Private Exchanges - What Employers Need To Know

As we approach the full implementation of the health reform legislation next year, employers have a lot to think about: Which provisions apply to them? What will happen to their premiums? And would they be better off dropping their coverage altogether?

Fortunately, some things are getting easier. While the government struggles to develop "exchange" websites in every state, the private market has been offering similar - and more advanced - solutions for years. And now, this technology is being combined ith taxadvantaged accounts to give employees more choices and allow them to design a benefits package that's right for their family. The result? Lower costs, less hassle, and higher employee satisfaction.

Up, Up, and Away

Health insurance premiums are wildly unpredictable, and this makes it difficult for employers to budget. This is compounded by the fact that most companies offer one or two plan options and contribute a percentage of the premium - usually just the employee only premium. This puts them at the mercy of the health insurance company - if rates go up 10%, the employer pays 10% more; if they go up more than that, the employer must absorb the increase.

That's part of the reason health reform is so frightening to most employers. We keep hearing that premiums are going up - in fact, "skyrocket" is a frequently used term. Under their current contribution model, employers will feel the brunt of this increase. There has to be a better way.

There is.

Defined Contribution

A recent trend in the large employer market - and now a growing strategy among small employers too - is for the company to stop contributing in percentages and instead define its contribution amount in dollars.

By disconnecting its contribution from the health insurance premiums, an employer can re-gain control of its employee benefits package. Instead of offering just one or two plan options - instead of defining the benefit for the employees - the employer instead defines the contribution and lets the employees choose which benefits they want. The contribution amount becomes the benefit, and the employees get to go shopping.

Of course, this only works if the employees have a selection of plans to choose from. So choice is a key component of a defined contribution strategy - with a number of different options, an employee can pick a plan that's right for them and their families.

The reason this strategy makes so much sense is because there is no one-size-fits-all solution, especially when it comes to health insurance. Everyone's situation is different, and it's crazy to think that an employer could pick a plan that will make all of its employees happy. It's a lot safer to let the employees choose. Think of it as giving them a gift card instead of giving them a toaster. With a gift card, they can pick their own appliance - or something else entirely.

Cafeteria Plans

The defined contribution strategy isn't new at all - in fact, it's been around for decades. Most people have heard the term cafeteria plan, but they may know what it is or exactly how it works. Here are the basics:

Under section 125 of the tax code, an employer has the option of giving the employees a "bucket of money" that can be used on a menu of different items. A section 125 plan, also known as a cafeteria plan, allows participants to choose among at least one qualified benefit, like health insurance, and one taxable benefit, such as cash.

Added to the Internal Revenue Code in 1978, the cafeteria benefits plan was a result of the idea that "one universal benefit program can no longer do the job," an observation made by Thomas E. Wood, one of the originators of flexible compensation.

Not only can employers provide their employees with tax-free dollars, a 125 plan allows employees to contribute their own funds on a tax-free basis as well. And now, the technology has finally caught up with this strategy.

Private Exchanges

If a cafeteria plan is the gift card, a private exchange is the store. It's the place where employees can go "shopping" for health, dental, and life insurance, ancillary products like critical illness and accident insurance, tax-advantaged accounts like FSAs and HSAs, and more. In contrast with the government's public exchanges, which only sell health insurance products, private exchanges allow employees to sign up for all lines of coverage in one place. Assistance is available from a licensed insurance professional, and yes - private exchanges can even be used to sign up for the subsidized plans we're hearing so much about.

There are rules, of course. For instance, employees and family members who are eligible for coverage under a group health insurance plan do not qualify for the generous government subsidies, but employers that don't offer a group plan can use their money on other valuable benefits while helping their employees access the advance tax credits. And while section 125 funds cannot be used for subsidized insurance premiums, there are still plenty of eligible expenses the employees can spend their money on.

The cafeteria plan does require a formal plan document, so it's important to work with an experienced Third Party Administrator who can make sure the i's are dotted and the t's are crossed. Some private exchanges are integrated with the plan administration software, providing employees with a seamless shopping experience.

In Summary

  • Employers are looking for a way to control costs, and defining their contribution amount rather than defining the benefit allows them to better budget for their employee benefits plan.
  • By running their defined contribution amount through a cafeteria plan, employees can give their employees tax-free dollars that can be used for a menu of options, allowing employees to choose a plan that's right for them and increasing employee satisfaction in the process.
  • To simplify the shopping and enrollment process, the various plan options can be offered through a private exchange, where employees can get the assistance of a licensed insurance professional, use the employer contribution dollars on eligible
    expenses, and apply for government subsidies.

We've been hearing a lot about private exchanges, and this is just the beginning. In fact, according to a recent report by Accenture Research, nearly 20% of U.S. residents will purchase health insurance through a privately operated exchange in the next four years. Forward-thinking employers won't wait that long.

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