Employer Sponsored Insurance is already a Defined Contribution analogue

Earlier this week in the post on the wide amount of state discretion in the ACA an interesting and valuable comment was made by Ohio Mom that I want to engage on a bit more:

IANADavidAnderson but my suspicion is that this is the first step to doing to employer-provided health coverage what was done to defined-benefit pension plans. You’re going to end up with a health coverage version of a 401k.

In my opinion, employer sponsored insurance (ESI) is already a kissing cousin to a defined contribution plan than a defined benefit plan when we look at ESI offerings over a several year period.

My parents are retired. My parents have two very different retirement funding streams beyond the baseline of Social Security.

My dad has a union backed defined benefit plan. He gets a direct deposit of $XXX per qualified work year per month for the rest of his life and if he dies before my mom, she gets .67(XXX) per qualified work year per month for the rest of her life. The benefit dies with them. The union pension fund is currently over-funded (the construction actuarial tables understate mortality for the cohort of folks who had significant pre-OSHA/pre-EPA careers, so it will be interesting/scary when more cohorts like my Dad start to retire when most/all of their work years are post-OSHA) as the union fund is on the hook for longevity surprises and market shocks. If the retiree cohort dies quicker than projected OR the markets do better, my parents get no new upside but they also don’t face any downside. My dad effectively signed a 50 to 70 year contract for his pension benefit.

My mom has a 401-K. She explicitly contributed to it during the 20 years she spent at a particular employer. Her employer kicked in their contractually obligated match. The employer had a legal obligation to make sure the promised payments cleared and that the advisors were not complete, total and blatantly obvious frauds that a 3 year old could check. Once the matching and lump sum payments landing in my mom’s account, her employer had no further obligations. The matching rate and lump sum payments could and did vary by year and by who owned the corporate entity. My mom bears all the longevity risk and all the market risk. If both my parents die before her 401-K is empty, the remaining benefits can be passed along. If the 401-K is empty before mom and dad are dead, they are SOL unless my siblings and I can step in.

Employers sign short term contracts for health insurance. Most employer health insurance contracts are between one to three years with a few four and five year contracts. Unless there is a specific contract, there is no obligation for an employer to offer the same plan at a predefined price schedule to employees for one, three, or fifty years in a row. Instead, the benefit is re-adjusted every year. If the employer believes that they are spending too much on insurance and insurance is not a marked labor market differentiation, they have numerous ways to change the benefit while still offering some form of insurance in the next year.

An employer can reduce costs by shifting from a PPO to an HMO, or going from a broad network to a narrow network or a network with multiple tiers. An employer can move from an inefficient insurer to an efficient insurer. An employer can lower their total costs by shifting from a low deductible, high actuarial value plan design to high deductible, low actuarial value plans. All of these changes happen on a frequent basis. Employers offering insurance have very few obligations over time.

An HRA arrangement like that in the proposed rules just moves the behind the scenes decision making that is barely noticed on Box 12-DD of an employee’s W-4 and makes it explicit. I don’t think it moves employer sponsored insurance from defined benefit to defined contribution as it is, in my opinion, far closer to defined contribution in reality than it is to a defined benefit plan once we get past a single contract year.

15 replies
  1. 1
    daveNYC says:

    Might be misreading, but you seem to be focusing on the relationship that the company has to the insurance (short term contracts, no long term liabilities) and not the ‘who ends up taking the risk’ that I think is more what Ohio Mom was talking about.

    Could be wrong though.

  2. 2
    Eolirin says:

    @daveNYC: The employee is taking on a good amount of risk as it is. You can suddenly find you don’t have coverage for your doctors or a type of condition or your copays just went up a bunch because the plan design changed. The share you have to pay in can be adjusted based on your work contract if you’re even lucky enough to have that defined. You’re on the hook for any of those increases and have to figure out how to deal with any loss of services, and the employer has ways of passing on rate increases on their end to their employees.

  3. 3
    luc says:

    What do you mean? It didn’t go well?
    For the believers, this interview explains the whole border mess perfectly adequately and reassuringly.

  4. 4
    daveNYC says:

    Your risk is relatively well defined though, at least on a per-year basis. You switch over to to an HRA and it seems more along the lines of ‘here’s some cash, good luck’. The company’s involvement is even less than with a 401(k) program, because at least there they have to pick the financial institution to work with. HRA’s seem like they could just throw you onto the exchange system and call it good.

  5. 5
    Robert Camner says:

    This post is one of the reasons I’m glad David exists! When I first read OhioMom’s comment, I thought, “Right…that’s just what’s happening: moving away from a defined benefit approach to health insurance to one that’s defined contribution. Bad!”

    But David’s post makes it clear that my conception of ESI was wrong. It IS much more like defined contribution. But, that doesn’t mean we should oppose attempts to make it MORE like a defined contribution plan.

  6. 6
    Leto says:

    My dad effectively signed a 50 to 70 year contract for his pension benefit.

    That’s how the military used to do their retirement benefit. Now it’s a 401k style benefit, with continued decreased health benefits. Conservatives won’t be happy until we’re back to lord/serf relations.

  7. 7
    patrick II says:

    If the employer contributes just $, does the employee have to buy from a particular spectrum of employer approved insurance deals? Or can he buy Obamacare? I imagine not, since that would both help the employee and Obamacare, and we can’t have that, but it should be an option open to anyone willing to pay in the health insurance market.

  8. 8
    Ohio Mom says:

    @daveNYC: Yes, DaveNYC articulates my concerns.

    This is somewhat academic for me because Ohio Dad and I are nearing our Medicare years and I don’t think things will change that much until then (and first, newly-laid off Ohio Dad needs to find a new job and get us off COBRA).

    It is true that our our employer-sponsored insurance has changed year to year, sometimes in significant ways that we haven’t liked. And our costs have consistently gone up.

    I get the part of the argument that these short-term arrangements are not at all like the promise of a traditional defined benefit pension where theoretically the terms are permanent (we can all think of instances when these promises were reneged upon).

    Still, the selection of the plan, and all the associated negotiating is not our headache, and we already have enough headaches. More importantly, there’s no reason to believe that a pair of amateurs (us) are in a good position to navigate these sorts of decisions. And we would not have leverage a large organization has.

    I’m reminded of self-serve gas stations and supermarket check-outs. These businesses increased their productivity by essentially making me an unpaid employee. Now I’m going to be an unpaid HR staff?

    I wouldn’t be as concerned if we had a solid public option or something similar to which we allocate our employer-provided health coverage allowance. But if it is going to be like the 401 plans where we are given a limited selection of investment vehicles, all the while wondering what kickback the employer is getting for choosing that investment company?

    Or maybe worse, we are thrown into a public-optionless open market?

  9. 9
    Ohio Mom says:

    @luc: You’ve already figured out you’re in the wrong thread but I wanted to add something to your comment.

    When I was listening to Trump making no sense, I was thinking, There are people who are sure that the reason they can’t follow what Trump is saying is because the entire issue is out of their league —like if I was listening to a physicist talk about string theory.

    They are just happy that someone as smart and savvy as Trump is taking care of it all (shudder).

  10. 10
    Ohio Mom says:

    Real life calls me but before I go I must say that I’m flattered to have inspired a David Anderson post.

  11. 11
    Ruckus says:

    @Ohio Mom:
    As an ex employer who had to every year pick and pay for a health policy for my employees, and use that policy for myself as well, let me say that no matter what the cost has always gone up more than I could raise my prices. In the last couple of decades the only way to maintain some level of reasonableness to the entire situation was to have less benefits. The US healthcare system has priced itself out of reality. And we are all paying for it.

  12. 12
    Robert in ATL says:

    Just a note to remember the large number of jobs in small employees. A single incident at somewhere I used to work kicked the next years premiums up by something like 50%+ if I recall – HR of course ended up moving to a new insurer (at something closer to a 15% jump). But it always struck me as a poor design to stick all of the 2, 20, 50 or even 100 size companies into siloed risk pools. Of course kicking people onto the state market only works if it’s reasonably functional, but at least it is somewhat rational idea when you stop to think about it. Also, the additional individuals going through the ACA market place would seem to add a big, and listened to, constituency. It would seem like states with more rationally regulated insurance markets (see David’s posts on CA) would make it easier to shop by eliminating the confusing “me to” plans.

  13. 13
    LongHairedWeirdo says:

    @daveNYC: short term contracts, with no long-term liabilities, is a beaming accountant’s pocket definition of risk determination.

    In business terms, “risk” is almost always “how much money could we pay in a terrible situation?”

    Now, I just happen to know about defined benefit versus defined contribution plans, but the reasoning for a change is *very* different. Let me explain, because it’s important to understand one of the GOP’s lies (“Tax cuts make jobs reduce profits by *far* more than they would have without the tax cuts, and therefore, employers will keep and create… uh… let’s see, something becomes more expensive, nothing else changes, want to get elected, people will believe whatever BS line I give them, because Fox will say I’m brilliant….”) .

    Where was I? Right.

    Imagine this: you’re a small business – expert construction, lawyer, doctor, heck, even the owner of The Best Local Pizza Shop. Back in the 70s and early 80s, the top tax rate was 70%. You’re in your 40s, and you want a tax shelter. What does your accountant say? Your accountant says “look, if we create a defined benefit pension plan, that will pay every employee with 25 years of service 50% of their highest annual salary, then 60% of the money you sock away will go toward funding *your* benefit. So: you put $100 into the plan. $60 is dedicated toward funding your retirement. If you don’t put money in the plan, you know how much you take home? $30, after 70% in income taxes. If you’ve got the spare cash to sock away, it’s a *great* deal – you’re basically *doubling* your money, and able to invest it, tax deferred!”

    Tax rates dropped. What happens when the top tax rate is 35%? Well, then if you put $100 into the plan, you get $60 in benefits, versus the value if you just take the money home, which is… uh… $65. Well, everyone knows that “money now” is worth less than “money later,” which is why you’ll give me *all* of your money right now, and I’ll pay you back every penny in one year’s… oh, right. Money now is worth more than money later; plus, it’s *more* money. NOW.

    Hence, we have the Defined Contribution plan. Under no circumstances will investment risk cause a company to have to make bigger pension contributions – if the employees take it in the proverbial balls, too bad for the employees! But it’s not enough. I mean, what if you gave each employee 10% of their annual salary in contributions? You *still* don’t have a great tax shelter; you’re still probably giving away more money to the employees than to yourself!

    Ah… but under 401(k) of the IRS code, a specific Cash Or Deferred Arrangement was permitted. You see, normally, if you tell me “I can give you $10,000 for your work today; or, I can give you $10,000, plus interest, on January 1 of 2020” then I’m said to be in “constructive receipt” of the money. Under normal circumstances, I have to pay taxes on that payment *today*, even if I don’t have the cash in hand, because I already have a bookable item on my balance sheet. So the code section has to allow people to defer taxes on money for which they’d normally be in constructive receipt.

    For normal commercial entities, we therefore have the 401(k). It’s a profit sharing plan (which is, essentially, “a money purchase plan, without a set contribution level” (hence, profits can be shared – contributed to the plan – when desired). If the plan administrator wants, they can also allow salary deferrals (which is the most common form). Some employers include a salary deferral match; many don’t even bother. Of course, because of 401(k), there’s an interesting tidbit. Salary deferrals are considered *employer* contributions. (Seriously; though from a practical perspective, it’s meaningless it still annoys me that it seems like the employer gets credit for your own choices. The point is, it’s illegal for you get *get* the money, and *then* decide it was a pension contribution instead of plain cash; instead, the employer must contribute it, to your account, so it’s *not* taxable.)

    So the reason there are no DB plans is, there’s not much economic sense to them. They can put a business at risk when deregulation causes another 2008; they don’t function as a good tax shelter; a “Target Benefit” plan generally works better for that – they try to provide the value of an annuity, but only up to the maximum contributions normally allowed in a defined contribution plan, which is (was?) 25% of salary, up to a limit (probably a hair over $30,000 these days, I think – it used to be 25% of the highest salary taxed by OADSI – Old Age, Disability, Surivor’s insurance – assuming I’m remembering my initialisms!). That still puts most money into the accounts of older, higher paid, employees, but doesn’t put the employer at risk if there’s a funding shortfall.

    It *is* true that employers are fascinated by the idea of short term contracts with no long term exposure, to define and minimize risk. For example, look at Paul Ryan’s Defined Contribution For Medicare plan. Isn’t that the entire “dump all the risk on the peasants” goal of most businesses? It will define the “risk” that the US faces in having to (ICK!!!!!!) pay EARNED BENEFITS to its (I have it on Good Authority that Paul Ryan’s face squinches up like a cranky toddler tricked into eating creamed spinach when saying this word) “citizens”. He might even add, with a spit of disgust, “not even to its wealthy, who might have to pay some *taxes* which will paid as ‘earned benefits’ given to these lousy, layabout, good-for-nothing ‘citizens’.”

    But while that is a thing, and while it is for a semi-similar reason, the demise of the defined benefit plan was due to tax rates.

    One reason why health care plans are less generous is something subtly different. See, health insurance benefits aren’t taxed; they’re not counted as part of your income (so you don’t pay income tax, social security tax, or state taxes on them). They also aren’t taxed to employers – they’re a necessary cost of doing business, because you can’t retain top talent without a good health care plan. (Well, not if your top talent is in his 50s, and has a chronic medical condition – oh, wait, it just got personal again :-).)

    Well: lets say you could get $15,000 in health insurance benefits, or, $10,000 in benefits, $5,000 in cash. Which would you prefer? Most people would generally prefer the latter – as David has frequently pointed out, medical care is *very* heavily loaded on the most-expensive end – I don’t remember where the 50% point is, but I think it’s over 80%. (That is: I think less than 20% of the population, is responsible for over 50% of its costs. I could be wrong! But IIRC, I’m not off by *much*.) So 80% of the people would naturally gravitate toward the “some in insurance, some in cash,” even if they *really* want insurance.

    Well, if you got $10,000 in insurance, and $5,000 in cash, your employer would have to pay social security and medicare on $5,000, and you’d pay taxes on the $5,000. So there’s now a “Cadillac Plan” tax – if health insurance costs too much, there’s a tax paid on the overage, to help trim those benefits. Me, I’ve always thought this was far too subtle an issue, but I did notice that a certain major software company in the Puget Sound region quickly moved toward plans with a *far* lower cost once the ACA came out.

    Anyway: gold-plated health insurance has lost some of its tax incentives, and tax cuts in general have made employee benefits cost more in profits (and it’s become *far* worse with the GOPpie-Trump Love Child tax cut bill), so there’s an expected downward trend in health care spending, and, yes, in reducing exposure to “risk”, i.e., future cash outlay.

  14. 14
    Another Scott says:

    @LongHairedWeirdo: Very interesting. I never caught the connection between slashing marginal tax rates and slashing retirement and other benefits, but it certainly makes sense from your description.

    It’s all JFK’s LBJ’s fault!!11. ;-)



  15. 15
    Ohio Mom says:

    @LongHairedWeirdo: I’m with Another Scott, that was very interesting. Now were the tax cuts’ effects on retirement and other benefits a feature or a nice surprise of a bug?

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