying for higher levels of health care. Ultimately, one of the main determinants of the success of the defined contribution approach will likely be whether or not the decision-making process of the healthcare consumer can truly be shaped into a new long-term behavior.
April 30, 2014
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