Redefining the defined contribution approach to employee benefits

When most people talk about defined contribution in a benefits context they think of either a healthcare spending account or a flexible benefits plan that permits the allocation of flex credits to fund various employee-selected benefits. Both represent a form of defined contribution—repositioning the benefit promise as a dollar amount versus a promise of specific benefits the cost of which is variable.

From an employer perspective, the advantage of a defined contribution approach is that it fixes their cost and in effect transfers the risk associated with cost volatility to the individual. However, there is a win in it for the individual as well in the form of additional flexibility—to spend money and/or select benefit options that are best suited to their unique circumstances.

There is another approach to defined contribution that is gaining considerable traction in the United States and that warrants consideration in a Canadian context. Healthcare reform in the U.S. has created a new industry—exchanges or marketplaces. Exchanges—private or public—provide individuals with the opportunity to purchase health insurance usually selected from a range of options and even vendors (insurers).

However, many exchanges also offer a wider range of products and services—beyond just healthcare—and therefore provide an alternative to employer sponsored benefit programs. Employers simply allocate a dollar amount—a defined contribution—to each individual and then direct them to a benefits marketplace from which they can purchase a full range of individual products that meet their needs.

So why are these exchanges/marketplaces gaining momentum in the U.S.? In addition to helping employers satisfy their healthcare commitments under the Affordable Care Act, exchanges are potentially attractive for a number of reasons, including:

  • It fixes the employer costs equal to the defined contribution amount. If individuals need to spend more to buy the program that satisfies their benefit requirements—it’s at their cost.
  • In using an exchange, an employer effectively outsources both the administration and communication related to benefits to the operator of the exchange. And these tasks are not getting any easier, particularly in the U.S. where there are many compliance-related activities.
  • There’s an opportunity to provide access to a broader range of products and services that might not otherwise be provided through the employer—the exchange offers more choice than a traditional benefits plan. It’s also more convenient as an exchange offers one-stop shopping.
  • Risk is transferred to the exchange. While employers would normally worry about how the changing nature of benefits risk might impact plan costs, the “risk” discussion becomes very different. Risk is redefined as “am I contributing enough dollars to allow my employees to adequately satisfy their benefit needs?” and “will the exchange I endorse provide an appropriate level of service and product to my employees?” These are very different discussions.

These are pretty compelling reasons to consider an exchange or marketplace. However, the concept is not flawless:

  • The concept works where there is a robust individual insurance market—there has to be enough product to support the needs/wants/expectations of employees and their dependents. In many cases, individual products tend to be more expensive than employer-sponsored products (due to the spread of risk) and they often include restrictions and/or limitations. Having said this, a large enough exchange can provide the necessary spread of risk to mitigate some of these issues.
  • An exchange is attractive because it transfers decision making to the individual. However, there is also a potential downside. Without proper education, an individual may make sub-optimal benefit choices and this may come back to reflect poorly on the employer.
  • Perhaps the biggest downside is that there is the potential for the benefits promise to be attached to the exchange provider versus the employer. And if you subscribe to the notion that benefits are an important component of the overall employment proposition, an exchange may not be a good fit.

Despite these limitations, I do believe that exchanges represent more than an interesting concept for Canadian employers looking to reposition their benefits promise and to respond to needs/wants/expectations of an increasingly diverse workforce. The benefits world is unlikely to get any simpler in the future and if nothing else an exchange provides the opportunity to transfer this complexity to a third party willing to accept it.

While exchanges don’t currently exist in Canada, a number of insurers are attempting to diversify their offerings that may—in some respects—replicate the benefits of an exchange. And the individual marketplace continues to evolve so there are more opportunities to leverage the individual marketplace to meet benefit needs. But I do see a future in Canada that includes exchanges or marketplaces for one simple and compelling reason—it’s a potentially attractive evolution of the defined contribution approach to employee benefits.