Assuming the Affordable Care Act (ACA) stays on track through the aftermath of the election, it will offer numerous new benefits, such as guaranteed coverage for all adults starting in 2014. Some companies may want to stop providing health coverage and instead give workers money to buy their own. One of the more popular ideas being discussed is to give workers a lump sum, a voucher or defined contribution, and then let them use that money to buy their own individual health plan through the state health insurance exchange. One upshot is that workers could shop for plans that best suit their needs in terms of doctors and benefits, rather than relying on what their employers pick. They also get to take their policies with them if they leave their jobs. This model “gets a boost now”, said David Lansky, chief executive of the Pacific Business Group on Health.

The defined-contribution model is like a 401(k) plan in which employers put a fixed amount of tax-deferred dollars into employees’ retirement accounts and leave it to the workers to manage the money. In the case of health benefits, employers gain more control over their spending and avoid the hassle of picking plans for their workforce.

Small business employers should be eager for a new way of doing things as medical costs and insurance premiums keep climbing. Businesses with less than 50 employees have nothing to loose - no penalties or “taxes” - for not maintaining a group health plan. Some smaller firms, especially in technology, may want to keep benefits in-house to compete for the best talent. But companies in retail, hospitality and other service sectors with lots of lower-wage workers will be at the front of the line to sign-up for defined contribution plans.

Larger companies tend to be fairly conservative are unlikely to give up their paternal healthcare role in the near term, but faced with escalating healthcare costs, some employers will look at unconventional options. Extend Health, a California-based company, has already helped 40 companies in the Fortune 500 make this switch on retiree health plans, and it said many of those clients are interested in doing the same for current workers. Aon Hewitt, a major benefits consultant, is launching a private health exchange this fall aimed at employers with more than 5,000 workers.

A Milliman study, published March 15, 2012, says the average annual health care costs for a family of four with an employer-sponsored PPO plan increased by 6.9% from 2011 to 2012, to $20,728.

Employee Cost-Sharing Increases

The study found that employees will pay an average of 41%, or $8,584, of the total cost through premium contributions and out-of-pocket expenses, while employers will cover the remainder.

Slower Rate of Growth

According to Milliman, the 6.9% increase was the smallest annual growth rate recorded by the consulting firm in 12 years, but the $1,335 increase was the largest jump in dollars. Lorraine Mayne, a Milliman actuary, said the study “helps illustrate the challenge of controlling health care costs,” noting that since “the total cost is already so high, even a slower rate of growth has a serious impact on family budgets” .

Today’s employer-sponsored health insurance market is dominated by defined benefit plans, under which employers determine a set of health insurance benefits that are provided for employees. These will gradually be replaced by defined contribution plans, under which employers pay a fixed amount, and employees use the money to buy or help pay for insurance they choose themselves.

The fundamental driver of this shift is the effort by American businesses to reduce their exposure to healthcare costs. The natural next step will be for employers to strictly limit their health-insurance contributions to a set amount of money that workers could use to buy insurance. Companies will thus eliminate their exposure to unexpectedly high health-care costs.

Health Care Reform Accelerates the Shift

The Affordable Care Act (ACA), or Obamacare if you must, will accelerate the shift to defined contribution plans. Indeed, the legislation may have a larger impact on the type of health insurance plan that employers offer than on their decision about whether to drop healthcare benefits altogether. A survey by McKinsey & Co. has suggested the potential for huge declines in employer-based health insurance. Such estimates are highly uncertain, and what actually happens will probably depend on herd behavior. Employer surveys indicate that most companies will consider dropping their health plans only if other firms do.

If most employers do retain their health plans, the state Health Insurance Exchanges created under the new federal health-care law will make the basic idea of a defined-contribution health plan more prevalent, and thus speed its adoption. The regulations written to carry out the new law will determine how things play out. If defined contribution plans that are sufficiently generous count as employer-based coverage, as is generally expected, the trend toward such plans will probably accelerate.

In any case, the bottom line is that a shift toward defined contribution plans seems likely. I’d be willing to bet that most large U.S. employer healthcare offerings in 2020 will be defined-contribution plans.

Our friends at ChamberofCommerce.com created this infographic to raise awareness of an issue important to us and millions of other small businesses. We are a small business ourselves and we serve small businesses. So, for us, it only made sense to bring light to an issue, which not only places a major burden on small business owners, but also rarely receives the attention it deserves.

The business owners we hear from are in the trenches competing, devote their life savings to developing innovative products and services, hiring more staff, and otherwise growing a business for the benefit of family, employees, and community.

Mike Sarafolean, CEO of Orion Corp. of Minnesota, said he had a limited number of insurance choices to offer his 70 workers: “I had to buy a plan that would make sense and fit for most people. Now they make choices that fit for them.” For the past few years, his company faced “double-digit premium increases every renewal.” A little more than a year ago, Orion received a 40 percent renewal increase, prompting him to move to Minneapolis-based Bloom Health, which set up private exchanges in Michigan, Minneapolis and Indiana.

Defined Contribution Model

Now, his company makes a defined contributions ranging $125 a month for younger workers to $350 for older ones to special health reimbursement accounts (HRA), which workers then use to buy an insurance policy. By making the change to a flat contribution and a private exchange, the company is saving 10 percent over its previous year’s cost of insurance, he says. Many of his workers also spend less, he says.

This “defined contribution” model in health care compares the to one that gained speed in the early 1990s - employers abandoning pensions in favor of offering workers 401(k) plans for retirement savings. But just as 401(k) plans transferred the risk of market downturns to workers, the flat-payment model would shift risk to workers if rapidly rising health costs outpace increases in employer contributions.

Rejection For Preexisting Health Conditions

Unlike most of the private exchanges, the Bloom Health model, which serves about 25,000 people, sends workers to buy their own policies on the individual market, rather than through a group health policy. However, insurers selling individual policies in most states can reject applicants with medical problems, a practice that will end in 2014 under rules in the health care law.

Bloom CEO Abir Sen says his company offers its services only in states where rejected applicants can qualify for special state-run, high-risk insurance programs, which generally cost at least 25 percent more.

Gabrielle Smith, a 16-year employee of Orion who has an auto-immune disease, worried that under Bloom she would be unable to get insurance “or it would be so in excess of what I could afford.” Smith, 48, did get coverage - through Minnesota’s high-risk pool - and she now pays $45 a month for her premium on top of her employers contribution. “I haven’t heard anyone who is unhappy with the current insurance because it was all individualized,” says Smith. “Some of the younger employees with no medical conditions (found low-cost plans that) don’t require any money out of their paychecks.”

Other Private Exchange Models

Other private exchanges, including Buffalo-N.Y.-based Liazon, which serves about 25,000 employees in 23 states, and the new Aon Hewitt model send workers to group policies, which cannot reject applicants with health problems. The exchanges vary in other ways, too: While Bloom and Aon Hewitt offer a variety of insurers, for example, Liazon contracts primarily with one main health insurer in each region..

It’s unclear how the advent of state-based exchanges will affect programs such as Bloom, Liazon and Aon Hewitt, or whether there will still be a demand for their services by small businesses.

Today, the Internal Revenue Service issued interim guidance to employers on informational reporting on each employee's annual Form W-2 of the cost of the health insurance coverage they sponsor for employees. The IRS is also requesting comments on this interim guidance. The IRS emphasized that this new reporting to employees is for their information only, to inform them of the cost of their health coverage, and does not cause excludable employer-provided health coverage to become taxable; employer-provided health coverage continues to be excludable from an employee's income, and is not taxable.

Reporting is Voluntary for All Employers for 2011 and Small Employers for 2012

The Affordable Care Act provides that employers are required to report the cost of employer-provided health care coverage on the Form W-2. Notice 2010-69, issued last fall, made this requirement optional for all employers for the 2011 Forms W-2 (generally furnished to employees in January 2012). In yesterday's guidance, the IRS provided further relief for smaller employers (those filing fewer than 250 W-2 forms) by making this requirement optional for them at least for 2012 (i.e., for 2012 Forms W-2 that generally would be furnished to employees in January 2013) and continuing this optional treatment for smaller employers until further guidance is issued.

Using a question-and-answer format, Notice 2011-28 also provides guidance for employers that are subject to this requirement for the 2012 Forms W-2 and those that choose to voluntarily comply with it for either 2011 or 2012. The notice includes information on how to report, what coverage to include and how to determine the cost of the coverage.

The 2011 Form W-2, prior IRS Notice 2010-69 deferring the reporting requirement for 2011, and Notice 2011-28 containing the new guidance are available on IRS.gov.

Under the proposed "Medical Flexible Spending Account Improvement Act" (H.R. 1004) co-sponsored by U.S. Reps. Charles Boustany (R-La.) and John Larson (D-Conn.), FSA participants would be allowed to withdraw and pay taxes on any remaining account balances rather than forfeit those funds to their employer.

Currently, the Code Section 125 regulations allow employers to use forfeited contributions to pay plan administrative expenses and offset costs incurred by employees who spend their FSA funds and then terminate employment.

Most Health Benefit Advisers would prefer legislation to allow unused FSA dollars to simply remain in an individual's FSA to meet future health care needs. That way the funds could continue to be available for the purpose they were intended to serve and both employees and employers could be spared the need to pay taxes on excess FSA contributions.

Many employer clients reported that the rule discouraged participation in "cafeteria plans" as these FSA plans are commonly called. These plans are an important employee benefit as employee contributions to premiums and other out-of-pocket expenses increase. FSAs can help families save by using pre-tax dollars to pay for theses expenses. The use-it-or-lose-it rule is a missed opportunity for FSA participants to better manage their health. This legislation ensures that individuals will not be forced to use up or forfeit any remaining FSA funds simply because their families' needs did not match their predicted annual health care expenses

The rule was designed to prevent FSAs from being turned into tax shelters during a time when that concern was top of mind at the federal level, but in 2013 the Patient Protection and Affordable Care Act will slice in half the $5,000 maximum FSA contribution that each employee is now allowed to make. FSA proponents argue that the impending change will eliminate such concerns.

Reps. Boustany and Larson recently noted in a letter that more than 85% of large employers offer FSAs, but only 20% to 22 % of eligible employees enroll. The principal reason for not enrolling, or for underfunding accounts is fear of the use-or-lose provision. They also said that one quarter of participants forfeit some of their FSA funds each year.