Commentary HRAs as an Answer to Rising Premiums

Employers who are hard-pressed to maintain a comprehensive health benefits program should not despair. There are ways of providing significant help to your employees—at a price you can afford.

    Though the current hysteria over the uninsured population is overblown—the percentage of uninsured Americans in 2005 of 15.9 percent is lower than the 1998 rate of 16.3 percent—that number is small comfort to an employer who is facing double-digit premium increases for health coverage.

    There are things an employer can do short of dropping coverage altogether. In fact, since the Internal Revenue Service issued its guidance on health reimbursement arrangements in June of 2002, there is a ready-made vehicle for switching to a defined-contribution approach to health care.

    The IRS has said that an employer may contribute any amount of money to an HRA, regardless of the kind of insurance plan it has. An employer may contribute $100 a year or $5,000 annually. It may contribute that money whether it has HMO coverage, high-deductible coverage or no coverage at all. The employee may then take that money and spend it on any Section 213-d eligible expense, which means just about anything that can be considered health care, including health insurance premiums.

    The only restrictions on an HRA are that the funds must come solely from the employer. An employee may not contribute any tax-free money. And the money may be spent solely on health care. It may never be cashed out.

    As long as those conditions are met, there is total flexibility in how the program can be set up. The contributions may be “notional,” meaning not pre-funded, but merely carried on the books as a future obligation, or it may be pre-funded. But in either case, the employer may not take a deduction until the funds are actually spent on a health care service. The employer may allow the whole unspent amount, or only a portion of it, to be rolled over into the next year. The employer may allow the funds to be spent on any 213-d qualified expense, or only certain expenses, such as deductibles and co-pays for covered services.

    However it is set up, the HRA is considered an “employee welfare benefit plan” under the Employee Retirement Income Security Act. That means it is subject to COBRA continuation rules and HIPAA nondiscrimination rules. The company cannot contribute more to “highly compensated” employees than to others, and a company with 20 or more employees must allow workers who leave the company to continue their coverage in accordance with the usual COBRA requirements (they must pay 102 percent of the employer’s cost, for instance).

    So, how does this help an employer who is facing substantial premium increases? Such an employer might decide to take the funds it has been contributing to health insurance premiums (say, $3,000 per worker per year), and put that money into an HRA instead. The worker would then have $3,000 in tax-free cash to spend on health care—and on health care only. Some employees might use that $3,000 to pay for coverage as a dependent on a spouse’s policy.

    Others might use the money to pay their out-of-pocket responsibility with a low-cost insurance plan they have bought on the individual market—say, one that doesn’t cover maternity or prescription drugs, or one that has “ridered out” certain conditions. Some might even “go bare” and use the $3,000 to pay directly for services as they are incurred, and let the balance build up to pay for more serious events in the future.

    Workers would be free to use the funds in any way that suits their family situation, and the employer’s responsibility ends with the HRA itself. In the following year, the employer would once again calculate what it can afford to spend on health care. Maybe business has been good and the contribution can be upped to $3,200, or maybe business has been not so good and the second year’s contribution needs to be scaled back. In either case, the employer sends out an announcement: “This year we have contributed $X,XXX to your HRA. If you didn’t spend all of the funds from last year, you may add them to the new balance.”

    In many states, employees may use the HRA funds to pay for individual coverage premiums. But some states have resisted that use of the money.

    The Texas Department of Insurance, for instance, issued a bulletin in August 2006, warning insurance companies that they might be violating Texas regulations if they accept premium payments from individuals using HRA funds. It is not clear how many states share the Texas interpretation, and some federal officials believe it will eventually be overturned by the courts. Also, employers are not subject to the jurisdiction of the Texas Department of Insurance, or any other insurance department, so need not fear any reprisals if an employee uses HRA money for that purpose.

    Meanwhile, HRAs are an important alternative for employers who find it difficult to keep up with constant increases in their health insurance premiums.