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.

By Annmarie Geddes Lipold Mar 1, 2003
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HR Magazine, March 2003 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 Crain, 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.")

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. Any medical use of these funds that is approved in the plan document will be allowed.

For example, the unspent funds can be used to pay an employee’s COBRA expenses, the IRS made clear in a statement last year. Or, accumulated HRA funds could help fund retirees’ health care premiums.


The decisions that HR professionals face regarding rollovers may require more thought. They certainly require more explanation.

Last year, in a ruling that spurred momentum for defined contribution health plans, the IRS said employees can roll over unspent HRA funds without tax consequences. While rollovers are permitted, they are not required. There are no legally mandated limits on how much can be carried over or how large accounts can become.

If you allow rollovers, you’ll need to decide if you want to impose limits on this practice. Currently, experts are divided on whether rollovers should be capped.

Permitting rollovers can encourage employees to let funds accumulate as a hedge against large medical expenses in the future, experts say. Kushner says that allowing accounts to grow uncapped may encourage employment longevity or let employees accumulate funds for health expenses after they retire.

Moreover, some add, capping rollovers could cause employees to make possibly unwise use-it-or-lose-it spending decisions.

But caps have their advocates. If employees are allowed to bank all of their HRA amounts each year, some say, they may forgo care at the early stages of a health problem, only to run up large treatment costs later on for conditions that could have been ameliorated or arrested.

“We don’t want people inappropriately building up large sums of money or forgoing care,” says Thomas Lerche, senior vice president with Aon Consulting, a Chicago-based human resources consulting firm.

What’s more, productivity could suffer if employees postpone necessary health care in an effort to build up their accounts, says Sean Sullivan, president and chief executive officer of the Institute for Health and Productivity Management in Scottsdale, Ariz.

Serena G. Simons, a partner with the Miller & Chevalier law firm in Washington, D.C., says companies would typically view burgeoning HRAs as unfunded liabilities, so most employers are likely to place caps on rollovers that reflect the limits of risk they’re willing to assume.

Whatever decisions employers reach regarding caps for HRAs, they need not feel rushed to make them. Ideally, cap decisions are made when a defined contribution plan is set up, says Kushner, but it’s not necessary to do so. Questions of caps—establishing them, adjusting them—“should be part of the annual benefit review,” says Kushner.

Countrywide, for one, has not yet decided whether to cap rollover amounts. Other companies without caps so far include Radnor Holdings Corp., an 1,800-employee plastics manufacturer in Radnor, Pa., and EnvestnetPMC, a small, Chicago-based financial services firm.

Data show that 38 percent of EnvestnetPMC’s participating employees rolled over a balance from 2002 to 2003, says Jim Rosenberger, vice president for finance. At Radnor Holdings, 63 percent of participating employees rolled over unspent HRA amounts from last year to this, says John McKelvey, senior vice president for human resources and administration.

In addition, Radnor Holdings has crafted its plan with a couple of features that employers don’t routinely adopt. First, it lets employees use the HRA for eye care and dental expenses and for services such as acupuncture, weight reduction and smoking cessation. Second, the company promotes wellness by setting aside $500 of each family HRA or $250 of each single-employee HRA to be used solely for wellness and preventive care. If those amounts are not used for those purposes, they are not rolled over.

Wellness has in fact become a large theme in the structuring of defined contribution plans. Some experts recommend first-dollar coverage—no deductibles, no co-payments—for immunizations, physicals and well-baby visits as part of the wellness component. Medtronic’s plan offers such coverage as part of its emphasis on prevention and long-term health, says benefits executive Ness.

Beyond the Basics

Structuring HRAs, deductibles and other elements of coverage is only part of the process, however. Employers who offer defined contribution plans to employees also must teach workers how to be good health care consumers, says Marc Backon, chief marketing officer for Destiny Health, a plan provider based in Bethesda, Md. “And a lot of employers are not willing to do that.”

Helping employees often means teaching them to make use of Internet resources, which generally are part of a defined contribution plan. Medtronic enables each participating employee to track his or her own health history online and gives access to a medical library, medical provider credentials, fees and pharmaceutical prices.

Before you sign on for a plan, test-drive the provider’s web site, says consultant Lerche. And because defined contribution plans are “fundamentally a different model than an HMO or PPO,” he adds, make sure the plan is communicated well. Individual employee meetings are best, he says, although larger training sessions can be effective.

Says Sullivan of the health and productivity institute: “Employers who choose to go the defined contribution route run the risk of removing themselves from helping to manage the health of their employee population. A thousand individual employee decisions about their health care do not add up to population health management for 1,000 employees.”

For defined contribution plans and their HRAs to work well, HR cannot just set them up and leave employees to their own devices, Sullivan says. Employers need to be an “active partner and friend” and help employees make the best health care choices.

Early Returns

It’s still too soon to tell if defined contribution plans will rein in health costs. “The jury is out on their viability,” says Lerche.

But some early indications look promising. Participating employees appear to be taking more control of their health care decisions, he says. Anecdotal data show that employees are making fewer office and emergency room visits, are opting more often for less costly generic drugs rather than name-brand prescriptions, and are calling nurse help lines—a less expensive alternative to doctor visits in some instances—at least twice as often as participants in other plans, Lerche says.

Countrywide’s participating employees “like taking control of their benefit dollars,” says benefits executive Crain. At the beginning of last year, 360 of the company’s 21,000 employees signed up. The number grew to 586 by the end of 2002 and reached 700 at the start of this year.

And Radnor Holdings’ McKelvey says that on a cost-per-employee basis, the company is saving “considerably” with its defined contribution plan. Of the company’s 320 salaried employees, 74 participated last year. The plan’s premium did not increase this year, while premiums on its HMO plans increased 14 percent on average.

EnvestnetPMC made a defined contribution plan its only offering for its 125 employees and saw its health coverage costs drop 30 percent, says finance executive Rosenberger.

Annmarie Geddes Lipold, a freelance writer based in Arlington, Va., has been covering human resource and health care issues for over a decade.

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