HSA or HRA: Which is better for your company, employees?

On Oct.1, 2004, the much anticipated Health Savings Account (HSA) product became available to the small group market (with 50 or less employees). With tax advantaged cash accounts that can be tapped to pay for a wide range of medical expenses not covered by insurance, HSAs are a welcome addition to an environment where employers are rapidly shifting to policies that feature high deductibles in an effort to contain premium increases.

But despite many desirable features, HSAs won't work for everyone. Some employers will find that the cost of making high out-of-pocket HSA plans palatable to employees prohibitive. In those cases, employers should consider establishing a Health Reimbursement Arrangement (HRA) as a way to allow them to achieve many of the same objectives, but at a lower cost.

Authorized by Medicare reform legislation that passed in December 2003, HSA "qualified" insurance policies must meet statutory guidelines for deductibles and out-of-pocket amounts. Minimum deductibles for individuals are $1,000 and $2,000 for families. Maximum deductibles are, respectively, $5,000 and $10,000, as are out-of-pocket maximums. If a policy has the same deductible and out-of-pocket maximum, it provides 100 percent coverage after the deductible.

Annual contribution limits to the savings accounts are capped at either the insurance policy deductible or $2,600 for individuals and $5,150 for families -- whichever amount is less. Going forward, deductible and contribution limits are indexed to inflation.

Contributions to savings accounts can come from employees, employers or both. Employer contributions must be comparable for similar persons (example: single vs. family coverage). Interest earnings are tax-free, as are withdrawals, either before or after retirement, when used to pay for a wide range of medical expenses . Employees own the accounts from the outset; there are no "vesting" rules for employer contributions. So, when an employee leaves, the money goes with him. The accounts roll over from year to year without limit and, at age 59 1/2, can be used for retirement income, subject to ordinary income taxation.

Clearly, Congress got a lot of things right when it did HSAs. Most importantly, the incentives: it won't take employees long to figure out they will have more money in their HSA now and at retirement by striving to be healthy, cost conscious consumers. And millions of penny-pinching consumers are more likely to get a handle on runaway health care costs than even a small army of HMO or government bureaucrats.

But despite these favorable attributes, the dilemma created by HSAs for employers quickly becomes apparent when they sit down and begin poring over the cost/benefit spreadsheets now being produced by brokers.

The only way to hold premiums down to a reasonable level is to adopt a plan with a relatively high out-of-pocket exposure for employees. And how do employees usually react to policies where their costs can run as high as $5,000 for an individual and $10,000 for a family? Panic and disdain are words that come quickly to mind.

Yes, the employer can counter by lowering the deductible or contributing to the employees' savings accounts. But both approaches get expensive quickly -- the former because richer policies always cost more, and the latter because employer contributions can't be targeted only at workers who have medical expenses , but must be comparable for all employees. Nor can many employers realistically expect employees to make substantial contributions to their savings accounts when they are already hard-pressed to pay their share of policy premiums.

  Find an HSA plan that's right for you.

And this is where a Health Reimbursement Arrangement may come in. HRAs are employer-sponsored plans that permit companies to reimburse employees for a wide range of medical expenses . Like HSAs, HRAs are tax free and work best with relatively affordable, high-deductible insurance policies.

But HRAs also differ from HSAs in important respects. First, since only employer money is used to fund the plans, employers are granted considerable leeway in how they define the medical claims that will be reimbursed. The HRA can specify that only certain types and amounts of expenses will be eligible for payment. Thus, on top of an insurance policy with $10,000 deductible, the employer can agree to cover hospital expenses above $5,000 until the policy kicks in. Note that the employer only has to pay the claim if it's actually incurred. Compare this to pre-funded HSA accounts, where the employer, if he elects to make a contribution, must make comparable contributions to all employee accounts, regardless of whether employees ever incur a claim. Thus, it may be significantly less expensive for an employer to make a high-deductible insurance policy attractive to employees with an HRA than with an HSA.

But, despite these advantages, HRAs, like HSAs, aren't always appropriate. First, since they are basically a form of employer self-funding, they should be reviewed cautiously because of the inherent risk, especially when the employer is aware that his group has a number of significant, ongoing health conditions. Nor should HRAs be seen as a great vehicle for health care cost containment; employees get a benefit only by spending money, nor can employees look forward to having more money for retirement if they are prudent health care consumers because the employer, not they, own the accounts.

With the move of HSAs from the ivory tower to the street, employers have an important new tool at their disposal in the neverending struggle to slow health care inflation.

As employers and their workers become accustomed to this new vehicle, it should be widely adopted. But as was the case with 401(k) s, the adoption process will take time. Nor will HSAs be right for everyone; for those for whom it's not a good fit, HRAs are an option worth exploring.

Spencer Swalm, a principal with Redstone Benefit System, is an employee benefits broker. He can be reached at 303-228-1675 or s1swalm@mho.com.

Legal Disclaimer