LET
THE BUYER BEWARE
Healthcare costs are out of
control. Employers faced with
annual increases of 10%-30% are
willing to explore different
alternatives to save money.
Recently there has been a lot of
interest in defined contribution
(“DC”) health plans as a way to
save.
Each day the press reports that
another major employer has
jumped on the band-wagon. How
well have these plans been
thought through by their eager
promoters? Are there pitfalls or
hidden traps employers and their
advisers should be aware of in
changing their health plan to a
DC health model? We think so.
Defeated Expectations
Face it: We have become a nation
of socialists with expectations
of cradle to grave health
coverage. The myth of the
current system is that the
employee can pay $10 co-pay and
$200 deductible and that is his
fair share. Employees have no
idea that the family health plan
for which he pays very little
may well be costing the employer
from $9,000 to $12,000 (or more)
per year. Even when employees
are required to make
contributions, those are
typically minimal: $150-$200 per
month will frequently cover his
share of premiums.
A change to a DC health plan
model says to the employee, “We
are putting away $750 per month
for you to spend any way you
like for benefits.” That is the
good part because employees
might finally get a clue as to
the real cost!
The bad part of this is that
some employers are using the
conversion as a means to shift
costs to employees at the time
of implementation. This means
that the employee’s share of
costs will go up unless the
employee accepts a greater
amount of risk. We strongly
discourage employers from
shifting a greater percentage of
their health plan’s cost to
employees at the time of
conversion to a defined
contribution model.
Recommendation: Let the new DC
health plan operate for a year
or two before shifting costs to
employees.
Uncertain Tax Laws
While the tax treatment of
insurance premiums is a matter
of well-settled law, the tax
treatment of amounts set aside
for employees to use in a
comsumer-driven health plan is
not.
Which non-discrimination
requirements apply to em-ployee
medical accounts? Various
sections of the Internal Revenue
Code potentially require
non-discrimination testing: 79,
105, 125, 419 and 505. How do
those apply to DC health plans?
IRS recently issued Notice
2002-45 and Revenue Ruling
2002-41 that discuss the tax
laws and regulations as applied
to a “health reimbursement
arrangement” (or “HRA”). In a
nutshell, those rulings permit
HRAs to be excluded from
employees’ income under certain
limited circumstances: (1) The
HRA may be used to reimburse
only IRC section 213(d) medical
expenses; (2) No other related
benefits may be provided
directly or indirectly (such as
paying a severance bonus to the
em-ployee where the amount is
related to the unused HRA); (3)
Long-term care benefits may not
be provided if the HRA is an FSA;
(4) The arrangement may not
permit employees to use salary
reductions directly or
indirectly to fund the HRA.
Recommendation: Obtain the
advice of a CPA or tax attorney
intimately familiar with
taxation of employee benefits
before implementing such a plan.
Loss of Tax Deduction
Under a traditional health plan
model, employers receive a full
tax-deduction for premiums paid.
Under most DC health plan
models, employers lose part of
that deduction, for the portion
going into the employees’
medical accounts.
Any violation of the
requirements described in Notice
2002-45 will result in the
entire HRA contribution’s
becoming taxable to the employee
whether or not spent for medical
expenses.
Recommendation: Use your tax
adviser to make sure that your
proposed implementation is in
accordance with your desires and
IRS’ requirements.
Hidden Liabilities
One issue that has not been
addressed by most DC health
arrangements are the new and
unexpected forms of liability.
Several of the DC models combine
a high-deductible health plan
with phantom “accounts” for
employees. In fact, the savings
from switching to a
high-deductible may not actually
exist anywhere, since those
funds are frequently under the
employer’s control. If the
employer has a cash crunch, it
may well access the funds “set
aside” for employees. Who is
then liable to pay those medical
claims?
Let’s say that a company
purchases a group health plan
from Blue Cross. On the renewal
date the BC representative
explains that the company can
save $100,000 per year by
switching to a high-deductible
health plan, and that BC will
keep track of employees’ claims
and bill the company each month
for the portion of the $100,000
required to pay those claims.
The savings are retained in the
company’s bank account so that,
during the slow season, the
company uses up the cash in
their bank account. Then
September 11th comes along and
the company tanks, but employees
have continued to incur medical
claims for which they are
entitled to payment. The
employees have a Blue Cross
health card, plus an accounting
showing how much they have
utilized and how much they have
left. The fact that the
accounting comes from a
third-party administrator and
not Blue Cross is no consolation
to the employee: he will simply
sue the employer (now defunct),
Blue Cross and the TPA. And he
will win.
The problem is that any DC
health model that does not
require that employees’ funds be
set aside out of control of the
employer is creating a liability
for the insurer and for the
administrator of the accounts.
Recommendation: Require that
employees’ funds be set aside
into actual accounts outside of
the employer’s control.
Cost Shifting or Actual
Savings?
Critics of defined contribution
health plans have universally
criticized the arrangement as a
way of shifting costs or cost
in-creases to employees from
employers. There is no real
appeal to simply telling
employees that if they don’t
obtain needed medical care they
can keep the savings. Yet that
is what many of the DC health
models do.
In the early 1990s, during the
Hillary-care scare, employer’s
costs had gone out of control
and managed care seemed like a
solution to the problem of
runaway costs. So many employers
switched to HMOs and vir-tually
all health plans implemented
elements of man-aged care. They
achieved a one-time savings, but
the escalating cost spiral
started up again within a couple
of years.
If DC health plan models are
employed without imple-menting
true cost saving ini-tiatives,
the result will be the same: a
one-time savings and then back
on the tread-mill. Only now,
since em-ployers have decided
that they will limit their
funding commitment, employees
will be hit with ever-escalating
and unaffordable cost increases.
Recommendation: Employers should
implement a method of creating
savings for both the employer
and the employees.
How can actual long-term
savings be achieved?
At first blush the employer’s
task should be simple: keep the
employee healthy until he or she
reaches 65 and then dump him on
Medicare. Most major illnesses
occur beyond age 65 and those
things that don’t can be tested
for.
Each DC health plan should
include several of these
elements in order to be
suc-cessful:
1. Create an economic in-centive
for the employee to be healthy.
2. Do a health risk assess-ment
for each employee and educate
him or her as to which steps to
take to become or remain
healthier.
3. Provide education for
employees and families relative
to health, fitness, diet,
checkups, etc.
4. Require (incentivize)
employees to have appropriate
check-ups and screenings
appropriate to their age, gender
and health.
5. Include a disease man-agement
program as part of the plan.
6. Include wellness and employee
assistance as part of the plan.
7. Provide consumer information
relative to medical providers
and procedures.
Ultimately what is required is
to turn our nation into
in-formed health care consumers.
When that has been accomplished,
the rest of the problems with
the system will solve
themselves.
Recommendation: Plan for the
long-term savings that can be
achieved by employees becoming
healthier and more highly
motivated.
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