Skip Group Health: Small Businesses Finding Savings in Health Reimbursement Arrangements

April 10, 2017

Despite the Affordable Care Act – and in some ways because of it – offering a traditional group health plan has become prohibitively expensive for many smaller employers. Between 2006 and 2016, average total per-employee premiums have risen by 58 percent, from $11,480 per year to $18,142. Workers are feeling the pinch: Their average contribution to their employer workplace plans increased by 78 percent over the same period, from $2,973 per year to $5,277 (and these numbers don’t count the average increases in deductibles over the same period, which come out of employee pockets). But employers have thrown out more money, total, with their average premium contribution increasing from $8,508 to $12,865 per year, according to data from the Kaiser Family Foundation.

These increased costs have put a severe squeeze on both employees and smaller employers, who must increasingly compete in a global economy without the advantages of massive economies of scale. But as the U.S. economy recovers from the Great Recession and competition in the market for talent becomes increasingly fierce, smaller employers have been looking for a way out.

They now have one.

Health Reimbursement Arrangements

Rather than provide a one-sized-fits-all group health plan (often with absurdly low deductibles that drive up premium costs, or unwanted extra features that lard up premiums), many smaller employers are finding success in bypassing the employer group health insurance benefit entirely, telling employees to find their own coverage, and then reimbursing them for all or part of the cost.

According to benefits consultant Arthur C. Gallagher & Co., the number of employers offering health reimbursement arrangements (HRAs) to employees is set to double between now and 2020.

The growth is made possible thanks to a little-known law – the Small Business Healthcare Relief Act – that Congress passed in December of 2016 and that was signed into law by the outgoing President Obama.

Employers win because they can control their health care costs now, and limit their exposure to increasing health insurance costs in the future by limiting the amounts they reimburse.

Employees win because they can choose from a wider variety of health insurance plans than the ones chosen for them by their employer, and they can shop for plans that are better tailored to suit their specific individual and family situations. Assuming the health insurance they purchase for their families covers the 10 essential health insurance benefits specified in the Affordable Care Act, they won’t be subject to the ‘shared responsibility’ tax penalty for not having qualified coverage – a tax that can amount to as much as 2.5 percent of employee income or $2,085 in 2017, whichever is greater ($695 per adult and $347.50 per child under 18, up to a maximum of $2,085).

Meanwhile, reimbursements employees receive via an employer health reimbursement arrangement are tax-free.

Plans are not subject to COBRA continuation or ERISA reporting.

Benefits and Caps

Benefits under the arrangement are capped at $4,950 per year for an individual or $10,000 for plans that extend to family members. These amounts are subject to increase each year along with inflation. All benefits paid under an HRA are tax-free to the employee, up to those caps, and tax-deductible to the employer as a compensation expense.

All contributions are employer contributions. Employees cannot contribute. Employers must offer HRAs to all full-time employees in order to qualify.

Reporting

IRS reporting for the HRA is very simple:

1.) You must send a 1095-B form to each eligible employee, and transmit a 1094-B form to the IRS early each year.

2.) You must include the amount of benefits paid under the HRA on the employee’s W-2 (as non-taxable compensation).

3.) Benefits are not subject to payroll tax either at the employer or employee level. This provides 7.65 percent in cost savings to the employer compared to simply increasing cash compensation to reimburse employees without the benefit of the HRA structure. It also saves employees between 20 and 40 percent in federal and state income tax.

Interface With ACA Subsidies

Participating employees who purchase qualified health insurance coverage via the exchanges are still eligible for the federal health insurance subsidy, via premium tax credits. However, the subsidy is reduced by the amount of the HRA benefit.

Is your business eligible? 

Not every business is eligible to set up a health reimbursement arrangement. If you are deemed an applicable large employer (ALE) under the Affordable Care Act, you cannot participate (generally, businesses with 50 or more full0-time equivalents) You must provide health insurance for all employees working 30 hours per week or pay the employer shared responsibility payment.

Furthermore, if the company offers a group health plan at all – even one offered to management and executives only – it cannot set up a qualified health arrangement (unless the group arrangement is terminated first).

Qualified Expenditures

Employer health reimbursement arrangements can only pay benefits for documented health expenses. It’s a ‘reimbursement’ arrangement, and the key to the tax-free status of benefits is in the fact that employees cannot use the program to line their pockets (and there’s nothing left over for employees to ‘kick back’ excess contributions to employers, essentially laundering tax-free benefits back to the plan sponsor).

To qualify for reimbursement under an HRA, employees must own an insurance policy that provides minimum essential coverage defined in the ACA, or be listed as a dependent/additional beneficiary on a family member’s policy.

HRAs can provide tax-free reimbursement for premiums for medical insurance as well as dental and vision coverage. Employers can also reimburse employees for copays, deductibles and other common medical expenses defined in IRS Publication 502, Medical and Dental Expenses. Per page 15 of that manual, qualified medical expenses exclude babysitting, child care, nursing services for normal, healthy babies, controlled substances under federal law, even if legalized at the state level (e.g., marijuana), cosmetic surgery, diaper services, electrolysis or hair removal, nor can HRAs include health club dues (though you may consider including health club benefits in a Section 125  plan.

Documentation

Because the HRA is a reimbursement plan, there has to be a mechanism for employees to document expenditures. But if employers did so directly, there would be serious concerns about discrimination against workers with expensive medical conditions or other issues such as sexually-transmitted diseases, claims for alcohol or drug treatment, mental health treatment and other conditions that potentially carry a stigma that could affect employment.

What happens to unused funds? 

If funds in an employee’s HRA are left unused at the end of the year, they revert back to the company. This is key to the tax-free nature of the benefit to employees.