Defined Contribution: THE Strategy to Encourage HSA Adoption

Most employers haven't adopted the ideal contribution-to-premium strategy to encourage enrollment in HSA-qualified plans.

Many employers offer an HSA-qualified plan as one of two or more options for medical coverage. But many companies don't provide the education or financial incentives that prompt employees to consider this plan seriously. As a result, too many workers simply re-enroll (whether actively or by default) in their current non-HSA-qualified plan and miss an opportunity to build a more secure financial future. That's unfortunate. But not inevitable.

Benefits of Encouraging HSA Plan Participation

Why should employers encourage employees to enroll in HSA-qualified coverage and contribute to a Health Savings Account? Here are a few important reasons among many:

• An HSA-qualified plan usually delivers lower premiums for both employers and employees.
• Employees can buy more protection for other risks when they save on their medical premiums.
• Employees have an opportunity to become more engaged in the cost of care and thus can in many cases affect the group plan's future premiums.
• With proper employer education and encouragement, employees can understand the challenges of paying for medical care in retirement and leverage their Health Savings Account to save and invest for these expenses.

These benefits of an HSA-qualified plan make it incumbent on employers to shake employees from their usual open-enrollment doldrums - most surveys show that workers spend less than half an hour annually selecting their benefits, even though often $10,000 or more of risk-reducing coverage is in play - and choose the best combination of products.

The Weakness of the Current Employer-Contribution Approach

Most employers who offer more than one medical plan contribute a percentage of the premium. That percentage has declined in recent years - sometimes a little, sometimes a lot - depending on the employer's financial position, the competitiveness of the labor market, and the cost of medical coverage in relation to employees' total compensation.

Example: Hometown Interior Design offers its employees the choice of an HSA-qualified plan with a self-only premium of $600 per month and or a traditional PPO with a premium of $800 per month. The company pays 75% of the premium. Thus, the price difference between the two plans is $50 per month for employees ($150 versus $200).

Here are the problems with this approach:

The company incents overinsurance. An employee who values the PPO plan by $51 or more will choose that coverage, even though the total premium difference is $200. The employee never would purchase a car, a vacation, or a new television if she valued the more expensive model at say, $75 more than the lower-priced option, but the price that she would pay was $200 more. In this way, the employer's sharing the cost of coverage with workers skews decisions and results in employees' buying more insurance than they would on their own. This situation doesn't occur in the nongroup market, where people pay the full price for each plan.

The employer can't set its benefits budget. The firm can't set its benefits budget until the end of open enrollment because it doesn't know how many workers will enroll in each plan. Some companies can deal with that level of uncertainty. Others may find their budget strained if they incorrectly project employee plan enrollment.

The company absorbs premium increases. In this model, the company absorbs annual premium increases. If premiums rise 10%, the company pays, in our example, 75% of that double-digit increase. This can strain benefits budgets over time, particularly when the company's revenues and the rest of the benefits budget are growing more slowly.

The Advantages of a Defined-Contribution Approach

The alternative is a defined-contribution approach through which the company gives a fixed dollar amount (adjusted for contract tier, e.g., self-only, employee+spouse, family) to each employee to apply to whichever plan she chooses.

Example: Cape Cod Crafters offers the same medical plans as Hometown Interior Design (in the example above), with the same premiums. But CCC gives employees a fixed amount of $500 toward medical premiums. Workers who choose the HSA-qualified plan ($600 premium) pay the remaining $100 through pre-tax payroll deductions. But employees who select the PPO plan pay the $300 balance of the $800 monthly premium - a $200 monthly difference ($2,400 annually) in employees' share of premium.

This strategy counteracts the issues with the traditional approach.

First, it discourages overinsurance. Only employees who value the PPO at least $200 more per month (not $50 when the company pays 75% of the premium) will enroll in that product.

Second, the employer can set its benefits budget much more accurately. It won't know with certainty how many employees will opt out of coverage and how many will choose self-only versus family coverage. But it knows how much it will pay within each contract tier (self-only and family) because its contribution is fixed.

Third, the employer can, if it chooses, increase its contribution in future years independent of the rise in premiums. Increasing the contribution below the rise in premiums shifts more of the burden of the price of coverage onto employees. That approach may compromise the company's ability to attract and retain talent and thus may not be desirable. But it's an option.

HSAs and Texas-Baylor Football Tickets

(Note: My apologies to those who've heard this example in my Continuing Education courses!) Seven years ago, my son wanted to attend a football game. He had grown up a Texas Longhorns fan, then turned the tables and attended Baylor University, the Longhorns' closest geographic rival. He wanted to attend a BU-UT game at Darrell K. Royal Texas Memorial Stadium in Austin with a friend who, conveniently, owned a car (which my son did not).

I researched ticket prices and saw that seats close to the field cost about $225, whereas my son and his friend (whose ticket my son was buying in exchange for transportation) could sit a little farther from the field for about $85 per ticket.

I gave my son two options:

1. I would pay 75% (my contribution was capped at $300) of the price of the two tickets. He and his friend would pay the balance, plus be responsible for parking, concessions, and other expenses.
2. I would give him $200, which he could apply to tickets, parking, and food.

Not surprisingly, he chose Option 2. He minimized his out-of-pocket expenses for the trip. Sure, he could have bought more expensive tickets at 25 cents on the dollar. And some sons might have done so. But he reviewed the options and valued one approach (slightly less attractive seats and very little money out of his pocket for food and parking) over the other (better seats, but a larger personal financial investment).

And so it is with medical premiums. Employees in a defined-contribution model have the same coverage options available. But they pay the full price difference between the two (or among three or more) premiums. They will choose the lower premium unless they value the more expensive plan at least as much as the price difference that they must pay in full.

Covering the Out-of-Pocket Difference

Employees who consider the HSA-qualified plan need to determine how they'll cover the difference in deductibles between or among the plans offered. For example, if the traditional PPO was a $1,000 self-only deductible and the HSA-qualified plan's deductible is $4,000, that's a $3,000 difference that the employee must cover in a worst-case scenario. (There may be differences post-deductible cost-sharing as well. And most individuals and families without chronic conditions don't reach their deductible regularly. But let's keep the example simple.)

How does the worker cover this difference?

1. Reduced pre-tax payroll deductions for her share of the premium.
2. An employer contribution to her Health Savings Account.
3. Tax savings from her pre-tax payroll deductions to fund her account.

When the company pays 75% (in our example) of the difference in premium, the HSA-qualified plan looks less attractive because it becomes harder to fill the difference in out-of-pocket responsibility with employer contributions and employee contributions. In the example above of Hometown Interior Designs, the real difference in premiums is $200 per month, but employees are responsible for only 25%, or $50, of that difference monthly ($600 annually).

Thus, in the traditional model, the employee can cover only $600 of the $3,000 deductible difference. In contrast, with a defined-contribution approach, the employee can cover $2,400 of the $3,000 difference in deductibles with this one variable alone.

An employer's traditional contribution-to-premium strategy artificially reduces the actual premium differences, which leads employees to overvalue the traditional PPO, undervalue the HSA-qualified plan, and thus purchase more insurance than they otherwise would.

Transitioning

Employers who have adopted the traditional approach may have difficulty shifting to a defined-contribution strategy immediately due to the price shock.

Example: Tri-County Pest Control pays 80% of the self-only premium for either the HSA-qualified plan with a $500 premium or the traditional PPO with a $750 premium. The company shifts to a defined-contribution approach and gives each single employee a stipend equal to 80% of the lower-priced plan (or $400). Employees currently enrolled in the traditional PPO see their share of the premium rise from $150 (20% of $750) to $350 ($750 premium less the $400 employer contribution).

A company may choose to buffer that shock by making the change over a multi-year period, perhaps by maintaining the $600 monthly subsidy of the traditional PPO but reducing its subsidy by $50 to $100 per month. This approach smooths out the employees' increased premium responsibility. But in doing so, it reduces (to what extent?) the incentive to move to the HSA-qualified plan.

The Bottom Line

An employer's contribution-to-premium strategy may distort employees' decision-making process by subsidizing their buying more expensive coverage that they wouldn't purchase if they were responsible for the full difference in price between or among plans offered. Companies that are concerned about overinsurance and the amount that they spend covering a large portion of premiums have a viable option. They simply need to understand it and have the courage to implement this alternative approach.

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The content of this column is informational only. They are not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.