New Alphabet Soup Spells Opportunity For Creative Benefits Advisors

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In 1973, Congress ushered in the Age of Managed Care by passing the Health Maintenance Organization Act. That bill also spawned the term HMO and a whole glossary of well-known acronyms for health plans.

Recent regulatory and legislative changes have generated yet another novel lexicon, and a new Consumer Era in health care, by introducing health reimbursement arrangements and health spending accounts.

Employers and benefits managers may be able to use HRAs, HSAs and the more traditional flexible spending accounts to lower benefits costs without reducing employees take-home pay.

The oldest of the 3 options, the FSA, is defined under Section 125 of the Internal Revenue Code. Employees usually fund FSAs using pretax dollars to pay for predictable health care costs, as described in IRC Section 213(d). Employers also gain from FSAs, because employee contributions lower the payroll base and reduce payroll taxes.

FSA rules are continuing to evolve. One recent regulatory change lets employees use FSAs to pay for over-the-counter drugs. But the tax code still imposes the infamous use it or lose it provision, which mandates forfeiture of unused funds at the end of the year. This provision may be the reason that fewer than 10% of eligible employees enroll in a typical FSA program, even though studies have shown that as many as 40% to 50% of employees who qualify would benefit from participating in the plan.

The second Consumer Era health account option is the HRA, defined by IRS Revenue Ruling 2002-41, IRS Notice 2002-45, and various other sections of the IRC. HRAs must be employer-funded and can be used only for allowable expenses, as stated in Section 213(d). Unused funds are rolled over into the following year.

HRAs are the most common form of consumer directed health plans. However, growth in HRAs has been modest, probably because the accounts are not portable and the government requires that employers provide all funding.

The third Consumer Era health account option is the new HSA, a portable creation of the recently passed Medicare Prescription Drug, Improvement and Modernization Act of 2003.

Unlike funds in an FSA, unspent balances in an HSA are rolled over at the end of the year. Account holders can invest the funds in a trust that grows with interest. In addition, HSA funding options are more flexible than HRA funding options, because contributions can come from employees, employers or both.

One requirement that may limit use of the HSA is the provision that it only can be used with a medical plan with an individual deductible of $1,000 minimum and a family deductible of at least $2,000.

Combining FSAs, HRAs, HSAs and health insurance can create new benefit options. One popular strategy is to utilize a lean, high-deductible health plan with an HRA program that employees can use to defray some of the cost of the deductible. The addition of HSAs creates a number of new combinations that are worth exploring.

Pending final IRS regulations, an employee could use an HSA to supplement both a carefully designed FSA (which is best suited to covering predictable expenses) and an HRA (which might contain too little cash to cover all expenses). If the HRA limited allowable expenses by excluding reimbursement for eyeglasses and OTC drugs, then the employee would have the alternative of using an FSA to pay for such items. Because an HSA is a portable, invested account, it is well suited to saving for COBRA expenses and retiree medical costs.

Employers that make creative use of the new programs can use tax savings to soften the impact of sharing a higher percentage of health care costs with their employees.

Assume, for example, that Joe Employees FICA, state taxes and federal taxes total 33% of his compensation, and he purchases all his health benefits with after-tax dollars. If Joe shares 20% of his employers health plan costs, helping him pay with pretax dollars could mean he takes home the same level of salary while increasing his contribution of health coverage costs to 30%.

Adding debit card technology can make use of multiple accounts and high-deductible insurance much more palatable for the average consumer, by removing the burden of submitting paper reimbursement forms and eliminating the need to write checks for large medical expenses.

Of course, employers that are pushing their employees toward greater consumerism will need to provide more information to help their employees make rational decisions. So what advice can a benefits advisor have for employers? Here are 3 suggestions.

1. Explain what you are trying to accomplish.

This goes beyond simply saying that the employer wants employees to buy the highest possible quality of care at the lowest possible price. The employer needs to show employees how available programs can help them reach their own goals.

2. Explain the options in plain language.

If the options include FSAs, HRAs and HSAs, an employer should provide examples that illustrate how employees in certain situations can accomplish a variety of objectives, such as funding current medical costs or saving for retiree medical costs.

3. Help employees estimate the cost of various options and help them model ways of paying for medical expenses.

Employees did not need formal decision support tools when the employer covered almost all of the health care costs. Now, as we move from that approach into the new Consumer Era, consumers are shouldering more expenses and require more sophisticated educational planning tools–if they are to spend wisely.

CDHPs have introduced decision-making tools for enrollees, but pre-enrollment decision support tools are not yet widely used. Some large companies have started offering rudimentary enrollment decision support materials, but these are not being used and promoted to the extent that they need to be if the new, complex combinations of programs are going to work.

Companies should include educational and analytical tools in their enrollment communications strategy. The cost of these materials is a small fraction of the savings that a well-designed, consumer-centered program might achieve, and skimping on analytical support will cripple the programs, because employees make their funding decisions before they enroll.

is a Fellow of the Society of Actuaries and a consulting actuary in the Hartford office of Milliman USA. He can be reached at steve.kaczmarek@milliman.com.


Reproduced from National Underwriter Life & Health/Financial Services Edition, February 6, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.