Structuring a new health plan: the building blocks of a defined contribution health plan include not just dollars and deductibles but choices reflecting your company's goals - Health Care

HR Magazine, March, 2003 by Annmarie Geddes Lipold

The concept is simple: Give employees access to a fund they can use for their current health care expenses or set aside for their health costs later on, and they'll spend the money as carefully as if it were their own. And even if they don't spend less, at least they might spend smarter--as they become better-informed and more involved in making decisions about their own care.

That's the core notion of defined contribution health plans--designed to rein in employers' health cost increases by encouraging employees to be temperate yet balanced in their health care spending. Such plans are offered at about 2 percent of companies, are on the drawing board at others and are getting a close look by benefits specialists in HR departments throughout the country.

While these plans are simple in concept, however, they can be as complex to structure as any other type of coverage, according to health industry experts. When HR gets down to putting together a defined contribution plan, it should take into account not only what plan providers are offering and pertinent rulings from the Internal Revenue Service (IRS), but also what the company hopes to achieve by offering such an option.

For example, Countrywide Financial Corp. in Calabasas, Calif., opted for a defined contribution plan because it offered more medical provider choices and better enabled employees to track their health spending, says Kathy Grain, first vice president of benefits. The plan, which covers every expense not disallowed by the IRS, "was not designed to save us money," says Crain.

Similarly, cost savings was not the primary reason Medtronic Inc., a Minneapolis-based medical technology company, decided to implement a defined contribution health plan. In fact, the plan is designed to cost the same as the company's other health plan offerings, says David Ness, vice president of compensation and benefits. "It wasn't that we were being killed by medical costs--we just thought there was a better model," says Ness.

"I personally think if you are going into this only to save money," Ness adds, "... in the long term, it will not work." For such plans to work, he says, they should convert employees from health care recipients to informed health care consumers. A successful plan should enlarge employees' access to relevant medical information and ensure they can understand and manage their actual health care costs.

Building the Foundation

Also known as consumer-directed or consumer-driven health plans, defined contribution plans promise employees health care choice, flexibility and autonomy. Each plan's cornerstone is the individual health reimbursement account (HRA), funded by the employer and available tax-free to the participating employee to pay for medical expenses. The employer decides how much to put into HRAs and which IRS-approved health services it will cover.

So-called pure plans provide funds for the HRAs--period. But most plans include more, notes Gary Kushner, president and chief executive officer of Kushner & Co., an employee benefits consulting firm based in Kalamazoo, Mich. In addition to an HRA, he says, plans typically offer comprehensive health insurance with a high deductible, a prevention and wellness program, access to health information, and a separate but coordinated health care flexible spending account as well as a prescription drug program.

The term deductible refers to the amount that employees must pay out of pocket after they have exhausted their HRAs and before the comprehensive health insurance kicks in, often with employee co-payments. In some plans, amounts paid out of an HRA count toward an employee's deductible.

It's important, Kushner adds, for HR to determine how a defined contribution option would affect the company's finances and culture--whether, for example, it would likely help attract and retain employees. Further, Kushner advises against adopting such a plan as an experiment with the idea of dropping it quickly if it doesn't meet expectations. Backing out could be a blow to employees' morale once they get used to accumulating money in their HRAs, he says.

Decision Time

When crafting defined contribution plans, HR professionals must make several key decisions, including:

* How much to contribute to each participant's HRA.

* How much of the account can be rolled over from year to year.

* Whether former employees will have access to untapped HRA funds and, if so, for what uses.

The first decision--how much to contribute to an HRA--may depend on each employer's resources. However, commonalities do exist among plans. For example, the plans cited in this article generally provide $1,000 to single employees and $2,000 to employees with families. (For more information on how these plans are structured, see "How Plans Stack Up" on page 62.)

Similarly, the decision on former employees' access to HRAs will depend largely on employer preferences. The only restriction on unspent HRA funds is that employees cannot cash them out or use them for non-medical expenses after they leave a company.