By William G. (Bill) Stuart
Director of Strategy and Compliance
October 27, 2016
It’s a trick question. There is no clear answer. It’s like asking, “What’s a better vehicle – a pick-up truck or a compact sedan?” The answer in both cases depends on your current and projected needs, your budget and your preferences.
Defining the Terms
A Health Reimbursement Arrangement, or HRA, is an employer-funded supplemental health plan that companies integrate with a medical plan with high cost-sharing. The HRA reimburses a portion (or, in some extreme cases, all) of employees’ out-of-pocket medical expenses. The employer determines the funding level, expenses that the arrangement reimburses, whether the employee or the HRA pays the first dollars of expenses and whether to allow a rollover of unused funds. Because they’re health plans, HRAs are subject to the continuation of coverage rules under COBRA. HRAs remain very popular in the Northeast, particularly when compared to the rest of the country, though we’re seeing a definite shift from HRAs to Health Savings Accounts, or HSAs.
An HSA is a personal financial account that eligible employees establish, often with the help of their employer. Employers can make tax-free contributions and employees can reduce their taxable income with personal contributions to the account. An HSA isn’t a health plan, so the account itself and employer funding aren’t subject to COBRA continuation rules (though the underlying health plan usually is).
Employers have little design discretion other than the level and timing of employer funding. Employees with HSAs manage all distributions and report their activity on their personal income tax returns. Although HSAs are the dominant program outside the Northeast, only during the past two or three years have we seen a larger effort with mid-size and larger employers to offer an HSA program as one of two or three coverage options.
Advantages and disadvantages of an HRA
HRAs offer a number of advantages to employers:
- HRAs can be paired with any medical plan; there is no “HRA-qualified medical plan.”
- An HRA is merely an IOU; employers don’t have any financial liability until an employee incurs an eligible claim. Employers’ financial responsibility often is between 20% and 40% of the total value of all employees’ HRAs, with variation as a result of medical plan design, HRA design and overall medical utilization.
- Employers can design the program to meet their budgets and employee satisfaction goals. An HRA that reimburses the second half of the deductible, for example, typically costs the employer half the total outlay of an HRA that reimburses the first half of the deductible, since many employees incur few deductible expenses.
- With a claims feed directly from the insurer to the third-party administrator, employees can receive their reimbursements without filing any paperwork.
- A third-party administrator keeps the plan in compliance (including substantiation to ensure that all expenses reimbursed are eligible).
HRAs also have some limitations:
- They are a health plan, so employers must maintain a Summary Plan Document and other materials to remain in compliance with IRS regulations.
- Because they are a health plan, they’re subject to COBRA continuation, including proliferation of accounts. The employer can charge a premium to former employees who continue coverage through the HRA.
- HRAs don’t offer employees an opportunity to reduce their taxable income (though they can be paired with a Health FSA or, in some cases, an HSA to help employees manage their tax liability).
- Administration is costlier than an HSA. An administrator typically charges an annual fee to draft and review plan documents, set up the HRA in the administrator’s claims system, process claims and submit reimbursements.
Advantages and disadvantages of an HSA
HSAs offer a number of advantages to employers:
- Employer contributions are tax-deductible and employees enjoy triple-tax benefits with pre-tax contributions, tax-free growth and tax-free distributions for eligible expenses.
- Employees can build medical equity by building balances in their HSAs.
- Employees can vary their contributions during the year.
- HSAs aren’t a medical plan, so employer compliance issues are limited (primarily to employer and employee pre-tax contributions through a Section 125, or Cafeteria, Plan).
- All unused balances roll over automatically for employees’ future use.
- Employees can use funds to pay not only medical plan cost-sharing, but also certain medical services not covered by insurance, dental and vision expenses, certain OTC expenses and certain medical and long-term care insurance premiums.
- Fees are low because administration is simpler (no claims substantiation, accountholder-directed distributions) and no plan documents are required. Employers usually have the option to absorb the fees, and most do, though some administrators allow employers to shift that responsibility to employee accountholders.
HSAs also have some limitations:
- HSAs can be offered only in conjunction with an HSA-qualified medical plan.
- Employees enrolled in an HSA-qualified plan aren’t automatically eligible to open and contribute to an HSA. They must meet individual eligibility criteria to take advantage of the account itself.
- Unlike an HRA, when an employer’s pledge of a dollar of reimbursement usually results in less than (often much less than) 50 cents of actual liability, employer contributions to HSAs are in cash and vest immediately.
Why HSAs are gaining in popularity
While the Northeast still has more employees covered by HRAs than HSAs (in contrast to the rest of the country), we’re definitely seeing the tide turning in our primary region. The process has been slow, but it definitely has accelerated during the past two to three years. This increased adoption represents more strategic thinking on the part of employers (who are including an HSA plan among their benefit offerings) and employees (who are adopting HSAs in growing numbers).
What’s behind this accelerating growth?
- Many companies already offer plans with $2,000 or $3,000 deductibles for one-person coverage that aren’t HSA-qualified. They realize that by broadening the deductible to include physician visits, prescription drugs and any other services currently covered with a copay, they can offer employees an HSA program to help them offset this higher potential liability.
- Employers understand that they must fund an HRA each year. By contrast, they can provide some employer funding during the first several years of an HSA program and then reduce their contributions as employees have time to build their own balances.
- Millennials are the largest population of workers today, and they are looking for financial flexibility as they struggle to pay student loans, save for a home and meet family obligations. An HSA medical plan typically has lower premiums than a comparable plan, so they can build HSA balances to meet their projected expenses (using premium savings), then channel those savings into other financial priorities. The alternative is to pay higher premiums to insurers for services that they often don’t access.
- Employers are evolving in their beliefs around “rich benefits.” Even hospitals and institutions of higher education – which represent a disproportionate share of regional employment and traditionally have attracted and retained employees with generous benefit packages – understand that they can design a benefits program with an HSA-qualified plan and a generous employer contribution that makes the program more attractive to employees than “first-dollar” coverage plans.
- Many employees now grasp the concept of medical equity and comprehending the parallels between saving for retirement and saving for future medical expenses. They understand that a well constructed employer HSA program allows them to save on premiums and apply those dollars toward future medical costs.
- Rising medical costs are forcing more employers to offer medical plans with higher out-of-pocket costs. Switching to an HSA-qualified plan creates a “win-win” when employees have access to the tax advantages of an HSA.
The future of HSAs
It’s difficult to project the future of HSAs. Some trends clearly point to continued growth. Employers are increasing employees’ out-of-pocket costs (sometimes to reduce premiums and sometimes because carriers are cancelling lower out-of-pocket plans). As more individuals purchase insurance in the nongroup market, where they are responsible for the entire premium if they don’t qualify for advance premium tax credits (premium subsidies), they gravitate toward lower premium options like HSA-qualified plans. As more individuals become aware of HSA plans and the financial advantages of participating in an HSA program, enrollment increases as well. Several proposed bills before the US Congress are designed to make HSAs more attractive by increasing contribution limits, allowing more services to be covered outside the deductible, allowing certain other forms of coverage (like enrollment in Medicare Part A) without an individual losing HSA eligibility and even allowing a variation of an HSA that individuals can own and fund without being enrolled in an HSA-qualified plan and meeting HSA eligibility criteria. Read about one here.
At the same time, some trends are discouraging. Earlier this year, the Obama administration issued new guidelines for plans offered in the public marketplaces (public exchanges). The guidelines are voluntary in 2017 and mandatory in 2018, though many insurers are adopting them in 2017 to avoid reconfiguring plans again and disrupting enrollees. The new plan requirements rule out HSA-qualified plans by mandating cost-sharing that falls outside the legal parameters for HSA-qualified plans. And some critics object to HSAs because they put more power in the hands of consumers and less within the control of elected officials and public policy advocates.
While we’ve analyzed the HRA/HSA choice as an either/or proposition, the two plans can work in unison. Individuals who have access to reimbursement through a traditional HRA aren’t HSA-eligible, but an employer can pair a Post-Deductible HRA with an HSA-qualified plan in an arrangement under which employees can be HSA-eligible. We discussed this topic at length in our last blog, which you can read here.
What we’re reading
The Society for Human Resource Management wrote an article earlier this month about a webinar in which Jason Cook of WEX Health and I presented information to benefits advisors and employers about HSAs. You can read the article here, view and listen to the webinar here or access the slides only here.
Not tired of the election coverage yet? The Kaiser Family Foundation, a good source of information on health care, outlines the health care policy proposals of Mrs. Clinton and Mr. Trump here.