Background. Onward! Tyson Fuehrer. CEO/President of Polestar Benefits, Inc.

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2 Background It is not news that healthcare premiums have and are rising exponentially faster than inflation. Even in the midst of Healthcare Reform being enacted, where the declared intention was to make healthcare affordable (it s even part of the name of the bill signed by President Obama), there is nothing in site that the #1 element that makes healthcare unaffordable to employers, i.e. healthcare premiums, will be impacted such that costs will level off to a place is that is affordable. Since the Affordable Care Act (ACA) was passed new regulations have and will create adverse risk that insurance underwriters must account for (i.e. increasing premiums), benefit rate adjustments will limit plan options that have existed for the majority of group sponsored health plans (i.e. will make premiums increase further) and new taxes are looming where insurance carriers and employers may simply exit the market all together rather than pay the additional premiums. In the case that employers leave the group benefits market, employees will be forced into buying insurance in a manner they have never known (or understood) and most will find, since the premium tax subsidies given in the Insurance Exchanges won t cover the amount employers do now, the available plans seemingly will be more unaffordable than the ones they currently have (especially for middle class individuals, families, skilled workers and higher wage earners). While all these challenges are going on, i.e. significantly more than inflationary premium increases, the full implementation of the ACA, etc. employers all still interested in maintaining a group plan that is valuable (cost and benefit coverage) and affordable. Since 2002 when Health Reimbursement Arrangements (HRA) were introduced through section 105 of the IRS code, employers have utilized these plans, usually in combination with a group medical plan to maximize premium savings and benefits for themselves and the employees. In turn, creating an affordable plan option for the employer, while maintaining a better benefit for the employee than what would have been available on a fully-insured basis. It is estimated that in 2005, over 2.6 million people where receiving benefits from an HRA, so the value of these plans shouldn t be taken lightly. Moreover the impact of the plan availability or reduced options being minimized by health care regulators should be scrutinized. In the proceeding commentary, we will be covering the basics of what an HRA is, how they are being used today and then using that information conclude with how HRAs can make a positive impact during what we call the Exchange Era. Onward! Tyson Fuehrer CEO/President of Polestar Benefits, Inc.

3 Introduction Health Reimbursement Arrangements (HRAs) are Internal Revenue Service (IRS) sanctioned programs (section 105 of the Code) that allow an employer to reimburse employees and their federal tax dependents healthcare related expenses. Being an IRS sanctioned plan means taxes are involved and in this case "tax advantages to offset health care costs." Ultimately an employer is able to write off the amounts reimbursed through the HRA, just like they do with health insurance premiums, and the employee receives the benefit without it being considered gross income. A great win-win! An HRA has a couple of unique plan components: 1. Employer dollars are the money allowed to fund a claim made by a member (i.e. an employee or their eligible dependents. 2. The plan is designed by the employer, meaning they decide to cover only medical deductible expenses or anything under 213d of the IRS code. This is different than a cafeteria plan or health savings account where any eligible expenses that used to treat, maintain or cure a specific health related condition are allowable. 3. If plan benefits are leftover, the employer can decide to allow funds to rollover to the next plan year (either a % or the whole amount). 4. HRA plans are COBRA eligible. 5. If the plan has a benefit of $5000 or more/member there is a Medicare reporting requirement. 6. Every HRA plan must pass a discrimination test that takes into account highly compensated employees and making sure they are not receiving an inequitable amount of the benefit versus non-highly compensated employees Normally plans that carve out the benefit for some and not all, will not pass the test. Since there are so many ways plans can be setup and the IRS is involved in auditing these plans, typically an employer will commission a third-party administrator (TPA) to coordinate all the components although some do take on administration themselves. In any case, the basic requirements of setting up the plan are there must be a plan administrator, a HRA plan document, HRA plan summary and now also a Summary of Benefits & Coverage (SBC). Employees are required to receive the HRA plan summary and SBC prior to the plan being effective. But only these persons are allowed to participate: 1. Current and former employees. 2. Spouses and dependents of those employees. 3. Any person the employee could have claimed as a dependent on the employee's federal tax return except that: 1. The person filed a joint return, 2. The person had gross income of $3,400 or more (this is called an income test, is indexed and fully described in section 152 of the IRS code), or 3. The employee or his/her spouse if filing jointly, could be claimed as a dependent on someone else's 2007 return. 4. Spouses and dependents of deceased employees.

4 If anyone is found to have received an HRA benefit during an IRS audit, the employer stands to be fined $100/day/violation, as well as the employee being levied fines for not reporting the correct amount of gross income on their taxes. Advantages & Limitations of a HRA Advantages of HRAs for employers include: Reimbursements of qualified claims are tax-deductible for the employer. Employers know their maximum expense related to their health care benefit. There can be a significant premium savings by the Employer with a HRA. Advantages of HRAs for employees include: Contributions that employers make can be excluded from employees' gross income. Reimbursements may be tax free if the employee has qualified expenses. Unused funds in the HRA can be rolled into future years for reimbursement (as described in the HRA plan document). HRAs may be offered in conjunction with other employer-provided health benefits including Cafeteria Plans (flexible spending accounts or FSA plans). Employees do not have to be covered under any other health care plan to participate, although they do have to be eligible for the benefit. Employees can be reimbursed for a health care plan that meets their or their families' specific needs, as opposed to a standard company plan. Limitations of HRAs include (also listed in IRS Publication 969): Self-employed persons are ineligible, as well as owners of Sub-Chapter S corporations "Highly compensated" participants may be subject to "certain limitations." A sole proprietor can employ their spouse and as long as their employable interest; i.e. the spouse does in fact help with the business and then the spouse and dependents may receive the HRA benefit (but the owner s expenses would not be eligible). How is a HRA typically used pre- Exchange Era? The adoption of HRA plans really took off with the movement towards consumer driven health plans, which potentially by coincidence, was in the early 2000s when medical expense reimbursement programs (MERP) and executive reimbursement plans where re-defined and Health Reimbursement Arrangements were wrote into the IRS code.

5 During that time insurance carriers were introducing the concept of offering an option to the employer of buying a less expensive health plan in exchange for employees taking on more of the financial burden when claims occurred (i.e. increased copay, deductible and maximum out of pocket amounts). However, most employers, unless motivated by financial necessity, where not highly interested in receiving a lower premium if the employees were going to be unfairly exposed to increased costs. That is where the HRA came in. Burden by multiple years of double digit increases, employers were willing to take advantage of the lower premium offered by the insurance carrier (through the consumer driven health plan). However, instead of pushing the costs onto the employee when medical claims occurred, the employer setup a HRA to reimburse employees for the difference of what the plan benefits where (i.e. a $500 medical plan deductible) to what they became ($2000 medical plan deductible) and the employee experienced the same expense exposure (they have a $2000 deductible medical plan, with a HRA that pays $1500 of the deductible, ultimately the employee has $500 of deductible exposure like they did before) AND the plan was affordable for the employer. See the case study below for additional illustration. HRA Case Study (Figure 1) PROBLEM: Employer receives a 12.3% increase on Group Health Plan Premium, the fourth year of double-digit increases. DILEMMA: In the past, Employer has made the choice of cutting benefits and/or charging employees for a portion of the increase. The Employer acknowledges this is not a solution. ANALYSIS: After a detailed review of Group Health Plan and survey of employees, it was determined that the majority of the plan usage was office visit and prescription related. SOLUTION: HRA combined with a consumer driven health plan... the Employer contracts with an Insurance carrier for a high-deductible to the employees. The difference between these two deductibles, the employer reimburses eligible expenses to the employee and/or their dependents. RESULTS: Employer reduces their first year cost by 16.8%, continues to offer a Group Health Plan the employees and their dependents can appreciate, and for the first time, has a long-term answer.

6 Since the true reason of rising healthcare premiums was not addressed by the employees, employers, insurance carriers, providers or hospitals (meaning tackling the issue of reducing the actual claim costs and frequency) overall medical plan costs continued to rise at the same level. Employers that won at funding the claim difference between what the plan benefits where to what they would buy the next plan year took on additional claim risk and currently we see employers funding the differences between copayments, coinsurance and deductibles. This essentially is an employer setting up a HRA that is like having their own medical plan inside of a fully insured plan. Even though employers are still seeing better savings in using a HRA combined with a consumer driven health plan versus simply buying a fully insured plan that does all the same thing and employees are still financially equivalent to the differences in the total benefits, there would come a point when employers are not willing to take on the claim risk. Unfortunately most employers, meaning small group, will not have the choice of when to decide they will no longer take on the claim risk, beginning in 2014, most of the plans available to employers to create the premium savings will not be allowed because the fully insured plan doesn t meet the guidelines of being a qualified plan in the Exchange Era and therefore, will not be approved by the state s insurance commissioners. 2 Options for HRAs to exist in the Exchange Era? Please note the main style of HRA described in the last section is not the only one seen in the market, but it certainly is the predominant one. Employers can and do also setup plans to fund a number of different health related expenses, for example creating HRA plans to reimburse for: dental or orthodontia expenses, insurance premiums, replacing vision plan and reimbursing for those costs, etc. So we certainly can see as option one, these less prevalent HRA plan going forward. There is some light beaming through Section 1302(d)(2)(B) of the Affordable Care Act to make one believe HRAs in its current form will exist long-term. In this section the Secretary is required to issue regulations about how employer contributions are to be accounted for in what is called the actuarial value of a medical plan. Actuarial Value (AV) is the new measuring stick of a medical plan s value. It quantifies the percentage of expected health care costs a health plan will cover versus what the member must pay. AV cannot be described in terms of only deductible, coinsurance or copayments it is all of those together. Example: If the medical plan expects to pay 60% of the claims for a member under a specific health plan (i.e. the member would pay the other 40% in the form of copayments, deductible and coinsurance), that plan is considered to have an actuarial value of 60%.

7 How people will start know the different actuarial values of medical plan is when they hear this is a Bronze plan or considered to have a 60% actuarial value. See figure 2 for more information. Plan Name Actuarial Value Why this is important is for 2 reasons: 1. Only Bronze, Silver, Gold & Platinum plans are intended to be offered in the Exchange Era for small group employers. 2. For large group employers, if a plan is offered to an employee and it is not considered affordable, meaning the costs for employee only coverage is too OR the plan isn t at least a Bronze level plan AND the employee receives a subsidy when buying a plan in the Exchange there is a tax penalty (initially set at $3,000/person meeting these parameters). So for large groups, who may not be offering at least a Bronze plan, they can add a HRA and the combined medical plan actuarial value along with the HRA actuarial value combine to create a total benefit that can meet the guidelines of being a Bronze plan or greater and therefore remove the exposure to the employer to have to pay tax penalties. This could be considered option 2 for HRA plans in the Exchange Era. Bronze 60% Silver 70% Gold 80% Platinum 90% The last anticipated option is what has been around for years, called a defined contribution HRA. These plans are a lot like they are for 401k plans; the employer sets the HRA benefit amount the employee can receive (typically on a monthly accrued basis) and that benefit is described to pay for individual insurance premiums. Recent guidance from the IRS, HHS, DOL, Treasury Department & Obama Administration have put the kibosh on these plans, namely in FAQ XI (released on 1/23/2013) where it states: Q2: May an HRA used to purchase coverage on the individual market be considered integrated with that individual market coverage and therefore satisfy the requirements of PHS Act section 2711? No. The Departments intend to issue guidance providing that for purposes of PHS Act section 2711, an employer-sponsored HRA cannot be integrated with individual market coverage or with an employer plan that provides coverage through individual policies and therefore will violate PHS Act section This was further clarified on March 8 when the Kevin Knopf, Esq., IRS office of the Chief Counsel documented that you can t integrate an HRA with individual coverage premiumonly HRAs have to meet the annual limit rules just like anyone else. Therefore, until further guidance is released this anticipated solution is not allowable in the Exchange Era and beyond.

8 Conclusion The Health Reimbursement Arrangement (HRA) market was designed to solve problems and it has, serving the needs of millions of Americans. We anticipate change, just like anything is this world but the long-term value of an HRA rests on the fact that it provides a tax advantage to employers and employees. So as long as that exist, so will HRAs. How to contact the author: Tyson Fuehrer Phone: tysonf@polestarbenefits.com LinkedIn: