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Health reimbursement arrangements: Practical approach to health spending

A landmark IRS ruling tells employers it's OK to offer a new-style health plan that promotes both choice and responsible spending.

Editorial. Aug. 12, 2002.

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Pay for what you need from your budget. What you don't spend can be kept for later use. That's a simple and sensible strategy with big implications for one of health care's toughest balancing acts -- how to maximize patient choice while minimizing unnecessary increases in the nation's overall medical bill.

A ruling by the Internal Revenue Service marks an important step forward in making that a much more common approach to health care spending. In June, the IRS clarified its position on the tax treatment of a new type of employee health coverage option. It is called a "health reimbursement arrangement," and a few pioneering employers already had been offering it. The IRS action essentially reassured all other companies that it was OK to also move forward with HRAs.

Health reimbursement arrangements are essentially employer-funded versions of the tax-favored medical savings accounts that have long been promoted for individuals. Under HRAs, employers provide each employee with a personal yearly budget -- say, $750 for an individual -- that can be used for health-care-related services.

As with MSAs, the account is typically paired with high-deductible health plan coverage (for example, $1,500 a year for an individual, with perhaps some preventive services paid for at nearly first dollar). That deductible is partially offset by the HRA budget and partly from the employee's own pocketbook.

What the patient does not spend in any given year rolls over from one year to the next, providing more money to meet the deductible. (Assuring employers that HRAs would not be considered employee taxable income was at the heart of the IRS clarification.) Employers can even let employees use rolled-over HRA funds to pay for health services and coverage after employment ends, an important portability feature.

The HRA represents the convergence of choice, personal accountability and health security, with an important plus for employers to encourage them to continue offering health benefits. They will now have a fair shot at savings in premiums and lowered administrative expenses. The AMA has praised the IRS announcement as should any fan of MSAs and the emerging trend of consumer-directed health care.

The medical savings accounts that HRAs emulate are, unfortunately, still hamstrung by congressionally imposed limits and regulations. In contrast, HRAs are now poised to be a broad and accessible proving ground of the same idea.

Treatment of the rollover portion of the HRA has implications for another patient-empowering vehicle, the flexible spending account. In FSAs, individuals can put aside tax-free money to be used to cover health expenses. Yet they operate on a yearly use-it-or-lose-it basis, a significant disincentive. The Bush administration has proposed, but Congress has not yet acted, on a $500 annual FSA rollover. An even better policy would be to allow unlimited rollovers.

Just as tax treatment was the key in encouraging HRAs, so should it be for the big picture in health care. The AMA is a leading advocate of an approach that would encourage employers to provide a yearly amount, mostly likely in the form of a voucher, for employees to apply to the price of any one of a number of available plans (an HRA could be one option).

The AMA also has called for that defined contribution, as well as traditional health benefits, to be taxable. The proposal would institute a system of sliding-scale individual tax credits to offset the new tax liability, tapering off at higher incomes. Lower-income individuals -- who now are often uninsured -- would get most of the help to secure coverage. Under this plan, nearly all Americans would be covered while preserving the best elements of American-style coverage.

In the meantime, the news on HRAs provides a welcome and needed boost to the overarching principles of patient choice, responsible spending and security that are among the essential elements of a sound heath care system.

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