Why HRAs Work as Defined Contribution Health Benefits

Understanding the Shift to Defined Contribution Health Benefits

For decades, small business owners have operated under a traditional group health insurance model where costs are fundamentally unpredictable. Your premium increases arrive each renewal period—sometimes jumping 8%, 12%, or higher—leaving you scrambling to adjust budgets or make difficult decisions about employee benefits.

Health Reimbursement Arrangements (HRAs) represent a fundamentally different approach to funding employee healthcare. Rather than betting on what insurance premiums will cost next year, HRAs function as defined contribution solutions, where you control exactly how much you’ll spend on healthcare benefits.

This distinction is transformative for small business financial planning.

What Makes an HRA a Defined Contribution Plan?

The Core Concept

A defined contribution benefit plan is straightforward: the employer contributes a set amount, and that’s the extent of the employer’s financial obligation. The employee then uses that contribution to purchase what they need.

Think of it like this—instead of buying insurance for your employees, you’re giving them a healthcare budget.

With an HRA, you establish an annual contribution amount per employee (for example, $400/month or $4,800/year). That amount is fixed. You know exactly what you’ll spend on healthcare benefits next year, the year after, and five years from now—unless you actively choose to change your contribution level.

This is radically different from traditional group health insurance, where: - Premiums are set by insurers based on claims experience, demographics, and market factors - Your costs rise with medical inflation, regardless of how efficiently the plan performs - You have limited control over year-to-year expense growth - Budget planning becomes an exercise in managing uncertainty

Why This Structure Matters for Small Businesses

Small business owners operate with tight margins. Predictable expenses allow for accurate forecasting, better cash flow management, and smarter strategic decision-making.

When you know your healthcare benefit costs for the next 12 months—because you’ve literally set that amount yourself—you can: - Build more accurate annual budgets - Invest savings elsewhere in the business - Avoid sticker-shock renewal surprises - Make informed decisions about company growth and hiring

HRAs vs. Traditional Group Plans: A Cost Comparison

Let’s illustrate why the defined contribution model appeals to small business owners:

Traditional Group Plan Scenario: - Year 1: $500/employee/month premium - Year 2: $545/employee/month premium (9% increase) - Year 3: $598/employee/month premium (10% increase) - Your costs are driven by insurance company decisions, not yours

HRA Scenario: - Year 1: You contribute $400/employee/month - Year 2: You contribute $400/employee/month (unchanged) - Year 3: You contribute $425/employee/month (you decided on a 6% increase) - Your costs increase only when you decide they should

Over a three-year period with 10 employees, the group plan costs $198,900 while your HRA costs $153,600—a $45,300 difference. More importantly, you controlled every dollar.

How Employees Benefit from HRA Defined Contributions

This isn’t just about employer savings—the defined contribution model actually serves employees well.

Individual Choice and Flexibility

With an HRA, employees receive a reimbursement account loaded with your contribution. They then choose their own health insurance coverage—typically a low-cost catastrophic or short-term plan, or they may select coverage from the individual marketplace.

This flexibility allows employees to: - Select plans that match their actual healthcare needs - Avoid paying for coverage they don’t need - Maintain benefits if they leave your company (portability) - Shop for better rates without being locked into group coverage

Transparency in Healthcare Spending

When employees have a defined contribution amount, they become more engaged in healthcare spending decisions. They see exactly what they have to work with and develop more intentional healthcare consumption habits—a phenomenon sometimes called “consumer engagement.”

Studies consistently show that healthcare cost growth slows when employees have more direct financial involvement in their care decisions.

The Regulatory Advantage: ICHRA Clarity

Individual Coverage HRAs (ICHRAs), approved under Internal Revenue Service rules, provide a clear regulatory framework for defined contribution health benefits. Key advantages include:

• IRS Guidance: The ICHRA model is specifically authorized in IRS Revenue Ruling 2019-1 and subsequent guidance
• Tax Treatment: Employer contributions are tax-deductible and tax-free to employees (when properly structured)
• Compliance Simplicity: ICHRAs don’t trigger ACA coverage requirements or Section 4980H employer mandate penalties
• Flexibility: You can offer different contribution amounts by job classification, tenure, or other defined criteria

This regulatory clarity makes HRAs a substantially lower-compliance-risk option compared to some alternative healthcare funding models.

Addressing Common Concerns

“Won’t employees struggle to find coverage?”

The individual health insurance market has matured significantly. Employees can access: - Healthcare.gov marketplace plans (including subsidies they may qualify for) - Short-term health plans - Association health plans - Direct primary care memberships - Catastrophic coverage plans

Most employees, especially younger and healthier ones, find suitable options quickly.

“What if costs still increase?”

You control the increase. If healthcare costs rise industry-wide, you can elect to increase contributions by 3%, 5%, or any amount you choose. You’re not forced to absorb uncontrolled inflation like traditional group plans require.

“Is this appropriate for all company sizes?”

HRAs work particularly well for companies with 5-100 employees. Very small companies (1-4 employees) may have limited options in their market. Large companies often stick with traditional group plans due to established systems and employee expectations, though HRAs can supplement group coverage.

Making the Transition

Switching to an HRA-based defined contribution model typically involves:

1. Assessment - Determine your current healthcare spend and desired contribution level
2. Education - Communicate the new model clearly to employees (this is crucial)
3. Setup - Work with an HRA administrator to establish the account structure
4. Implementation - Help employees select individual coverage during the transition
5. Ongoing Management - Monitor utilization and adjust contributions as needed

Most transitions take 2-3 months, and employee satisfaction typically increases once they understand the flexibility and cost savings.

The Bottom Line

HRAs function as defined contribution health benefits because they shift financial predictability from an insurance company’s ledger to your balance sheet. You decide what you spend. You control the budget. You benefit from cost savings without being punished for healthy claims experience.

For small business owners tired of surprise premium increases and unpredictable healthcare costs, the defined contribution structure of HRAs offers both financial relief and strategic clarity.

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Nexus Benefit Solutions is an independent employee benefits advisory firm based in West Michigan. Questions? Reach out at jason@nexusbenefitsolutions.com or call 616-425-9740.