Defined Contribution in Health Insurance

Many in the health insurance and employee benefits space are claiming to have found the next new, innovative and sure fire way to reduce health insurance costs.  Actually its an old idea, originally deployed in the retirement/pension area of the overall employee benefits palette, and fairly recently resurrected for use in employer provided health insurance.  The next “silver bullet”?


(Remember 401(k)s gradual replacement of many defined benefit retirement pension plans in the eighties?) Two large, well known U.S. businesses recently announced their intent to go with a defined contribution strategy for their health insurance offering (Time Magazine and Hilton Worldwide), joining others previously taking the plunge including Darden Restaurants, Sears, and Walgreens.  So what are the pros and cons to such an approach?  What is it exactly?  How does an employer deploy it?

Let’s start with the basics.  Employers have a choice as to the structure of their benefit plan offerings:
1. Defined Benefit – where the employer makes all the decisions relative to benefits available, cost of coverage, availability of spending accounts, plan specifics such as deductible, copay, coinsurance, PPO network, etc.; and

2. Defined Contribution – this approach is more “budget oriented”, and involves an employer providing funds (rather than predetermined benefits) to employees with which they can make their own choices, including those outlined in no. 1 above, and more.  (Note: Some employers deploy a subsidized premium approach rather than simply providing funds and access to benefits/coverage.)

Prior to the passage of the Affordable Care Act (ACA), there were several deterrents to defined contribution relative to the offering of health insurance, including the lack of guaranteed issuance of coverage, preexisting condition limitations, and coverage that didn’t always include the benefits (see the ACA’s 10 essential health benefits, now required) employees were accustomed to in group health plans.  Well…the ACA has eliminated these, and other impediments, thus making defined contribution viable, although with limitations.

The critical and essential element of a sound defined contribution health plan offering is something called a private exchange (PEX)…NOT to be confused with the government run/controlled public exchanges, which are a critical aspect of the ACA.  PEXs come in two varieties: 1. single source (one insurer offering several options); and 2. multiple source (several insurers offering multiple options, side by side).  Further, the sponsors of PEXs come from a variety of sources including insurers (e.g. United Healthcare), brokers/consultants (e.g. AON Hewitt), and third party vendors (e.g., bSwift).

There are a variety of other variables associated with PEXs including:

  • Group plans
  • Individual plans
  • Fully insured plans
  • Partially self funded plans
  • Employer specific (or custom) plans
  • Generic (or “off the shelf”) plans

Health insurance, and for that matter an employer’s overall employee benefits package, is unique to each employer.  There are a variety of considerations that need to be factored in when considering the optimal form of offering (defined contribution, defined benefit, or neither).  Here are the PROs and CONs as I see them, of transitioning from defined benefit to defined contribution:



  • Potential for initial reduced premium (over the long term, premium increases tend to be higher on individual plans, and plans that lack centralized, coordinated risk mitigation programs)
  • Significantly reduce employer time/cost associated with human resource management, compliance, new hire orientation, on boarding, etc.
  • Better alignment of benefits/coverage to the individual, member level of need, desire, purpose, etc.
  • Avoidance of certain fees and taxes (although there could be ACA employer shared responsibility exposure depending on the structure of the plan offerings)


  • Loss of control, focus, and concentration of the benefit offerings. (Some employees may opt to forgo health insurance and use their funds for alternative offerings. )
  • Employees may not be ready to take on the responsibility of shopping for, and purchasing health insurance, and other benefits.  The vast majority of working Americans have never in their lives had to take on the job of evaluating available insurance offerings, make comparisons, and ultimately make purchase decisions…decisions that have significant implications.
  • The jury is out on whether a defined contribution approach will reduce premium costs over the long haul.
  • Questions still persist on whether some or all defined contribution health plans meet the ACA’s employer mandate/shared responsibility criteria, which could present undesirable penalty exposure to employers.