Types of Consumer-Directed Health Plans

Types of Consumer-Directed Health Plans

Objectives

After completing this module, you will be able to:

identify high-deductible health plans and the three major types of consumer-
directed health plans (CDHPs);

describe the main features of FSAs and HRAs;

summarize the HSA rules regarding eligibility, qualified HDHPs, preventive care,
contributions, and distributions; and

discuss the potential impact of healthcare reform on CDHPs.

In the last module we introduced the consumer-directed health plan (CDHP) products
available today. In this module we will provide a closer look at flexible spending accounts
(FSAs) and health reimbursement arrangements (HRAs) and a detailed examination of
the fastest-growing type of CDHP, health savings accounts (HSAs). We will conclude by
discussing how healthcare reform legislation may affect these DCHPs.

Consumer-Directed Health Plans

In today's healthcare market, employers are looking for lower-cost health coverage
options, while consumers are seeking broad choice among providers and more control
over their healthcare dollars. Consumer-directed health plans are increasingly popular
products that address these needs.

As discussed in the preceding module, CDHPs generally combine a core funding

contribution by employers with increased choice and financial responsibility for
employees and greater accountability for health plans and providers. CDHPs typically
couple a high-deductible health plan with a tax-advantaged personal healthcare account.

High-Deductible Health Plans

Most CDHPs are based on a high-deductible health plan (HDHP), a plan with a
considerably higher deductible than traditional insurance products. HDHPs generally
have lower premiums than traditional plans, and the money saved can be placed in a
personal healthcare account.

Some HDHPs do not apply the high deductible to preventive care, which has first-dollar
coverage or a low copayment. HSA-qualified HDHPs are subject to federal rules that
specify minimum deductibles and limit annual out-of-pocket expenses.

The Three Major Types of CDHPs

CDHPs are not new. They were introduced in the 1970s and have been retooled in
several iterations over the past three decades. This evolution has produced three major
types of CDHP accounts:

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flexible spending account (FSA),

health reimbursement arrangement (HRA), and

health savings account (HSA).

All of these products provide federal tax advantages while allowing consumers to save
money for their healthcare. Each has a unique design and is subject to a unique set of
federal rules.

Flexible Spending Accounts

Flexible spending accounts (FSAs) were introduced in the late 1970s and are the
oldest type of CDHP account. FSAs are established by employers to cover uninsured
healthcare expenses or dependent care expenses of their employees. FSAs may be
funded by the employee with pretax dollars, by the employer, or both. They may be
offered on a stand-alone basis or in conjunction with any type of health insurance plan or
other employer-provided benefits. They can be offered under a employer’s cafeteria
plan, which may offer a wider spectrum of benefits than just an FSA. An employee can
choose to participate in an FSA even if he does not participate in any other benefit plan
offered by the employer. Because FSAs can only be established by employers, they are
not an option for self-employed individuals.

In 2007 health FSAs were available to about a third of all workers. But participation is not
high—about half of employees of large firms had access to them, but in 2008 only 22
percent participated.1 The limited popularity of FSAs is partly a result of design-related
restrictions on funding and use, including the following:

“Use-it-or-lose-it” provision. Balances in an FSA may not be rolled over from

year to year. Employers have the option of allowing funds for one year to be used
for expenses incurred in the first two and a half months of the following year.

Lack of portability. Employees who change jobs or retire cannot take FSAs with
them, and employers are not allowed to refund FSA balances to employees
when they leave. (However, ex-employees continuing their health coverage
under COBRA can access funds from their FSA.)

Health Reimbursement Arrangements

Health reimbursement arrangements (HRAs) were introduced in 2000 and gained
momentum after a 2002 U.S. Treasury Department ruling clarified their treatment in the
tax code. The establishment and funding of HRAs is exclusively limited to employers;
self-employed individuals are not eligible, and employees cannot make contributions.
Employers decide how much money to “contribute” to HRAs, and employees can
withdraw funds for expenses allowed under the employer's HRA plan documents. HRAs
may be offered on a stand-alone basis or in conjunction with any type of health
insurance plan, including an HDHP.

Unlike with an FSA, HRA funds may, at the option of the employer, be rolled over from
year to year tax-free, increasing their appeal. There is some limited portability: As with
an FSA, an ex-employee continuing health coverage under COBRA can access her

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HRA. And unlike an FSA, an employer may structure its HRA to allow balances of
employees leaving the company to be rolled over to an HRA of their new employer, and
it may allow ex-employees to be reimbursed from their remaining HRA balances for
expenses incurred while they were still employed.

A survey of employers found that between 2 and 3 percent of the workers covered by
health insurance were enrolled in an HRA between 2006 and 2009.2 Although
employees like the roll-over feature of HRAs, they dislike that the account might not be
portable if they change companies.

Health Savings Accounts

The Medicare Modernization Act (MMA) of 2003 accelerated the consumer-directed
healthcare movement by creating the most recent CDHP option, the health savings
account (HSA). The HSA is designed to address several of the limitations of previous
personal healthcare account products: It allows funding by both employees and
employers and provides for employee (or individual) account ownership, portability,
annual rollover, and tax-free investment earnings and gains.

Eligibility

To set up and contribute to an HSA, an individual must:

be covered by a qualified high-deductible health plan (one that meets federal

requirements);

not have other broad health coverage that is not an HDHP (Limited coverage
such as accident insurance, dental or vision benefits, workers' compensation,
disability income insurance, or long-term care insurance is permitted.);

not be enrolled in Medicare (Medicare beneficiaries cannot contribute to an HSA,

but they may spend money contributed to an HSA before they enrolled in
Medicare.); and

not be claimed as a dependent on someone else's tax return.

Qualified HDHPs

An HSA must be coupled with a qualified high-deductible health plan (an HDHP that
meets certain federal requirements). A qualified HDHP must have (2010 and 2011
figures, adjusted annually):

an annual deductible of at least $1,200 for self-only coverage or $2,400 for family
coverage.

an annual limit on out-of-pocket expenses (deductibles, coinsurance, and

copayments) no greater than $5,950 for self-only coverage or $11,900 for family
coverage.

The deductible and out-of-pocket limit must apply to all benefits covered by the plan,
including prescription drugs. The only exception permitted is for preventive care

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services. If an HDHP provides benefits through a network of healthcare providers, the

deductible and out-of-pocket limit do not apply to services provided outside of the
network.

Preventive Care

A qualified HDHP may cover certain types of preventive care without a deductible or with
a lower deductible. These services include:
routine prenatal and well-child care;
immunizations for children and adults;
periodic health evaluations, including tests and diagnostic procedures ordered
with routine examinations such as annual physicals;
smoking cessation programs;
obesity/weight-loss programs; and
screening services (such as mammography, Pap testing, and screening for
glaucoma and tuberculosis).
Also exempt is treatment that is incidental or ancillary to a preventive care service or
screening, where it would be unreasonable or impractical to perform another procedure
to treat the condition (for instance, the removal of polyps during a diagnostic
colonoscopy).

Limited categories of medications are also considered preventive care, including:

medications to prevent a disease or condition when a person has risk factors but
no symptoms (for instance, cholesterol-lowering medication to help prevent heart
disease for people with high cholesterol); and

medications to prevent recurrence of a disease from which a person has

recovered (for instance, ACE inhibitors for individuals who previously had a heart
attack or stroke).

Contributions

The rules allow tax-free contributions to an HSA by an employee, an employer, a self-

employed individual, or a family member on behalf of an eligible individual. Each year
the total contributions to an HSA cannot exceed a maximum, $3,050 for an individual or
$6,150 for a family (2010 and 2011, adjusted annually). Individuals age 55 or older can
make additional "catch-up" annual contributions of $1,000. Individuals are responsible
for ensuring that their annual HSA contributions do not exceed the maximum allowed by
law.

Distributions

Individuals can withdraw HSA funds tax-free to pay qualified medical expenses, as
defined by the IRS. These include but are not limited to doctor's office visits, hospital
care, dental care, vision care, prescription drugs, and over-the-counter medications, as
well as deductibles, copayments, and coinsurance. Under healthcare reform, over-the-

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counter medications will not qualify unless prescribed by a doctor (effective January 1,
2011).
In general individuals cannot use HSA funds tax-free to pay health insurance premiums.
But they may do so for the following:

COBRA continuation coverage;

tax-qualified long-term care insurance (LTCI);

Medicare premiums (Parts A, B, D, and Medicare Advantage), but not Medicare

supplement (Medigap) policies (only persons 65 or older); and

health coverage while receiving unemployment compensation.

Unlike with an FSA or HRA, an individual may withdraw money from an HSA for items
other than qualified medical expenses or allowed premiums. However, such withdrawals
are subject to federal income tax plus an excise tax (10 percent in 2010, under
healthcare reform increasing to 20 percent in 2011). If the individual is 65 or older or if
the withdrawal is made after the death or disability of the individual, regular income tax
applies but not the excise tax.

Healthcare Reform
The healthcare reform legislation of 2010 will likely have only a modest impact on
CDHPs and their associated healthcare accounts (FSAs, HRAs, and HSAs). There were
proposals to eliminate some of these options (in particular FSAs and HRAs), but they did
not survive the legislative process.

We have already mentioned two changes affecting healthcare accounts: the increase
from 10 to 20 percent in the excise tax on HSA withdrawals for purposes other than
qualified medical expenses, and the elimination from qualified medical expenses of over-
the-counter medications not prescribed by a doctor. Two other provisions will affect
these accounts:

Small employers will be prohibited (effective 2014) from offering health plans with
deductibles greater than $2,000 (individual) or $4,000 (family) unless the
employer offers a healthcare FSA that reimburses the difference between this
limit and the deductible.

There will be an annual limit on employee contributions to a healthcare FSA

(effective 2013) of $2,500 (adjusted annually). This could encourage people to
switch to HSAs, which have higher limits.

The impact on CDHPs of some elements of healthcare reform will not be clear until the
federal regulations implementing the legislation are developed. The following provisions
may or may not negatively affect HDHPs depending on how the regulations are written.

Minimum actuarial value. All health insurance plans will be required to be

designed to pay, on average, at least 60 percent of the expected cost of services
covered by the plan. If the regulations are written to consider only benefits paid,

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some HDHPs might not meet this standard, whereas if funds deposited into
HSAs are taken into account, most likely will.

Medical loss ratio. Insurers will be required to pay at least 80 percent of their
premium revenues on medical claims. This could be challenging for HDHPs
because they must incur the administrative cost of processing claims incurred
before the deductible is met, even though such claims are not paid and do not
count toward the medical loss ratio.

Preventive care. All health insurance plans will be required to provide first-dollar
coverage (no cost-sharing) of preventive care services. Most qualified HDHPs
already provide this, but the healthcare reform regulations defining “preventive
care” will need to be consistent with the IRS definition for HSA purposes or plans
may no longer meet the HSA requirements.

On the other hand, some healthcare reform provisions could encourage CDHP
enrollment. There will be an excise tax on high-value employer-sponsored health
coverage, and in many cases the best way to avoid this tax may be a CDHP. Subsidies
will be provided to help people with income below a certain level pay health insurance
premiums, and many people may find that a CDHP is the best way to make the most of
these subsidies.

Conclusion
Although they have existed in various forms for over 30 years, consumer-directed health
plans have entered the spotlight in recent years in response to the demand for lower-
cost health coverage options that offer greater choice and control. CDHPs meet this
need by combining a core contribution by employers with increased choice and financial
responsibility for employees, along with increased accountability for health plans and
providers.

Notes

1
Bureau of Labor Statistics. Table 24: “Pretax benefits: Access, private industry workers,”
National Compensation Survey, March 2007. Mercer Human Resources Consulting, National
Survey of Employer-Sponsored Health Plans 2008. Both cited in “Health Care Flexible Spending
Accounts” by Janemarie Mulvey, Congressional Research Service, May 11, 2010.
2
The Kaiser Family Foundation and Health Research & Educational Trust, Employer Health
Benefits 2009 Annual Survey, 2009. Cited in “Tax-Advantaged Accounts for Health Care
Expenses: Side-by-Side Comparison” by Carol Rapaport, Congressional Research Service, June
18, 2010.

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