Defined Contribution: Finding Certainty in Employer Benefits
How employers can stay competitive… and retain talent
“Uncertainty” is not likely to warm the hearts of many CFOs and Finance VPs, and perhaps no aspect of corporate administration has a higher level of uncertainty than healthcare and benefits. As with pension plans, the administration of defined benefit health plans is best suited to those with a defiantly optimistic view of business trends or to companies certain that they will experience year-over-year gains to fund defined benefits indefinitely.
Such growth is anything but certain yet maintaining benefits for employees is as critical as ever for retaining top talent. According to a survey prepared by Prudential Financial and CFO Research earlier this year, 94 percent of CFOs believe that employee benefits are a critical factor for attracting and retaining employees. Defined contribution funding models are growing in popularity as a means for companies to continue offering employees benefits coverage while providing employers with greater financial certainty.
With defined benefits, employers are generally locked into offering limited plan choices for their employees, which ends up being an imprecise way to predict and control costs. In addition, traditional plan designs may encourage employees to overuse their insurance rather than manage their own costs. This dual lack of flexibility has left many CFOs unable to calculate with certainty how much employee benefits coverage will cost them each year.
Defined Contribution, Predictability and Choice
By contrast, a defined contribution model offers the predictability of a known cash outlay at the beginning of the year with year-over-year increases to account for the rise in healthcare costs (more on controlling those costs below). Every employee is given a predetermined contribution that they can use to shop for benefits through a private marketplace. With this option, employees may be offered more choices at various levels of coverage than are available in a defined benefit model. This lump-sum approach shifts responsibility in such a way that employees have more choices along with more responsibility while employers have more control.
Employees can choose to spend all of the defined contribution and perhaps more of their own money for a plan with more coverage and a higher premium such as a PPO or opt instead for a high deductible health plan (HDHP) that allows for lower premiums and is particularly well-suited to those who may be younger and with fewer health concerns. Offering HDHPs can benefit employers generally as they allow for reduced employer contributions toward premiums while still offering minimum coverage requirements.
By combining an HDHP with a Health Savings Account (HSA), employees can use tax-deferred contributions to pay the higher deductible costs if there is an immediate need or wait until a future health issue arises. Rather than using their entire contribution to purchase medical insurance alone, employees can put the remaining amount toward voluntary benefits like dental, vision, life and disability to supplement their existing coverage.
Driving Efficiency and Cost Savings
Greater certainty for employers might also come with reduced costs in other ways. Traditionally, providing health benefits has been expensive, not only because of the rapid rise in healthcare costs, but also because of the administrative necessities that accompany their management. With defined contribution on a private marketplace, employers are effectively outsourcing the administration of benefits and creating a more retail-oriented environment.
Having sufficient decision support to help explain which benefits are best suited to their needs could result in employees making better decisions about their benefits. Support features could reduce the number of questions fielded by a company’s benefit administrators. They may also offer a powerful combination of cost effectiveness for employers as well as cost transparency for employees, the latter fueling the consumer tendency to better evaluate personal needs before making purchasing decisions when there is detailed cost information.
Retiree and Part-Timer Solutions
Additionally, private marketplaces offer employers the flexibility to provide a defined contribution to both retirees and part-time workers. Many large employers have significant retiree populations who receive company-sponsored defined benefits that are increasingly cost prohibitive for even large corporations to offer. Rather than send them to a public marketplace with a potentially disjointed experience, employers can instead offer retirees a defined contribution within a private marketplace that mirrors what is available to full-time employees but offers plans specific to retirees — and, importantly, falls outside of the company’s risk pool. Retirees, therefore, receive the same personalized decision support tools and other features that may not be found in a public marketplace while also being retained within their company’s support network.
Similarly, part-time workers who are not eligible for employer-sponsored health coverage may be offered voluntary benefits through a private marketplace, allowing them to purchase certain benefits at the negotiated corporate rate. This platform consolidation could represent significant cost-savings for employers, streamlining administration for more efficiency across the board.
Changing Economics by Changing the Ecosystem
Consolidation of administration brings about cost-savings, and a defined contribution method allows for benefits cost certainty for each year. However, the long-term cost-savings that come with defined contribution may also have an indirect component. When employees take control of their benefits and decide how they will spend their contribution amount, and that control ultimately leads them toward HDHPs, there can be an increased sense of responsibility about their health in general. Rather than rely on pricey prescription drugs and doctor visits, employees better recognize the cost of treatment when they see how money is being spent.
Combining defined contribution benefits with a wellness program can help employees achieve better overall health and reduce their expenses which can concurrently boost productivity as a result of better physical health. Improving employee health should be the long-term goal of any company, not only from a corporate social responsibility perspective but also when considering the bottom line: there can be a significant cost-savings associated with a healthier, happier workforce that is less prone to absenteeism.
Big Data and Marketplaces
With a private exchange marketplace may also come an additional invaluable resource for executives: big data. As employees shop for and use their benefits, this data can be tracked to better understand their healthcare spending. Through data analytics, thousands of data points and variables can be quantified and analyzed so that employers better understand the relationship between wellness and productivity, not just through sick days but also through less obvious measures such as poor performance and absenteeism.
Employers can drill down to focus on certain variables, allowing them access to vital information that could help more accurately predict how their corporate assets will need to be allocated in the future. This predictive capability offers employers a degree of certainty as to cost allocation that would be challenging without the tracking capabilities of a private exchange.
Defined contribution benefit plans go hand-in-glove with private marketplaces. With more efficient use of an employer’s funds, the two in tandem offer both a greater degree of choice for employees as well as a more efficient administrative solution for companies. However, perhaps even more important for employers than reduced costs is the added certainty that defined contribution offers. Rather than be at the mercy of fluctuations in the healthcare market, companies can know with more certainty how much they will be paying out for employee and even retiree benefits over the course of the coming years.
Employers should do more to recognize both the benefits of defined contribution for themselves as well as their employees. Better communication with employees in regard to their own empowerment and the increased options from which they can choose should display defined contribution in a genuinely positive light. Increased financial certainty coupled with a more consumer-centric user experience may result in an attractive combination for finance executives when they consider shifting to defined contribution benefit plans.
Fowler, S (2013). Defined Contribution: Finding Certainty in Employer Benefits. In Life & Health Advisor. (Retrieved November 14, 2013, from http://www.lifehealth.com/defined-contribution-finding-certainty-employer-benefits)
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