Health Reimbursement Arrangements for small businesses

by Tony Novak, MBA, MT, OnlineAdviser at Freedom Benefits, last updated on 11/29/2011

Healthcare Reimbursement Arrangements or HRAs provide the best available framework for a small business that wants to provide health benefits to its employees. There are significant advantages to the business itself, the individual employees and the owner/employees. This article provides a brief overview of HRA plans and the pros and cons of switching to this type of health plan.

To better understand the issue, it helps to look at the current state of a typical small business health plan. See if this typical scenario sounds familiar:

The business buys group health insurance for its employees and pays most of the cost. It is an expensive benefit that is not fully appreciated by the employees. The employees complain about the portion of the premium that they must contribute. They often complain about the quality of the plan and the service provided by the insurer. Since the plan was picked by the employer, these is a sense of blame. The cost of this plan rose 14% last year and is expected to rise by 10% to 30% again this year, just as it has in most years in the past two decades. The cost is rising faster than any other business expense. Every year the business shops for alternate health insurance plans looking for a better deal. This is expensive, time-consuming and generates anxiety among the covered employees. It is difficult to properly budget for future years, since health plan cost increases vary widely and are difficult to predict.

Now consider the same small business that switches to a Health Reimbursement Arrangement:

The business switches to an HRA plan that is designed to suit its own needs without the restrictions formerly imposed by the health insurance company. The HRA plan allocates a uniform $2000 for each employee. Additional health benefits are available to executives outside of the HRA. The maximum cost of the health benefit plan is known without any need for budgeting guesswork. Employees fully appreciate the value of "hard cash" now available to them. Employees may stay with their current health insurance plan or select any other health insurance plan that they like better. Some drop insurance completely or find that they can be covered under another available plan. Some find better and less expensive health coverage on the Internet. Other switch coverage simply to streamline their benefits to fit their own lifestyle expenditures. Employees like the fact that they are in total control of their health care money and that independent professional help is available if they have questions. Now that the employees have access to an independent benefits adviser there is no longer a need to rely on over-stressed health insurance company customer service department. Every medical expense is covered. No more out-of-pocket costs, co-pays or deductibles. The HRA offers 100% coverage up to the plan limit of all medical, dental, eye care, preventative expenses and alternate health care. No need to seek approval from a health insurance company. Treatment may be obtained with any medical provider without the need to worry about a PPO list. Unused benefits are carried over to the next year, providing an incentive to conserve as well as a built-in employment retention tool. Executives and owners may award themselves with full health coverage in addition to the $2000 HRA benefit. Budgeting is easy; the employer simply decides to boost the benefit to $2100 per employee next year. Everyone is happy.

This example scenario is an oversimplification meant for the purpose of providing an overview of how HRA plans work. There are several potential disadvantages of a HRA plans that should be considered:

1) Some employees might not be able to afford the full cost of health insurance coverage with the amount of benefit offered by the HRA plan. In this case, the employer is free to supplement this cost for an important employee as a privately negotiated issue, separately and outside of the scope of the HRA in the same manner as a salary negotiation.

2) Some employees may take imprudent risks if offered the option to take cash instead of health insurance. For example, an employee might drop expensive health insurance in order to apply all HRA funds toward orthodontic expenses and then incur a sudden large medical bill. The employer can require that employees maintain minimum health insurance as a condition of eligibility for HRA benefits.

3) HRAs are subject to nondiscrimination rules and owner/employee limitations. Owner/employees (other than C corporations) are treated the same as self-employed individuals in this regard and are not eligible for tax-free non-insured health benefits.

4) HRA plans require independent claim administration in order to meet IRS requirements for tax-free benefits. The cost of professional assistance should be calculated into the decision to adapt a HRA plan, probably $600 per year for a company with 15 employees or less.

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Health Reimbursement Arrangements for small businesses

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