by Tony Novak, CPA, MBA, MT
Update: This article is out-of-date as of tax law changes effective January 1, 2014. See "18 Things Small Businesses Must Know About Health Reimbursement Arrangements (HRAs)" for the 2014 rules.
Health reimbursement arrangements (HRAs) are now the plan of choice for innovative small businesses that provide health coverage to employees. Besides the obvious reason that they save money for the business, there are many other reasons why these plans are likely to become commonplace as more businesses learn about them. These plans first showed up on the national radar screen last summer after the IRS issued several favorable tax clarifications. In recent months, a handful of benefits providers have been promoting the HRA plans and, surprisingly, some large health insurance carriers are even advertising these plans. HRAs are independent of health insurance and generally reduce the amount of money spent on health insurance. Here are some of reasons why these new health plans are better than small group health plans of the past.
HRAs can be used in combination with any type of individual or group health insurance or may be used without any health insurance at all. Unlike Medical Savings Account plans, insurance is not a prerequisite to qualifying for tax-free benefits.
In the past, a business could get a better deal on health insurance if a group purchased a plan together. The idea was that there was power in numbers, and the bigger the group, the better the purchasing power. But modern laws make the opposite true. Most individuals can find a better deal on health insurance within minutes on the Internet than their employees can find using all of the professional resources that might be available to group insurance buyers.
There are more health insurance options and non-insurance benefits available in HRAs than traditional group health insurance plans. In fact, each employee could actually choose a different combination of health benefits.
The employer defines the dollar amount of contribution to the HRA for the year. The employer is in complete control of the cost. Unlike insured health plans, the employer is not automatically obligated to increase the plan contributions when the cost of health care increases. While no one is immune to the long-term effects of the national crisis in spiraling health care costs, the HRA allows the business to maintain a fiscally healthy distance from the fire. Simply by severing the knee-jerk connection between medical inflation and employer costs, the benefit plan is inherently more stable.
The days of "one size fits all" health plans are gone. Each employee may have a different idea of what is the best plan for them, and the Internet makes more health plan choices available than ever before. This flexibility is great, as long as it does not mean extra work for the employer. The HRA enables employees to take advantage of these choices at no additional expense or administrative burden to the employer.
There are few "absolutes" when it comes to designing a HRA plan. Applicable laws allow employers more latitude in determining who is covered under the plan, when they become eligible, and whether they may retain benefits during a leave of absence or termination than traditional health insurance plans. HRA plans can cover part-time employees, seasonal workers, or only full-timers or veteran employees. Health insurance company underwriting rules do not dictate these coverage factors.
State-mandated coverage that must be included in the traditional group health insurance plans are one of the key factors driving up health insurance costs. HRAs are exempt from these provisions. In some states like Florida, the insurance that may be paid for with HRA funds is 30% to 50% less expensive than traditional group insurance plans. This feature is especially important to those who do not support the changes brought by the Affordable Care Act of 2010.
HRAs are extremely efficient. For every dollar that the employer pays into the HRA, about 99 cents goes directly to the employees. Typically less than one percent of the employer' s outlay is spent in administrative costs. Compare that to an average of only 70 cents out of every dollar paid into a typical small group health insurance plan.
Unlike the "use it or lose it" medical reimbursement plans of the past, HRA plans allow employees to carry forward their benefits into future years. So instead of going on a health care spending spree every December, employees have an incentive to be smart healthcare consumers. Employees know that dollars saved today on an unnecessary prescription, for example, are still available to them for another purpose in the future that the employee values more, like an annual exam or coverage for eyeglasses.
Unlike Health Savings Accounts (HSAs)and most other types of "funded" benefit plans, there is no need to set up a separate account to hold the contributions.
There is no need to pre-fund the healthcare expenses in an HRA. Employers may simply use a pay-as-you-go accounting system for the best cash flow efficiency.
Online resources make it possible for any business to start an HRA plan on demand. Unlike group health insurance plans that take weeks to get started, HRAs can be started in a day.
The setup cost is typically about $150 and the entire cost of operating the plan is substantially lower than a 401(k) or other health insurance plan. Operating costs are less than $200 per employee per year.
For those financial do-it-yourselfers, an HRA plan can be administered internally without any outside support or costs. While most firms will want some professional help setting up and running their health plan, it is good to know that the plan is not dependent on any specific provider. The employer maintains control over the plan service and the cost.
HRAs tend to shift more of the emphasis on preventative care and other types of expenses that employees appreciate most.
It is easy and affordable to provide 100% coverage plans. Since the average American household incurs about $1200 in out-of-pocket health expenses per year, an employer contribution of only $100 per employee per month in a HRA plan could fund 100% of the ordinary healthcare needs of the company.
While low cost insurance is not always available and can be especially difficult to find in states like Massachusetts, Rhode Island, Vermont and Washington state*. In contrast, HRAs are available in every state. (*New Jersey and New York were previously on this list but the expansion of low cost limited benefit plans is expected for 2012).
All businesses with employees are eligible for HRA plans. High-risk industries are eligible and employers do not need to prove that their businesses are eligible to utilize a HRA plan. Employees with health problems cannot be turned down in a HRA plan.
The next time an employee has to make an out-of-pocket cash payment for a doctor' s visit or prescription drug, it will be easier knowing that the expense will be reimbursed under the HRA plan.
Unlike health insurance plans that use difficult language, HRAs are easy to read and understand. The plan document is only a few pages in length and written in plain language that can be understood by all of the employees.
By teaming up inexpensive PPO discount plans with 100% reimbursement of the lower network payments, the employer’s benefit budget can be stretched even further. These discount plans can easily trim 25% off of the cash price of most medical, dental, eye care, orthodontic, prescription and chiropractic expenses.
The IRS allows more items to be covered in an HRA plan than any insurance company allows under a health insurance plan. Items like preventative care and alternate medicine are always covered items under the HRA.
Claims payment can be fast and simple. The employee simple shows the plan administrator evidence of qualified expenses and the claim is covered up to the HRA plan’s dollar limit.
HRA plans are free from the inherent conflicts that plague health insurance plans. There is no inherently adversarial relationship between the plan administrator and the plan participant. In fact, the plan administrator and the employee both share the same common interest - to have the pre-stated plan benefit paid tax-free to the employee and to avoid having the plan payments taxed as income.
Taking all of the factors above in whole, smart employers can see that the HRA plan will save them a substantial amount of money over the long term. The immediate cost reduction (on an comparable coverage basis for a typical business in the first year after converting from a traditional fully-insured health plan) will be between 10% and 30% of the previous year’s expenses.
This article has been updated for 2012.
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Opinions expressed are the solely those of the author and do not represent the position of any other person, company or entity mentioned in the article. Information is from sources believed to be reliable but cannot be guaranteed. Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues or a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. Tony Novak operates as an independent adviser under the trademarks "Freedom Benefits", "OnlineAdviser" and "OnlineNavigator" but is not a representative, agent, broker, producer or navigator for any securities broker dealer firm, federal or state health insurance marketplace or qualified health plan carrier. He has no financial position in any stocks mentioned. Novak does work as an accountant, agent, adviser, writer, consultant, marketer, reviewer, endorser, producer, lead generator or referrer to other companies including the companies listed in the articles on this web site.