HRA Plan Design

Health Reimbursement Arrangements and Plan Design

© By Thomas P. McCormick, Esq., CFCI, and the Employee Benefits Institute of America LLC (EBIA). [1]

Now that the IRS has issued guidance on health reimbursement arrangements (IRS Notice 2002-45 and IRS Revenue Ruling 2002-41), employers are left to assess whether an HRA should be added to their benefits package. This article addresses some reasons why employers might want HRAs, and discusses ten plan design options from a big picture standpoint.

HRAs are employer-funded plans that provide employees with an account balance that can be used to pay for out-of-pocket medical expenses (like health FSAs can do) and, subject to unsettled HIPAA and other legal issues, to pay for health and dental insurance premiums (which health FSAs cannot do). In contrast to health FSAs, HRAs must be employer-funded outside of a cafeteria plan (no salary reductions or flex credits). The key feature of HRAs is that (unlike health FSAs) they can be designed to permit the carryover of unused account balances from year-to-year.

Why have an HRA? There may be many reasons, but here are three.

FIRST, as health insurance premiums continue to rise, some employers are shifting to plans with high deductibles. While premiums for such plans are lower, employees' out-of-pocket expenses will increase due to the higher deductible. Employers can use some or all of the premium savings to fund an HRA that employees can use to cover the increased deductible and other out-of-pocket medical expenses. An HRA coupled with a high deductible plan might heighten employee awareness of health costs and could reduce unwise expenditures by having employees bear the direct cost of their medical care up to the high deductible amount (by having to dip into their HRAs).
SECOND, some employers who already have employer-funded medical or dental reimbursement plans with low annual limits may wish to add a carryover feature, so that unused amounts from one year are available in subsequent years (e.g., an employee who uses $0 of the $1,000 annual limit in year #1 has a carryover-increased $2,000 limit in year #2).
THIRD, some employers may wish to establish an HRA to provide a mechanism for employer funding of retiree medical benefits, whereby retirees can use (or carryover) the annual limits for out-of-pocket medical expenses or for retiree medical insurance premiums.

Employers interested in establishing an HRA will be faced with many plan design options. While not exhaustive, this list of ten plan design considerations should serve as a good starting point in designing an HRA plan.

Type of HRA and Eligible Employees - Do you wish to have an integrated or stand-alone HRA? The most talked-about type of HRA is one that is integrated with a high deductible major medical plan, whereby the HRA is offered only to those who take the major medical coverage (see the first reason above). Alternatively, an employer could have a stand-alone HRA that is not linked to a major medical plan and has separate eligibility rules (see the second and third reasons above). Whichever approach is followed, the class of eligible employees must be nondiscriminatory. See Code Section 105(h).
Accrual Method and Amount - Do you wish to accrue HRA amounts on a monthly basis or annual basis? For example, an employee could have $100 credited to her HRA account at the beginning of each month, or the HRA could use the annual accrual method and credit $1,200 to her account as of the first day of the plan year. There is no Code-imposed limit on the maximum HRA accruals. By plan design, an employer must decide how generous it wishes to be.
Carryovers - Do you wish to permit carryovers of unused amounts (the ability to permit carryovers is the key feature that distinguishes HRAs from health FSAs and other self-insured medical reimbursement plans)? If so, perhaps you might wish to place a cap on the carryover amount.
Limitations on Covered Medical Expenses - Do you wish to limit the category of expenses that can be reimbursed by the HRA? In an integrated HRA, one design might be to limit the HRA so that it can be used only to pay for expenses that the major medical plan would cover but for the plan's deductible, co-pay and other limits. Another design, whether in a stand-alone HRA or an integrated one, would permit the HRA to be used to reimburse any out-of-pocket Code Section 213 medical expenses, including ones not covered by the employer's major medical plan or other insurance.
Reimbursement of Insurance Premiums - Do you want the HRA to reimburse employees for premiums that they pay for health insurance under plans not sponsored by the employer? Permitting the HRA to be used in this fashion raises a variety of legal issues, including HIPAA health status nondiscrimination issues. If an HRA is a stand-alone HRA for retirees only, the HIPAA issues should be less of an obstacle (HIPAA's nondiscrimination rules likely do not apply to stand-alone retiree-only plans).
HRA vs. Health FSA Ordering Rule - Do you wish to design the plan so that the health FSA pays first and the HRA pays second, or vice versa? Careful plan drafting is required.
Spend-Down Feature - Do you wish to give terminated participants the right to spend down their unused HRA account balances, without electing COBRA? A spend-down feature is permissible, but a cash-out feature is not. Alternatively, you may wish to terminate coverage upon termination of employment (effectively causing a forfeiture of unused amounts). Note that even if a spend-down feature is offered, the HRA must offer COBRA once a qualifying event has occurred. COBRA must also be offered when the HRA coverage terminates if the HRA does not contain a spend-down feature.
Administration - Do you wish to self administer the HRA, or hire a third party administrator to administer it for you (including claims processing and payment)? Do you wish to use electronic payment mechanisms (e.g., debit cards) with your HRA? The IRS is expected to issue guidance soon on the use of debit cards for health FSAs, which ought to be equally relevant for HRAs.
No Employee Contributions, Salary Reductions or Flex Credits - Do you want employees to contribute to the HRA? If so, you have picked the wrong vehicle. Use a health FSA instead. HRAs must be funded solely by the employer outside of a cafeteria plan (there can be no direct or indirect salary reduction or flex credit funding of an HRA). The one exception is where an HRA participant has a COBRA qualifying event, and elects COBRA and pays the HRA COBRA premium with after-tax dollars. It is not clear whether non-COBRA after-tax contributions from current employees or retirees are permitted under the HRA guidance, but employers subject to ERISA should steer clear of such contributions to avoid plan asset and trust requirement issues.
Funding - The IRS guidance does not require that HRA funds be set aside in a trust or other account. However, ERISA Section 403 requires that "all assets of an employee benefit plan shall be held in trust by one or more trustees." ERISA will require a trust (and financial reporting) if an employer creates a separate HRA account or arrangement from which HRA benefits are paid, if the separate account or arrangement is considered not to be part of the employer's general assets. Of more universal importance, however, is that under a literal reading of ERISA's plan asset regulations, ERISA might require a trust for all HRAs because COBRA premiums paid to an HRA by individuals to continue their HRA coverage are plan assets. As plan assets, they must be held in trust until they are used to pay benefits, unless an exception applies. One possible exception is ERISA Tech. Rel. 92-01, which would relieve an HRA of the trust requirement if it accepts participant contributions through a cafeteria plan. Because an HRA does not (and cannot) accept participant contributions through a cafeteria plan, it appears that ERISA Tech. Rel. 92-01 does not apply. However, if an employer has an integrated HRA and high deductible major medical plan, and a qualified beneficiary who wants COBRA is required to take both the HRA and the major medical coverage, one might argue that ERISA Tech. Rel. 92-01 should apply to the entire arrangement if the major medical portion was funded in part by participant salary reduction contributions under a cafeteria plan. Employers should consult with their legal counsel to determine whether ERISA Tech. Rel. 92-01 will apply to their HRA. If it does not apply, all COBRA premiums for the HRA coverage will need to be held in trust. And recall that a trust would be needed anyway if an employer creates a separate HRA account or arrangement from which HRA benefits are paid, if the separate account or arrangement is considered not to be part of the employer's general assets. If a trust is established, it could be a fully taxable trust or it might take the form of a tax-exempt Code Section 501(c)(9) VEBA.

Conclusion

HRAs offer a great opportunity for creative plan design. The above ten points illustrate just some of the possibilities. Employers should consult their attorneys to make sure that their plan design is tailored to their needs and satisfies applicable legal requirements.

Footnote:
[1] This article is derived from material in EBIA's Cafeteria Plans manual, with permission of EBIA. Mr. McCormick is Director of EBIA and a co-author of that manual.