HRA or HSA?

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“These companies need to calculate the cost of not attracting potentially valuable candidates or losing employees who add the greatest value to the company. Those costs typically are measured in tens of thousands of dollars. The HRA vs. HSA decision should be made in this larger context.”

William G. (Bill) Stuart

Director of Strategy and Compliance

June 8, 2017

A growing number of employers are asking whether they should offer an HRA or an HSA in one of two contexts. First, should I introduce an HRA or an HSA program to help manage medical insurance costs? Second, should I transition from my current HRA program to an HSA offering?

It’s important to ask the right question and to answer it correctly. The answer could be worth tens or hundreds of thousands of dollars in the benefits budget and even more to the company’s bottom line.

For most employers, the proverbial horse has left the barn. No longer is a “first-dollar” (no deductible) plan a viable medical insurance option. These plans are largely extinct except within certain public employment populations and among employers in which benefits costs represent a small portion of total compensation.

First-dollar plans have two major flaws. First, the first dollars of insurance are the most expensive. In other words, nearly everyone incurs some medical expenses during the year. If insurance covers all expenses after, say, the first $500 or $1,000, the insurer processes no claims and reimburses no expenses for many individuals covered by those policies. By contrast, the administrative and reimbursement costs associated with being involved in every medical transaction dramatically increases costs.

Second, first-dollar plans increase utilization. We are all economists. We purchase goods and services when their value to us exceeds what we pay for them, whether the item is a flat-screen TV, a cup of clam chowder or a ticket to a sporting event. When a physician visit costs us $25 in a first-dollar plan vs. $157 in a deductible plan, we value that visit differently. We may self-medicate, engage a physician through a telephone program (at perhaps a $42 cost), visit a retail clinic (at perhaps an $89 cost) or pay the $157 to see a physician. Regardless of what we ultimately do, we are more engaged when we are responsible for paying the full cost – rather than a fixed copay – for the service.

Advantages of an HRA Program

HRAs remain the primary reimbursement program in New England, despite the dramatic rise of HSA programs nationally. An HRA is a notional account – in effect, an IOU that an employer promises to pay to employees if they incur eligible medical expenses. Employers typically cite the following reasons for choosing to offer an HRA program:

First, employers reimburse claims only as they’re incurred. Many individuals incur no claims, which means that employers don’t pay any reimbursements. In fact, in a typical HRA program, employers reimburse anywhere from 20% to 40% of their total potential liability, depending on their medical and HRA plan designs and general health of their employees and dependents. A program that promises to pay a dollar but actually satisfies its obligations with a payment of perhaps 35 cents is an attractive option for employers. And it’s attractive to employees as well, since it reimburses all the expenses that the plan promises to cover.

Second, employers can design the program. They determine the dollar limit on their reimbursement, which expenses are covered by the HRA, payment order (whether the employee or the HRA pays the first dollars of eligible expenses), whether to allow carryover of unused funds and limits on the amount of carryover. With this degree of flexibility, employers can design a program that meets their financial and employee-satisfaction goals.

Third, HRA programs are easy to understand and implement. They can work with any medical insurance plan (although insurers may impose certain restrictions). Employees don’t need to meet special eligibility requirements to participate, as they do with HSAs. Employees don’t need to manage their accounts to receive reimbursements if the insurer sends eligible claims electronically to the administrator. The program works automatically behind the scenes when the administrator is integrated with the insurer, which makes an HRA program attractive when employees have limited financial savvy or language barriers.

Advantages of an HSA Program

An HSA is a personal financial account owned by individual employees who meet federal eligibility requirements to open and contribute to an account. Employees are responsible for managing the account to ensure that they’re eligible to participate, don’t contribute in excess of statutory limits and understand when an expense is eligible for tax-free distribution. Employers who have introduced an HSA program often cite these reasons:

First, an HSA program shifts responsibility from the employer to the employee. An HSA program isn’t an employer-sponsored plan, so much of the compliance responsibility that an employer assumes for the medical plan and HRA moves to the employee.

Second, an HSA program empowers employees. Employees determine how much they want to reduce their taxable income by contributing to their HSAs. Employees decide how much medical equity to build in their HSAs through a combination of contributions and distributions. Employees saving for retirement choose the right proportion of total contributions into an HSA and qualified retirement account.

Third, the underlying medical plan typically has a lower premium than other coverage with similar deductibles because more services are subject to deductible on an HSA-qualified medical plan. The lower premium gives employers the flexibility to share savings in the form of employer contributions to employees’ HSAs.

Offering Both Options

Some employers choose not to make this decision by offering both programs. In this model, the value of the HRA is generally higher than the employer contribution to an HSA, since the employer often pays less than 40 cents for each dollar of promised reimbursement through an HRA but must pay employer contributions to HSAs in cash (one dollar equals one dollar, not 60 cents or less).

In this model, the employer may offer a medical plan with a $1,500 deductible and an HRA that reimburses the second $750 of that deductible, leaving employees responsible for the first $750 of covered expenses. The HSA plan may have a $2,000 deductible with a $500 employer contribution and $250 in employee premium savings, with employees’ enjoying additional tax savings of between $300 and $800 (depending on their tax rates) with a $2,000 employee contribution to the HSA.

Employees with high medical expenses, poor budgeting skills, limited time and financial skills or a focus on the present gravitate toward the HRA, since it leaves them with a net deductible responsibility of $750. By contrast, employees with low medical expenses, a long-term vision of building medical equity and a desire to actively manage their tax liability gravitate toward the HSA program.

For employees, having two options is ideal. Because each employee has different medical and financial conditions, needs and goals, having choices allows more of them to be satisfied with an employer solution.

Choosing One Approach or the Other

Employers who want to adopt one program or the other, seek to consolidate from two programs to one or are thinking about transitioning from HRA to HSA must ask themselves the following practical questions to arrive at the right decision:

  1. What can the company afford? When asked properly, this question transcends merely the company’s benefit budget. The benefits budget shouldn’t drive the process, especially for companies that rely heavily on human capital (their employees’ knowledge) to achieve results. These companies need to calculate the cost of not attracting potentially valuable candidates or losing employees who add the greatest value to the company. Those costs typically are measured in tens of thousands of dollars. The HRA vs. HSA decision should be made in this larger context.
  1. What do my employees value, and what can they handle? If your work force is younger, smarter, more highly compensated and more financially savvy than the population as a whole, your employees probably can handle managing an HSA and would benefit from realizing immediate tax savings and accumulating long-term medical equity. On the other hand, if machines add more value than workers, your employees have language barriers, they lack financial skills or they’re higher utilizers, an HRA may work best because an HRA program integrated with an insurer works behind the scenes with little or no direct employee involvement.
  1. What behavior do I want to incent? Employees with a $1,500 deductible and a $750 HRA – money that can be applied to only eligible medical expenses – behave as though they have a $750 deductible. And for all practical purposes they do. The same employees with a $1,500 deductible and a $500 employer contribution to an HSA behave like they have a $1,500 deductible and are more prudent spending the first dollars of coverage, which can help reduce future premium increases. Unlike HRA participants, whose reimbursement is an IOU that they can cash only with qualifying expenses that year, HSA owners receive a cash contribution whether they incur expenses or not. Those funds, if unused, roll over for use in the future. Thus, an employee who spends that $500 employer contribution is reducing a personal asset by $500 – and that’s usually enough money to grab employees’ attention.
  1. What’s my long-term strategy?  Where do you want your benefits program to be in five years? The answer is important. An HRA offers financial advantages to an employer (pays a fraction of every dollar promised, can be designed around certain parameters to manage costs), but it’s a fund that must be replenished each year. If an employer’s goal is to wean employees off company reimbursement funds, it’s not the right approach long-term. By contrast, an employer can encourage employees to fund their HSAs through negative elections (automatically making deductions from employees’ paychecks that employees can alter but often don’t) or matching contributions. These steps increase employee contributions, which may allow employers to  gradually reduce or eliminate their contribution entirely.
  1. What level of resources can I commit to the program? An HRA program integrated with an insurer runs itself. The insurer sends eligibility and claims files (typically weekly), and the administrator processes the files and issues reimbursements when appropriate. There’s little for a benefits manager to explain to employees beyond the basic mechanics of the program. By contrast, an HSA program requires HR staff knowledge and work, particularly during the introduction phase. A chronically short-staffed benefits department may be challenged to deliver the training necessary to launch an HSA program.

Some health-care reform proposals have advocated eliminating Health FSAs, HRAs and HSAs and replacing them with a single account that combines features of all three programs. Others have proposed building reform around free-market principles that leverage HSAs for everyone. Still others have floated the idea of a Roth HSA that allows individuals, regardless of their underlying medical plan, to contribute post-tax dollars into an account that grows tax-free and from which owners can make tax-free distributions for eligible expenses.

I sit on the American Bankers Association HSA Council, an educational and advocacy trade group that represents administrators of more than 80% of the 20 million active HSAs. We’ve consistently opposed these efforts. While we understand and appreciate the value of HSAs and advocate on behalf of HSA owners to support legislative and regulatory changes to strengthen HSAs, we also understand that different employers and employees have different needs. Creating a one-size-fits-all approach to tax-advantaged medical reimbursement removes tools that better fit certain employers’ and employees’ needs.

More choice is better than less. In all other aspects of our lives, we make the right choices only when we access the right information and ask the right questions to identify the solution that works best for us. The same holds for HRAs and HSAs. Each has its place. And in some cases, both have their place for a single employer (offering a medical plan with an HRA and another with an HSA program) or within a single medical plan (higher medical deductible with a Post-Deductible HRA and an HSA).

Employers need to review their situations annually, working with their benefits advisors and a trusted administrator like Benefit Strategies, to ensure that their current solution remains the best approach moving forward. As the world and their industries change, so might their optimal combination of medical plan and account.

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Despite failed efforts in Vermont (scrapped after the estimated new taxes were too difficult to swallow) and Colorado (rejected by a 4:1 margin in a state that overwhelmingly elected Democrats in November 2016), the single-payer movement is alive and well. The California legislature is proposing a state-run system that covers all residents with open networks, no premiums and no cost-sharing at a cost between $300 billion and $400 billion. The plan is a step backwards, according to this report. More globally, the CEO of medical insurer Aetna says it’s time to have a discussion about single payer, while others say we’ve had that discussion and it has been rejected consistently.

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