How will we cope with the ever-increasing premiums on health insurance? One way to get a handle on the costs is to subject the health care delivery system to free market forces. That’s not new. Adam Smith postulated it 200 years ago.

Over the past several months, we’ve heard rumblings about “defined contribution” health insurance plans, wherein the employer puts dollars into an employee’s account for the purpose of paying medical expenses, including health insurance premiums. However, the income tax consequences of such a plan
have been uncertain...until now.

The IRS published a ruling declaring that money provided by employers for employees’ out- of-pocket medical expenses will not be subject to federal income tax. The ruling also stated that
unspent funds can be rolled over year-to year and retained by the employee upon
change of employer or at retirement.

That new IRS ruling removed much of the uncertainty attached to money purchase health insurance plans, and established what the IRS calls “Health Reimbursement Arrangements” (HRAs), subject to the same rules as now apply to other employer sponsored health insurance plans.

A few such plans were established in 2002 by some major US corporations, betting the IRS decision would fall in their favor. Recall that the siren song of the HMO’s was they would control fees and
thus control costs. However, never discount the rule of unintended consequences. Usage of HMO services by its members skyrocketed–and why not when you can get an $1,800 test for a $10.00 co-payment? Over time, insured members lost track of costs for services and prescription medicines.

Employers are no longer able to pay the cost of these plans, yet they’re unwilling to jettison them and set their employees adrift. A recent study indicated that since 1960, the average share
of health care expenses paid by employees covered by group health insurance has dropped to 20%, with someone else picking up the remaining 80% of the tab. No wonder there’s little incentive to shop for cheaper drugs and health care services.

HRA’s are not HMO’s. They are see-anydoc, go-to-any-hospital plans. Here’s how they work:

If you already own a Medical Savings Account Plan (MSA), you own a solo practice version of HRA. The employer purchases a high deductible major medical health insurance policy to act as a stop loss vehicle for the employee. The employer next contributes specified dollars into an HRA for the employee. For the employer this action should result in a savings of premium dollars. The employee then taps his or her HRA for medical expenses as needed. That sets up an incentive for the employee to shop around for health related services, because whatever’s left in the employee’s HRA kitty at year-end rolls over to the next year. If the employee has a year in which medical expenses equal the deductible on his or her stop loss policy, the insurance kicks in to pay covered expenses for the rest of that year. Younger employees who see little need for health insurance during those “bullet proof” years, should be attracted to HRA’s, as they see an opportunity to retain control of dollars that formerly flew away to the HMO for potential services never used. Older employees should obtain relief from high HMO premiums.

According to a July 2, 2002 editorial in the Wall Street Journal, “The health insurer Humana, which offered the product to its own employees this year, saw an expected 19% increase in health costs drop to less than 4%.” In Florida, the state legislature must initiate necessary changes to the group health insurance regulation before Florida businesses can provide HRA plans to their employees. Contact your state representatives and senators to urge them to tackle this task. HRAs are an idea whose time has come.

Ken Smith, CLU, FLMI, owns Insurance
Planning Services. He may be reached at
904-285-5255 or ksmith6288@aol.com.