Should Three Reimbursement Accounts Be Consolidated into One?

A leading thinker proposes transforming three distinct medical-reimbursement accounts into a single product. Does this approach make sense?

Economist John Goodman is one of the original thinkers and writers in the consumer-driven health space. For more than three decades, Goodman has studied medical coverage (insurance) and care (services received by patients) and added tremendously to the consumerism movement to put patients in control of more healthcare spending.

In a recent article (see the last question he's asked), Goodman proposed consolidating Health Savings Accounts, Health FSAs, and Health Reimbursement Arrangements into a single account.

The idea is worth considering. After all, employees and their spouses often don't know which account covers a portion of their out-of-pocket health-related expenses. They frequently don't understand how their own or a spouse's enrollment in one can affect their opportunity to benefit from another. And when they're covered by more than one, they're often confused about which account pays which portion of their financial responsibility.

A single account certainly would reduce employee confusion, potential duplication, and occasional disqualification from one plan because of another. And it would reduce complexity for a company that offers more than one program. But it would also reduce employer flexibility and the opportunity for employers and workers to benefit from a reimbursement program tailored to their specific situations.

Let's look at each account, then try to incorporate the best features into a single program.

Health Savings Account

A Health Savings Account is a personal financial account to which employers (tax-free) and employees (pre-tax) can contribute. Individuals must meet eligibility requirements to open and fund an account. Anyone who meets the requirements - including the self-employed, the unemployed, and small-business owners - can open and fund an account.

Unique Features

• It's a personal, portable financial account with investment options.
• It's employer-sponsored, so available to nongroup medical-plan enrollees.
• There is no plan year, so funds don't expire, but rather carry over forever without limitation.
• Employer can't limit the range of expenses qualified for reimbursement.

Downsides

• Availability is limited to people enrolled in a medical plan with a broad deductible who meet other requirements.
• It operates like a checking account with no overdraft protection - participants can withdraw no more than the current balance (although some administrators are designing options that mimic overdraft protection).

Health Reimbursement Arrangement

An HRA is an employer-designed and -funded arrangement that reimburses expenses as defined by the plan. Think of it as an IOU that an employer offers each eligible employee: The IOU can be converted to cash (reimbursement) only if the employee incurs qualified expenses. Otherwise, the employee isn't entitled to any portion of the balance (but can celebrate her good health). This plan is particularly attractive to employers because they can tailor a specific program that meet's their employees' medical and the company's financial requirements.

Unique features

• The employer has a great deal of flexibility in design (dollar value, qualified expenses, recipient of reimbursements, whether unspent balances can be carried over).
• It's a notional account, funded as employees and covered dependents incur qualified expenses. Employers usually spend about $50 in reimbursement for every $100 of HRA value because many families don't reach reimbursement thresholds or ceilings. This feature allows companies to use their pool of funds to help employees who incur the highest medical-plan cost sharing.

Downsides

• Employees can't contribute to reduce taxable income (though the HRA is often paired with a Health FSA, which addresses this issue).
• Only employees who are covered through the employer's medical plan can participate.

Health FSA

A Health FSA is an employer-sponsored reimbursement account funded by employees through pre-tax payroll deductions. Participants make a prospective election before the beginning of the plan year and the employer sets up level pre-tax payroll deductions throughout the plan year. Both parties assume risks. Participants forfeit some or all of their balances left unspent at the end of the plan year. Employers must allow participants access to their full election at the beginning of the plan year and must cover any overspending (expenditures in excess of payroll deductions) by employees who leave the company during the plan year.

Unique Features

• All benefits-eligible employees can participate (even if they waive medical coverage).
• Participants have access to their full election on the first day of the plan year.

Downsides

• Participants can change their elections only with a qualifying life event, not because their medical needs change.
• Unused balances are forfeited back to the company (although employers can allow a limited carryover or grace period to minimize this loss).
• Participants can't accumulate funds to reimburse future qualified expenses.

Designing the Optimal Single Account

So, how do we create a single account that incorporates the best features of each plan? Here's a possible approach: an account that would incorporate some of the features of a commuter plan, which allows monthly election changes and the opportunity to spend balances until the employee is no longer eligible (usually because she leaves her company).

• The account would have no plan year (like a Health Savings Account).
• All benefits-eligible employees - including working seniors and workers who waive medical coverage - could participate (like a Health FSA).
• Participants could change their elections monthly, increasing them up to a statutory monthly maximum (like a commuter plan).
• Participants couldn't spend more than their accumulated payroll deductions (like a Health Savings Account), but employers could adopt a program to allow participants to borrow against their future deductions (in effect, like a Health FSA) that they - the participants - would pay back with future deductions or a settlement when they end their employment.
• Employers could contribute to the account as well (like a Health Savings Account and also a Health FSA, though few companies fund Health FSAs).
• Employer couldn't narrow the list of qualified expenses in the federal tax code (like a Health Savings Account).
• All distributions would be substantiated at or immediately after the time of purchase (like a Health FSA and an HRA).
• Unused balances would remain available for spending in future months until the participant lost eligibility (like a commuter plan). At that point, the participant could carry the unused balance into a tax-deferred retirement account or convert the balance to cash by including the amount in her taxable income and paying an additional 20% tax as a penalty.

This proposed account would check a lot of boxes. It would allow a participant to change her pre-tax payroll deductions monthly if she found that she needed more - or less - money based on her changing medical condition. It would eliminate the risk of Health FSA forfeitures by allowing the participant to change her elections monthly and carry over all balances if she remains with the company. If she left employment, she could roll it into another tax-advantaged account or convert it to cash (less income taxes and a penalty).

One downside to this account is that it wouldn't incorporate any of the benefits of an HRA. Thus, an employer can contribute, but that contribution is in the form of cash that vests immediately. The company can't steer additional funds to employees with higher claims, as it can with an HRA.

Another lost opportunity is that participants who accumulated balances over time wouldn't have an investment option. This proposal certainly could be modified to include this feature. As it stands, participants couldn't invest their balances until they left the company and rolled the funds into a tax-deferred IRA. One positive aspect of this take-away is that it would help address the belief among many policymakers that the wealthy disproportionately benefit from Health Savings Accounts. If long-term employees wanted to bolster their long-term savings and investing, they could be better off increasing their funding of their workplace retirement account to accelerate the growth of their balance and use this healthcare account to reimburse current expenses.

Employers would have to manage monthly changes in payroll deductions, as they do now with employee contributions to Health Savings Accounts and workplace retirement accounts. They could establish a process through their payroll system to automate this process.

The Bottom Line

The proposed account isn't perfect. It incorporates some of the best features of each of the three existing accounts, but it also eliminates some unique features that make one account more of a fit for a company than another (or a choice of accounts with different benefits from which employees can choose).

What do you think? Can you design a better option?

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