'Self-directed' health plans shift risk, cost to workers

Unlike traditional "defined benefit" plans, where the employer chooses and pays for some or all of an employee's health insurance, "defined contribution" plans allow companies to contribute a flat amount toward medical expenses – not insurance – and the employee selects and pays for the services and covers any additional costs.

This new approach to healthcare is similar to the changes that retirement benefits went through over the past two decades.

Until the 1980s, the retirement vehicle of choice was the defined-benefit retirement plan. With these traditional pension plans, the employer guaranteed a fixed benefit and assumed responsibility for funding it. But these plans have given way to defined-contribution retirement plans, such as 401(k)s.

Here, the company makes a voluntary, predetermined contribution to an account controlled by the employee, with no guarantee of final benefits.

Similarly, defined-contribution health plans, also called "self-directed" or "consumer driven" plans, allows an employer to pay a set dollar amount toward healthcare annually instead of providing a specified package of healthcare benefits with open-ended costs for the company. With defined-contribution plans, the risk of higher expenses or cost increases is largely transferred to employees.

Any unspent employer contributions are typically carried over from year to year.

In many cases, the company offers catastrophic coverage to protect the employee from the devastating costs of major illnesses or injuries.

Stand-alone defined-contribution healthcare plans are still uncommon.

"Most employers are offering defined-contribution plans next to traditional plans, so the employee still has a choice," says Clelland Green, chief executive of America's Choice Healthplans in King of Prussia, Pa.

Louisville, Ky.-based Humana, one of the largest healthcare companies, now provides modified defined-contribution plans for its 14,000 employees.

Jonathan Lord, Humana's chief clinical strategy and innovation officer, reports that the company began offering a pair of low-cost defined contribution plans last year.

"These products include an up-front allowance for the first $500 of healthcare spending, a large deductible for the next $1,000 or $2,000, and then insurance coverage for subsequent expenditures, capped to limit employee out-of-pocket costs," he says.

In July, the IRS gave the green light to defined-contribution healthcare plans, a sure sign of growing employer demand.

A survey by the Employee Benefits Research Institute, however, found that most Americans do not favor a defined-contribution approach.

Still, experts predict substantial numbers of companies will adopt these plans within the next 3 to 5 years.

For many employees, this development will mean immediately higher out-of-pocket costs.

Another likely consequence, says Ms. Cooper, "will be an increase in the number of uninsured."

David Cowles, executive vice president of Benemax, a benefits-management firm in Medfield, Mass., believes that "initially, some costs are shifted under such plans, but that doesn't mean that employees end up paying more, especially if costs are calculated over several years."

Employees who tend not to tap their health plans often may end up paying the same or even less for health coverage under a defined-contribution plan, he says, while employees with higher medical expenses may spend more.

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