This is the second of three posts on the primary consumer-driven health care arrangements under the current Internal Revenue Code.
The first post on consumer-driven health care discussed the health FSA, a useful but ultimately flawed vehicle hampered primarily by the use-it-or-lose it rule and ObamaCare limits. This post discusses the HRA, a more dynamic arrangement that can be used in many creative and powerful ways - pending a number of ObamaCare changes that will dramatically limit the HRA’s versatility.
As stated in the first post, the ideal consumer-driven health care vehicle should strive to achieve three main objectives:
- Provide incentive for the individual to spend less on health expenses;
- Maximize the individual’s flexibility in contributions and ownership of all assets contributed; and
- Limit the individual’s financial exposure by including an out-of-pocket maximum
What is an HRA?
A health reimbursement arrangement (HRA) is a creature of Sections 105 and 106 of the Internal Revenue Code. It’s an entirely employer funded account used to pay for health care expenses on a tax-free basis. Employers can structure HRAs to offer many benefits, including:
- Direct reimbursement for medical expenses as the primary form of health coverage;
- A way to pay for deductibles and other out-of-pocket expenses from major medical coverage;
- As an account to pay for the premiums for major medical coverage; or
- Any combination of those purposes
This versatility, as well as a few other key advantages over the health FSA, have made the HRA a commonly used employer-sponsored plan since 2002 when IRS guidance first blessed the HRA concept.
- HRAs are not bound by the use-it-or-lose-it rule. Any funds remaining in the account at the end of the year can carry over to the next year. This eliminates the health FSA’s perverse incentive to increase health expenditures at the end of the year to drain an underspent account.
- It’s essentially the only consumer-driver vehicle that you can use to pay premiums for major medical coverage. This approach can be used to combine the defined-contribution aspect of an HRA account balance with the financial exposure limits of an insurance policy - and in a manner that promotes market-based coverage decisions
- HRAs can also be used as a method of funding the deductible for a high deductible health plan (HDHP). Although I think the health savings account (HSA) is superior for this purpose, the HRA has the advantage of not limiting participants to the strict HSA eligibility rules
- The reimbursements for qualifying medical expenses are not taxed
- Most Section 213(d) medical expenses for you, your spouse, and your dependents qualify for reimbursement
- There are no contribution limits
- Employees cannot contribute to an HRA. Contributions are controlled entirely by the employer.
- Employer contributions for any employee benefit are best described as an involuntary employee contribution. HRA contributions are part of an employee’s total compensation that employees cannot choose to receive in cash. The goal should always be to empower individuals to choose exactly how to receive all forms of income.
- There are no cash outs permitted of unused HRA funds. This isn’t a problematic as with the health FSA because there’s no use-it-or-lose it rule (i.e., unused funds can carry over to subsequent plan years). But the incentive to to limit health expenses would be stronger if the employee could receive cash for unused amounts (as with HSAs).
- It’s generally only portable through COBRA, which doesn’t apply well to HRAs, or an optional post-termination spend-down provision.
- Because of DOMA, expenses incurred by a same-sex spouse or domestic partner usually are not reimbursable.
- As with health FSAs, Obamacare now prohibits HRAs from reimbursing over-the-counter medicines or drugs (other than insulin) without a prescription.
- More importantly, stand-alone HRAs for active employees are nearing their end of days. Obamacare prohibits lifetime and annual limits on the dollar value of “essential health benefits.” HHS waived the requirement for HRAs, but the waiver program lasts only until 2014. As of 2014, HRAs will have to be integrated with other major medical coverage or just for retirees to comply with these and other Obamacare rules.
The Bottom Line
HRAs are far from perfect, particularly because they are limited to employer contributions. But HRAs do offer far more flexibility than any other form of consumer-driven health care. That flexibility allows employers to be creative in the design and use of HRAs in a manner that can be both innovative and market-based. Unfortunately, the freedom to tailor an HRA design to the employer’s overall benefits strategy will largely disappear come 2014. It’s yet another reminder that we need to refocus on the landscape of consumer-driven health care before we start to lose the concept entirely under the upcoming full implementation of Obamacare.