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Tony Novak, CPA, MBA, MT
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Consumer-driven health plans
An introduction for small business owners
by Tony Novak, CPA, MBA, MT
, revised 11/19/11
Employer-provided health plans have changed rapidly in the past few years. New tax rulings on health benefits plus technological advances in delivering health benefits combine to save money and improve the quality of benefits at almost all large companies today. In contrast, these sweeping changes that transformed health plans at larger firms have largely eluded small businesses. Most small firms are still struggling with the same problems they faced a decade ago – hyperinflation in health care costs and high ratio of employee complaints about unacceptable health insurance provisions. Relief is now in sight as today’s best consumer-driven health care plans are slowly filtering down to smaller firms.
There are three primary types1of employer-provided health plans: 1) group health insurance plans, 2) Health Reimbursement Arrangements (HRA), and 3) Flexible Spending Accounts (FSA). HRAs and FSAs are collectively called “consumer driven health plans”. This article summarizes the primary benefits and drawbacks of each type of plan.
Group health insurance plans
Group health insurance is the historic standard prior to implementation of health reform law in 2010. This category includes HMOs, Blue Cross plans and commercial group insurance plans2. Historically a small business employer shopped for the best health insurance plan available in the local market and left all of the other details up to the insurance company. The health insurance company determined which employees were eligible, what benefits were covered and the cost of those benefits. The primary advantage is that these plans are simple for the employer. The employer’s only responsibility is paying the monthly bill. On the downside, traditional group health insurance plans have the highest overall cost and the lowest employee satisfaction ratings. Employees are no longer willing to accept a “one size fits all” health plan selected by the employer and want more coverage for out-of-pocket expenses, well-care and preventative health care expenses. Small group health insurance is expected to be obsolete by 2014 because of federal health reform law
Health Reimbursement Arrangements (HRAs)
Health Reimbursement Arrangements allow the employer to determine the cost of health benefits that the business will provide and then leaves all of the other decisions to the individual employees. Each individual employee determines what benefits to provide with the amount budgeted by the employer. Of course, some insurance is necessary to protect from catastrophic losses and an employer may require that the employee elect at least a catastrophic insurance coverage as a condition of eligibility in the HRA plan. HRAs make a wider range of low cost health plans available to the individual employees than were formerly available to the employer so HRA plans are more effective in reducing the cost of health coverage because employees tend to select insurance that is much less expensive than traditional group insurance plans. This leaves the balance to be allocated as the employee wants – covering out-of-pocket, preventative and well-care expenses. Another big advantage of HRA plans is that they allow unused funds to be carried from year to year. This encourages conservation of funds at the consumer level, which in turn, helps further control health costs for the business.
The disadvantages of HRAs are that employee contributions are not allowed (all benefits must be employer-paid) and the administrative costs are higher.
In addition to deciding the amount of benefits to provide, the employer must also select an administrative firm to handle the direct contact and service for the employees. Federal laws make it too risky for an employer to handle administration of these plans in-house. HRAs cost more to administer than fully insured health plans. The HRA plan must also meet ERISA, HIPAA, and COBRA requirements by the IRS and Department of Labor. Employees typically need more assistance in selecting benefits because more options are available. Costs are reduced by using Internet-based services that offer online enrollment and claims processing. While the average traditional group health insurance plan charges about $25 per month in administration costs, a typical small business HRA plan costs about $60 per month.
Flexible Spending Accounts (FSA)
Flexible spending accounts offer all of the flexibility features of HRA plans but also allow employees to make voluntary contributions to their health benefits. FSAs often include benefits other than health plans that are not covered in this article4. The administrative cost and requirements are about the same as an HRA plan.
The primary disadvantage of an FSA plan is that funds may not be carried over from year to year. Unlike HRAs, an FSA cannot bank funds accumulated in good years to be used in future years with higher health care costs. This is known as the “use it or lose it” requirement. This requirement tends to result in wasteful spending at year-end.
The trends in health care are becoming increasingly clear to small business managers:
- Consumer-driven health care will ultimately prevail
- Insurance is out, pay-as-you-go is in5;
- Paper-pushing is out; Web-based service is in;
- Internet firms reduce cost and improve services for smaller firms.
Small firms that are able to incorporate these improvements will save money and improve the quality of their health benefits. The average small business should be considering a move to an HRA plan within the coming year and more progressive firms may wish to consider a more comprehensive FSA plan.
1 Other types of less popular health plans that cover less than a million people in the U.S. are not addressed in this article. Medical Savings Accounts and Health Savings Account plans are omitted from discussion.
2The IRS treats health benefits for owner/employees differently than other employees. State insurance regulations and specific health insurance plans may also apply different standards. These differences are not covered in this article. The comments in this article apply to health plans for regular employees who do not have a substantial ownership interest in the business. A separate article titled “HRA Plans Benefit Owner/Employees”at www.tonynovak.com addresses some of these issues.
3 Details of HRA plan tax treatment were clarified byIRS Revenue Ruling 2002-45 in May 2002, IRS Revenue Ruling 2003-43 in July 2003 that clarified the use of debit cards for health expenses and IRS Revenue Ruling 2003-45 that authorized coverage of over- the-counter medications and other health-related expenses. IRS Publication 502 issued in November 2003 details the generally more liberal treatment for 2004.
4FSAs typically include other tax-free benefits including dependent care, life insurance, education, and retirement planning. FSAs may also include other taxable benefits offered on a group basis.
5 An article titled “Comparing Health Discount Plans” at www.tonynovak.comaddresses the advantages and disadvantages of pay-as-you-go health plans.
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