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Overview of Health Reimbursement Arrangements (HRA)
by Tony Novak, CPA, MBA, MT
revised on 10/12/2012
Note for 2014: I recommend a flexible benefit plan design that accommodates a combination of tax-free and after tax health benefits as allowed under the Affordable Care Act and prior law without the need to revise the benefit plan documents as tax regulations continue to evolve.
Healthcare Reimbursement Arrangements (HRAs) are often the most cost effective way for a small business to provide health benefits to employees. There are significant advantages to the business itself, the individual employees and the owner/employees. This article provides a brief overview of HRA plans and the pros and cons of switching to this type of health plan.
To better understand the issue, it helps to look at the current state of a typical small business health plan. See if this typical scenario sounds familiar:
The business buys group health insurance for its employees and pays most of the cost. It is an expensive benefit that is not fully appreciated by the employees. The employees complain about the portion of the premium that they must contribute. They often complain about the quality of the plan and the service provided by the insurer. Since the plan was picked by the employer, these is a sense of blame. The cost of this plan rose 14% last year and is expected to rise by 10% to 30% again this year, just as it has in most years in the past two decades. The cost is rising faster than any other business expense. Every year the business shops other health plans for a better deal. This is expensive, time-consuming and generates anxiety among the covered employees. It is difficult to properly budget for future years, since health plan cost increases vary widely and are difficult to predict.
FreedomBenefits.org offers small businesses with assistance in the design, documentation and setup of these plans. The typical charge is $75 to $150 for the smallest companies. Each additional employee adds about one hour of additional service work, mostly for communication about plan operations.
Now consider the same small business that switches to a Health Reimbursement Arrangement:
The business switches to an HRA plan that is designed to suit its own needs without the restrictions formerly imposed by the health insurance company. The HRA plan allocates a uniform $2000 for each employee. Additional health benefits are available to executives outside of the HRA. The maximum cost of the health benefit plan is known without any need for budgeting guesswork. Employees fully appreciate the value of “hard cash” now available to them. Employees may stay with their current health insurance plan or select any other health insurance plan that they like better. Some drop insurance completely or find that they can be covered under another available plan. Some find better and less expensive health coverage on the Internet. Other switch coverage simply to streamline their benefits to fit their own lifestyle expenditures. Employees like the fact that they are in total control of their health care money and that independent professional help is available if they have questions. Now that the employees have access to an independent benefits adviser there is no longer a need to rely on over-stressed health insurance company customer service department. Every medical expense is covered. No more out-of-pocket costs, co-pays or deductibles. The HRA offers 100% coverage up to the plan limit of all medical, dental, eye care, preventative expenses and alternate health care. No need to seek approval from a health insurance company. Treatment may be obtained with any medical provider without the need to worry about a PPO list. Unused benefits are carried over to the next year, providing an incentive to conserve as well as a built-in employment retention tool. Executives and owners may award themselves with full health coverage in addition to the $2000 HRA benefit. Budgeting is easy; the employer simply decides to boost the benefit to $2100 per employee next year. Everyone is happy.
Granted, this scenario is an oversimplification meant for the purpose of providing an overview of how HRA plans work. There are several potential disadvantages of a HRA plans that should be considered:
Some employees might not be able to afford the full cost of health insurance coverage with the amount of benefit offered by the HRA plan. In this case, the employer is free to supplement this cost for an important employee as a privately negotiated issue, separately and outside of the scope of the HRA in the same manner as a salary negotiation.
Some employees may take imprudent risks. For example, an employee might drop all health insurance in order to apply all HRA funds toward orthodontic expenses. The employer can require that employees maintain minimum health insurance as a condition of eligibility for HRA benefits.
HRAs are subject to the complex maze of state and federal employee benefit plan rules. Compliance is a simple task for an employer who uses a professional benefits adviser, but it is not realistic for a small business to remain legally compliant. Some advisers say that HRA plans require independent supervision to meet IRS requirements. The cost of professional assistance should be calculated into the decision to adapt a HRA plan, probably $500 to $1000 per year.
If the business has long term employees with carry-over balances in their HRA plan, this creates an unfunded liability account for the business. While it is great from a cash flow perspective, it could make the business owner or the bank nervous. A benefits adviser can easily show alternate funding methods to minimize this risk while not losing the tax advantages of health benefit plans.
Other HRA articles:
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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.