A June 2002 ruling by the Internal Revenue Service may boost sales of defined-contribution plans by health insurance companies, but it’s debatable whether the decision will slow spending on health services.
The ruling pertains to so-called “health reimbursement arrangements,” HRAs, through which employers contribute funds to employees to pay for health services or reimburse employees for medical expenses.
Up to now, employers have been reluctant to use HRAs because the IRS had taken no position as to whether employers may fund HRAs with pretax dollars, and had not given employers guidance on their use. “There was a cloud of uncertainty,” said Issaquah health policy expert Dr. Steve Barchet, former deputy surgeon general for the Navy.
“Cloud of Uncertainty” Gone
In a June 26, 2002 ruling, the IRS removed that cloud.
It’s now clear that employers may fund HRAs with money that’s not taxable; that employees may use the money to buy health insurance and medical services; that employees may carry over unspent HRA funds, free of taxes, to the following year; and that employees retain access to HRA funds when they change jobs or retire.
“This is a significant change,” said consultant Larry Chapman, chairman of Summex Corp. “We’re likely to see a very rapid expansion” of employer-sponsored health plans using HRAs.
Employers now can safely use HRAs in defined-contribution health plans, which are still relatively new to the market but are attracting interest in the business community as a way to control rapidly rising health care costs.
Characteristics of Defined-Contribution Plans
In a written summary and discussion of consumer-driven health plans, Barchet and Chapman identified the characteristics of defined-contribution plans, including the following:
- Employers make fixed-dollar contributions to employees to pay for health insurance.
- Employees are given choices among health plans that vary in deductibles, copayments, premium levels, and types (such as HMOs and preferred provider organizations).
- Employees pay the difference between employer contributions and the premium charged by the health plans they choose.
In Washington, two health insurance companies now market defined-contribution plans. Last year, in partnership with Portland-based MyHealthBank, Regence BlueShield introduced a product enabling employers to make defined contributions that employees use to pay for the Regence health plan of their choice.
Funds not spent on health insurance are placed in pretax, accruable accounts that employees may use to pay for deductibles, co-pays, eyeglasses, and orthodontics.
Regence officials said it’s too early to speculate on whether the IRS ruling on HRAs will boost sales of their product.
Last year, Aetna began marketing to large employers a consumer-directed plan, of which defined-contribution plans are a subset. In July 2002, the carrier followed up with a plan for midsize employers.
The product combines insurance for serious illnesses and high-cost medical expenses with a “health fund.” Into these health funds employers contribute $250 for individual employees and $1,000 for families. Employees control how these funds are spent on covered services.
Spending Control Mechanism?
In a July editorial, the Wall Street Journal waxed enthusiastic about the IRS ruling and said HRAs will help control health care spending. Barchet and others, however, question whether that will occur.
Barchet said that unlike medical savings accounts, HRA funds are owned by the employer, not by employees. Employers make the funds available to employees to pay for health insurance and medical services. And that may affect how much employees spend on health care.
By contrast, Barchet said, money in medical savings accounts belongs to the employees, who can withdraw the money for other uses provided they pay taxes on the withdrawals.
Medical savings accounts were authorized by the 1996 Health Insurance Portability and Accountability Act. But the number of MSA plans is capped at 750,000 nationally, and the act makes the plans available only to firms with fewer than 50 employees.
The cost-controlling effect of medical savings accounts is that employees know they’re spending their own money, according to Pat Rooney, former chairman of Golden Rule Insurance Co., a Lawrenceville, Illinois carrier that markets MSAs. The money goes with them they leave. Employees can use it for an extra pension benefit at retirement or can take it out as a rainy day fund by paying excise tax on early withdrawal.
Rooney predicts HRAs, by contrast, will neither increase employee satisfaction nor control costs.
“When insured persons have a fund that will pay their deductible for them,” he said, “they not only spend the money in the fund, but their consumption goes into the umbrella insurance that follows after the deductible, and cost of the umbrella insurance is increased by at least a third.”
Peter Neurath writes for the Puget Sound Business Journal, a newspaper belonging to American City Business Journal Inc. This article is reprinted from that publication with permission. Contact the author at [email protected].