Defined Benefits Are Outdated, So Why Are We Still Using Them?

Defined benefit pension plans were once the most popular retirement plan offered by employers, but today only 15% of private-sector workers have access to one.

Pension plans are expensive to maintain and are unpredictable. They require ongoing funding, and future costs can be challenging to estimate. Funding for the plans comes directly from future corporate earnings, which impacts a company's value and future profit.

Since the 1980s, companies have moved away from defined-benefit pension plans to avoid ongoing liability and the challenges of estimating future costs. Now most companies opt to offer defined-contribution plans, like 401(k)s, which are much easier to predict costs and protect future company profits.

The same logic for moving away from defined benefits applies when you look at your company’s group health plan.

Through a group health plan, your company selects a plan, gives employees access to a network, and can be locked in for a year or more. If your employees have a high plan usage rate that year, you can see your group rates skyrocket. 

Your company is bearing the full weight of that financial risk. Companies have essentially eliminated the financial risk due to pension plans, so why are they still taking the risk with health insurance?

In the same way many companies moved toward the defined contribution model of a 401(k) over a pension plan, companies today are switching to tax-incentivized Health Reimbursement Arrangements (HRAs) accounts from their group health plan.

A Health Reimbursement Arrangement (HRA) is a health spending account that an employer can set up to reimburse employees tax-free for out-of-pocket healthcare expenses. The funds in the account can cover a wide range of healthcare costs, including premiums, co-pays, and dental and vision expenses.

By determining a fixed contribution amount, you have complete financial predictability on your benefit costs, insulating your PnL from risk and giving your employees access to more flexible—and often more affordable—options for your employee health insurance.

In the past few years, recent legislation has created new HRA types, expanding how employers can reimburse employees for health-related expenses.

For example, it is now possible to use an HRA to reimburse employees for individual health insurance premiums. There are also fewer restrictions on who can be covered by an HRA. Employers can offer HRAs to part-time and seasonal workers, as well as retirees. 

Group health plans are the norm today, but that doesn’t mean they are the most strategic option for your business. Moving to a defined contribution model will give you more financial predictability on cost, increase plan flexibility for your team, and—for many companies—save you thousands on your overall costs.