We believe the answer lies in Health Reimbursement Arrangements (HRA) and Health Savings Accounts (HSA). We believe that HRA's will enable employers to more easily afford health care insurance for employees, while reducing the cost to the employer, yet still afford the employee the benefits of group coverage. The combination of HRA's and HSA's will motivate employees to become health care consumers, again, while enabling them to save for future health care costs.

How do these work?

HRA: High-deductible health insurance

The cost of insurance increases with usage; the less chance there is that any given form of insurance will be used, the less expensive that insurance costs. As an example, if you purchase a liability insurance policy it is more expensive to purchase $500,000 worth of coverage than it is to purchase $250,000 worth of coverage; however, it is less expensive to purchase the second $250,000 in coverage of a $500,000 policy, than it is to purchase the first $250,000. Why? Because the first $250,000 will be used a lot more than the second $250,000.

It is for this reason that you will pay a lower premium for your auto and home owner insurance if you have a $1,000 deductible, than you will if you have a $500 deductible. If you are going to be responsible for the first $1,000 of any claim the insurance company is going to reduce your premium because, regardless of the size of any given claim, you are going to spare them the first $1,000.

The same concept is true with health insurance. Since most health care that is received by people occurs during physician visits that cost anywhere from $50 to $500, depending on tests and the like, the real expense incurred each year by most people is not one huge claim of $50,000, but several small claims totaling, perhaps, $2,000. If you save the health insurance company that $2,000, the health insurance company can reduce your premium. This forms one of the basic premises behind HRA's: make people financially responsible for a larger portion of their basic health care and they will make more judicious use of the system, along with becoming better consumers.

Therefore, a simple explanation of an HRA is that it is part of a high-deductible health plan. However, because of recent tax law changes the combination of HRA's and HSA's is much more.

The way an HRA works is that an employer secures a high-deductible health plan and funds, in most cases, part of the deductible for the employee. This employer contribution is a tax deduction for the employer and is not considered income for the employee. The employee then obtains health care as needed, going to whatever doctor the employee feels is necessary to receive proper care. There are no additional costs incurred from having to see "gate keepers" prior to seeing specialists; however, depending on the plan there may be additional savings from seeing doctors in network.

What happens if the employee needs so much health care in a year that the deductible is used up? The health plan secured by the employer kicks in (unless the employer chooses to self-fund) and the employee has coverage. But, what if the employee uses so little of the deductible that there is money left over at the end of the year? As opposed to a Flexible Spending Account (FSA), where you lose any money not used, the money in an HRA rolls over to the next year where it can be added to the next contribution, providing more coverage.

Under the current health insurance system, if an employer pays $5,000 in premium for an employee to have coverage with an insurance company and the employee only "uses" $2,000 in health care that year, the balance is profit for the insurance company. With an HRA, the employer and, under certain conditions, the employee get to keep that money, which sits in an interest-bearing account.

Over time the average employer will have more employees not use the entire deductible, on an annual basis, than will use the deductible. As unused contributions roll over each year and grow, the amount of the employer contribution can be reduced. Yet, if any single employee has a bad year with high health care costs the impact is primarily felt solely by that employee, in the form of the deductible being used up and the major medical plan having to be accessed.

As noted, under certain conditions unused contributions can be retained by the employee. At the discretion of the employer a vesting schedule can be implemented; once the vesting requirements have been met the employee is allowed to keep all contributions made in his/her name by the employer. This can be a significant employee retention tool for the employer. For the employee it changes the HRA from solely a high-deductible health plan into a company-sponsored health care savings plan, allowing a long-term employee with average health problems to develop a significant "nest egg" to assist in paying for future health care.

Two examples of this will suffice. First, most people do not consider long-term care insurance as a part of their personal asset protection plan until later in life, when premiums are higher. Money retained in an HRA account can be used to purchase long-term care insurance. Another example is the oft-quoted "statistic" that the average person spends 80% of his health care dollars in the last two years of life; money built up in an HRA can help defray these costs and protect assets for loved ones.

HSA's: The personal piece of the puzzle

In addition to HRA's, effective in January 2004 the tax laws will change to allow individuals to set aside money, using pre-tax dollars, to pay for health care. Called Health Savings Accounts, or HSA's, they will allow individuals to build a savings account for their health care. These are more flexible than and replace Medical Savings Accounts.

The amount that can be set aside is currently limited to $2,250 if coverage is for the employee only and $4,500 if it is for family coverage. If you are over 55 years of age you can set aside an additional $500 per year. Just as with the HRA, any unused money rolls over each year and grows over time, as opposed to a Flexible Spending Account where you must use the money each year or lose it.

This money can be used for any health-care related expenses, allowing people to plan for the future ("Tommy will need orthodontia in a couple of years."), as well as to save for unknown future costs. The money is not taxed if it is withdrawn for health-care related expenses. If it is used for non-health care expenses it is taxed as regular income and there is a penalty. If you are over 65 and use the money for non-health care expenses, the money is taxed but there is no penalty.

Is the Flexible Spending Account dead?

With the advent of HRA's and HSA's it is fair to ask if there is any benefit to a medical FSA? Obviously a dependent care FSA remains very valuable for working parents with children, but what about a health care FSA?

There are still some benefits to a health care FSA, although the size of the contribution should probably be reduced for most people with access to an HRA and an HSA. One benefit of an FSA is that the law concerning what the money can be used for has been loosened to include over-the-counter medications, which are excluded under HRA's and HSA's. Also, each employer who implements an HRA can choose whether the account will be fully funded from the first day or if funds will grow over time as money is deposited. FSA's are fully funded from the first day of coverage and can be used to cover deductible expenses if the HRA is not fully funded.

For example, if an HRA is not fully funded and an employee incurs medical expenses totaling $18,000 in the second month of the plan, having an FSA could help. If the deductible program is $2,000 and only $200 has been deposited into the account, the employee may have to pay all or some of the balance of the deductible and then be reimbursed over time as funds become available. Another possibility is that the contributions of all the employees will be tapped to cover this one individual, in effect having the individual obtain a "loan" from the fund. However, if the employee also has an FSA it can be used to cover all or part of the deductible.

Finally, as always, FSA's reduce taxable income for the employee and also reduce the FICA match for the employer, saving both money in the form of lower tax payments.

Wouldn't it be neat if this was all integrated and someone else did all of the administration? And, wouldn't this be even better if the employee could pay for all the deductible and FSA expenses with a debit card, and the employer would get a report each month showing everyone's status?

This is available now through PhillipsCox in Virginia and through our partner, CPPR, LLC, nationally. In fact, one debit card can be used to pay for HRA, HSA, medical and dependent care FSA's, and even a Transportation Management Account (an FSA used to pay for mass transit and parking expenses related to work). Whether you want your HRA to include a high-deductible, fully-insured plan, or a high-deductible, self-insured plan, PhillipsCox has developed a working relationship with a large, national TPA that can give you complete, integrated HRA's and HSA's, and more.