What is an HRA?
Health Reimbursement Arrangements (HRAs) have received attention because they are considered "consumer driven healthcare." The theory behind consumer driven healthcare is that if an individual has a financial stake in the process, then the individual will be careful in spending money for healthcare.
How does an HRA Work?
It's like an FSA (health care flexible spending account). But, there are three primary differences between an FSA and an HRA:
1. There is no use it or lose it with an HRA.If amounts in an HRA aren't used, then a plan is permitted to carryover the unused amounts to the next year. This is the financial incentive to spend money wisely. With an FSA, amounts not used are lost. Thus, there is an incentive to use health care even if not needed (e.g., all cafeteria participants will get a statement towards the end of the year telling them how much remains in their account so that they can spend it by getting some sort of medical care/equipment - like a new pair of eyeglasses). With the HRA, whatever isn't spent can be used in a later year. The ability to carryover amounts depends on the design of the plan. The HRA can limit the amount that can be rolled over and it can also provide that unused amounts can be used to reimburse medical expenses that occur even after termination of employment. This is just a plan design issue. However, an HRA is like an FSA in that amounts in the plan, including carryover amounts, can only be used to reimburse an individual for medical expenses.
2. Reimbursements under an HRA are limited to the balance in the HRA account of an individual. With an FSA, the employer has a risk of loss. In an FSA, an employee is entitled to a reimbursement up to the maximum he/she elected for the year regardless of how much he/she has contributed.
3. An HRA can't be funded through a cafeteria plan. Thus, it's expected that HRAs will only be funded with employer funds. It may be possible to have a plan where the employer matches after-tax employee contributions, but it is not common. In most other respects, an HRA is similar to an FSA. Both are selffunded health plans, a trust isn't required (as long as it's employer funded), and the plan can be designed to reimburse any desirable medical expenses allowed under the Code (in other words it's a plan design feature as to which medical expenses are covered).
What about an example?
Here is an example of an HRA can be used:
An employer's health premiums have doubled. In order to reduce premiums, the employer will go to a higher deductible - from $200 to $1,000. An old concept is where the employer establishes a self-funded health plan for the increase in the deductible. The plan provides that medical expenses covered by the policy will be reimbursed up to $1,000, subject to a $300 deductible. Thus, the only impact on employees is an increase in the deductible by $100. The employer is just self-insuring the rest of the increase in the deductible. However, the employer could go with an HRA to self-insure the increase. The difference with an HRA is that if an employee doesn't use all of the $700, the HRA can allow the participant to carryover the unused amounts. Thus, the maximum in the next year would be $700 plus the carryover amount.