Controlling Health Insurance Premiums with FSA, HRA, HSA Plans

Employers have a variety of options on healthcare plans that can lower costs.

Health insurance costs are rising much faster than inflation. But what can manufacturers do about it? One idea that seems to be working is giving employees "ownership" in their health plans. A big problem is that employees are disconnected from the cost of healthcare. For instance, when asked in surveys, a surprising number of people think the doctor only receives their health plan's co-pay amount, $10 or $20!

This misperception leads employees to think, "I've already paid for my health care via these premiums, so I want to get the most I can out of the plan." The result of this thinking leads to wasteful use of healthcare services and rapidly escalating costs.

But durable medical equipment, such as crutches, wheelchairs and the like, has averaged less than 5% inflation over the last 20 years. In October, the Department of Labor announced that the inflation rate for prescription drugs had dropped to 1%.

Not coincidentally, in both categories consumers pay a larger share of costs than in other healthcare expenses. Durable medical equipment benefit is usually limited to some relatively small amount ($750-$1,500 maximum benefit) with the insured paying the rest. And often the insured shares in the initial cost, too.

Prescription cost-sharing has changed in the last ten years. Not long ago most drug plans required only a $5 or $10 co-pay for all drugs. And drug inflation reflected that disconnect, reaching a high of 22% per year. But in the last half dozen years most health plans have changed to a three-tier drug co-pay plan: $10 for generic drugs, $25 for "approved" brand-name drugs and $45 for non-approved drugs.

To break the disconnect, smart employers are using supplemental plans: Flexible Spending Accounts (FSAs), Health Reimbursement Arrangements (HRAs) and Health Savings Accounts (HSAs). Each offers tax breaks to employer and employee alike, and each gives employees ownership of the results of their spending decisions. Frugality reduces costs; profligacy increases them.

FSAs

The employee deposits money into the FSA account on a paycheck-by-paycheck basis. The money in the plan can be used for a huge variety of health-related costs. The employee's contribution is tax-deductible, and the withdrawal is income-tax free if used for medical expenses.

There are, however, three problems. First, if the employee doesn't use it, any money remaining at the end of the plan year is forfeited to the employer. Second, if an employee puts $100 per month into the FSA and incurs a $1,200 expense in the first month, the employer must advance the money.

But the biggest problem is that the FSA is usually offered in addition to the traditional health plan, so it's mostly used for "fringe" expenses -- eyeglasses, over-the-counter medicines, etc. -- that aren't covered by the health plan. So it has no effect on the cost of the company health plan.

HRAs

With an HRA the money is provided 100% by the employer, not the employee. The tax-deductible contributions can be spent on healthcare. Creatively used, it's an extremely effective tool, particularly for smaller employers. The employer can select a plan with a large deductible, slashing premiums, and establish an HRA to help cover the deductible. Hopefully, the lower premiums will offset reimbursed deductible costs.

The employer controls how the money is used. For example, the employer needn't ever vest the employee in any monies in the plan. The employer can choose whether or not to "roll over" money from year to year and can restrict the items on which employees can spend, thus focusing the savings on health-plan-related costs.

The HRA mainly benefits the employer via lower premiums on the underlying plan. But therein lies the HRA's primary disadvantage: without ownership of some kind, employees are less interested in spending money wisely. However, HRA money doesn't always cover the full deductible, so foolish spending means a penalty, but there's typically no economic carrot to go with the economic stick.

Nevertheless, an employer-specific plan HRA can be a powerful savings tool, particularly for companies with fewer than 100 employees.

HSAs

The newest option, the HSA offers the greatest potential combination of carrot and stick. It is the only triple-blessed tax vehicle; first, money deposited is deductible; second, it grows tax-free in the account; third it can be withdrawn income-tax-free for medical purposes, at any point in life.

The employer, the employee or both may contribute. All money accrues to employees, who can use it for healthcare. If they spend intelligently, they can retain it (carrot), but if they spend foolishly, they'll pay the cost (stick).

Lower premiums make contributions affordable. An HSA can only be sold in conjunction with a qualified "high-deductible health plan" -- nothing may be paid until the deductible is satisfied. High deductible means lower costs, and the savings can cover both employer and employee contributions.

Early experience is encouraging. Carriers are finding that employee health-system utilization is low enough to let them now aggressively lower rates. For instance, one carrier in Massachusetts just reduced premiums on HSA plans by 10% in the fourth quarter of 2007.

Find a broker who is knowledgeable, creative, and able to discuss the rewards and pitfalls of each of the plans. Then -- move ahead with a plan designed to meet the particular needs of your company.

Jim Edholm is President of Business Benefits Insurance (BBI), an employee benefits planning firm in Andover, Mass. He has worked with employers for more than 25 years and can be contacted at (978) 474-4730, via his website www.Group-Insurance-Guide.com, or via e-mail [email protected]

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