Healthcare Reimbursement Arrangements for Small Businesses

It is no secret that healthcare expenses are a top concern for businesses of all sizes – but smaller businesses in particular.  With double digit increases in premiums the norm, employers are spending more each year while employee are irate because their share of the cost is increasing.  

One of the reasons behind increasing premiums is that employees are often not responsible for actual healthcare costs other than a $10-20 co-payment and are not very prudent when making healthcare choices.  Now there is an alternative that makes employees more responsible and brings down the cost for employers.

Healthcare Reimbursement Arrangements (HRAs) have emerged as one of the best ways for a smaller business to provide healthcare benefits to employees.  Small business owners and their advisers are beginning to understand and embrace the advantages of this new type of health plan authorized by the IRS in 2002.

An HRA is a type of tax-qualified employee benefit plan just like a 401(k) plan or Section 125 Cafeteria Plan, sanctioned by the IRS as an approved method of providing tax-free benefits to employees.  With an HRA, an employer allocates a fixed dollar amount to reimburse each eligible employee for healthcare related expenses.  In addition, the employer offers a high deductible health plan (premiums could be paid by the employer or employee out of their HRA allocation).  Since employees now have a finite sum of allocated dollars, they are likely to be more prudent when incurring healthcare expenses. 

Switching from a traditional "defined benefit" type small business health plan to a "defined contribution" HRA plan is easy once there is a clear understanding of the objectives and mechanical procedures.  Let’s consider a small business that chooses an HRA:

The business chooses an HRA plan that is designed to suit its own needs without the restrictions imposed by traditional healthcare plans. The HRA plan allocates a uniform $2000 for each employee (although an employer can allocate any amount and can allocate different amounts to different employee groups such as individuals and families) to be used for any allowable healthcare expense.  HRA funds received by the employees are tax-free and tax deductible by the company.  Suddenly there is a huge incentive for employees to make more diligent healthcare purchase decisions and conserve unused funds.  HRAs allow flexibility in providing additional health benefits to select employees. 

HRAs are usually combined with high-deductible health insurance that is priced at about half the cost of traditional health plans. Small healthcare costs paid directly to a medical provider through an HRA plan avoid the overhead expense that makes up $0.30 of every dollar handled by traditional health insurance plans. At the same time, these smaller out-of-pocket expenses paid with pre-tax dollars save wage taxes for both the employer and the employee. Together these can add up to an expected savings of more than $600 per employee per year when a business switches to an HRA.

Some of the benefits to the employee:

• No more out-of-pocket deductibles and co-pays
• HRAs cover expense not typically covered like vision and dental
• Employees have more flexibility in choosing health care providers
• Depending on employer chosen options, employees can roll funds in the future years

The transition procedure to an HRA is simple.  The business adopts a written benefit plan, communicates it to the employees and then adjusts its internal accounting to comply with the provisions of the new benefit plan.  While businesses are free to administer the plans themselves, most employers prefer to utilize an administrator.  While many in the industry cite yearly estimates of $100 per employee, many small businesses have found that their HRA administration costs are about $1000 for the year, and some companies find that their costs are much below that. 

Other things to note and/or consider:

• Will the amount to be allocated to each employee, the administrative costs, and the premium for the high deductible plan be more or less than what the employer is currently paying?
• HRAs are subject to the maze of state and federal employee benefit plan rules including those imposed by IRS, the Department of Labor as well as state labor and insurance laws. Normally, HRA funds are treated as non-wage expenses and are not subject to wage taxes. A poorly-designed or poorly-managed HRA plan could lose its tax-free status and create retroactive taxes and penalties.
• With an HRA, the employer has many options including whether or not to carry over unused balances.  If an employer allows employees to carry over balances, those balances could be significant.
• HRAs do not address the underlying issue of healthcare inflation which is expected to outpace cost increases in all other sectors of the economy.  While HRA plans improve the efficiency of funds applied toward payment of healthcare expenses, an HRA plan that does not increase employer contributions over time at a pace equal to the rate of healthcare inflation will eventually lead to a reduction in the level of healthcare provided to the participants.
• When setting up an HRA, keep in mind that in rare instances there can be difficult cash flow burdens on a company.  Make sure your HRA advisor discuss those instances with you before you make the plunge.

There are many more options to tailor an HRA to best fit your goals and resources.  For more information see http://www.hrahelper.com/ and http://freedombenefits.org/HRA.htm.