Many small businesses fear the impact of rising health care costs on their bottom lines. In fact, a recent study found 68 percent of small business owners cite health care costs as a significant worry.1
The good news is that there are many ways to contain costs and still meet employee needs. And small business owners who take the time to understand their healthcare options can more effectively control healthcare spending—a money-savvy move that offers a competitive advantage.
Here are three common approaches to offering health benefits. Which model an employer selects depends on several things, including cash flow, risk tolerance, overall employee health and available manpower to manage claims.
Defined contribution. This model allows employers to set and control health care spending, making it a good option for organizations seeking a low-risk approach with predictable costs.
Employers contribute a fixed dollar amount to each employee’s health benefits each year. Employees then select their own benefits and use the employer’s contribution (think of it like an allowance) to offset the cost. Contributions are tax deductible for employers, and for employees, they are tax-free.
This model offers employees more choice – and control – over their benefits and works well for companies with a diverse workforce. Too, defined contribution encourages employees to become better healthcare consumers because they purchase health benefits based on their needs and true out-of-pocket cost differences between plans, not based solely on monthly premiums.
Level funded. With this approach employers have regular and predictable health plan costs while only paying for the healthcare costs actually incurred by employees. This can be a good option for employers with a relatively healthy workforce. And that’s an important caveat because when employees are healthier than average, payments go down; however, if the group has higher-than-anticipated annual claims, costs will go up.
With level-funded plans, employers pay a “level" (or fixed) amount of money each month to a third-party health services company (often an insurance carrier) to cover both administrative and anticipated employee claim costs. At the end of a year, if an employer's total payments are greater than the actual claim costs, the surplus will be refunded. However, if employee claims exceed what’s been paid, embedded “stop loss” insurance covers the difference.
Self-funded. Self-insuring employee benefits offers a business greater flexibility and control in both plan design and financing, and can provide potential savings in the form of tax benefits. However, this approach comes with higher financial risks and is typically best suited for a business with significant cash flow and a relatively healthy employee base.
As with the level funded model, an employer pays a monthly amount based on employees' anticipated medical expenses. But here, claims are paid as employees submit them, so if claim amounts are lower than predicted, employers can invest the money and earn interest. (For help processing claims, many small businesses enlist a third-party administrator.)
To mitigate the financial risk if claims are more than expected, most employers choose to purchase stop-loss insurance from an insurance carrier to cover the overages.
Regardless of how a small business funds its health benefits, both employers and employees can save money on insurance premiums with lower-cost High Deductible Health Plans (HDHPs), which typically have higher deductibles than traditional HMO or PPO plans. And by pairing these plans with tax-advantaged savings accounts employees can do more with their health care dollars. Here’s a quick primer on how they work.
Health Savings Account (HSA). Used only with an HDHP, employees deposit a specified amount of pre-tax money directly into their HSA through payroll deductions. Employers can contribute to the account as well, and often do as a means to offset higher upfront costs for care. At the end of the year, any money remaining in the HSA carries into the next year.
Flexible Spending Account (FSA). Like an HSA, employees contribute pre-tax dollars for medical expenses to this account via payroll deductions; and employers can contribute too. While an HSA can only be used with an HDHP, an FSA is compatible with any type of health plan. But unlike an HSA, the money in an FSA expires at the end of the year and reverts to the employer.
Health Reimbursement Account (HRA). Usually paired with an HDHP, an employer sets up this savings account and deposits funds for each employee. Employees cannot contribute to the account, but they can use the funds to cover pre-deductible, out-of-pocket healthcare expenses up front and receive pre-tax payroll reimbursement, which saves them money. Employers save too, by reducing their Federal Insurance Contributions Act (FICA) tax with this strategy.
For small businesses, carefully considering how to offer health benefits can yield opportunities and savings. The right approach can help employers manage health care costs while still providing employees with benefits to keep their families healthy.
1 "Bank of America Small Business Owner Report"; Bank of America. http://newsroom.bankofamerica.com/press-kit/bank-america-small-business-owner-report