IRS Ruling Makes Patient Power A Reality For All Employers

Commentary by Pete du Pont

There is a saying I often think of when discussing the Internal Revenue Service (IRS): "Bureaucracy is the art of making the possible, impossible." But every now and then even the IRS surprises me by doing the exact opposite.

This summer the IRS released guidance on the use of "Health Reimbursement Arrangements" (HRAs) by employers. This action adds another important tool to the effort to restore patient power to a financing system that has become ever more dysfunctional over the years.

It may seem ironic that a bureaucracy like the IRS should move so decisively while the United States Congress has spent the better part of a decade on issues like the Patient Bill of Rights and prescription drugs in Medicare, without resolution. There is irony, but also justice in the action. After all, it was the IRS that set us on the path to the current employer-based system over fifty years ago when it decided the value of employer-sponsored health insurance benefits would not be considered "taxable income" to workers.

That simple decision resulted in an enormous advantage of employer-financed health insurance over all other means of paying for health services. Benefits sponsored by an employer are free of all taxes, state and federal, income and payroll, while health insurance purchased by an individual, or health services paid directly by a patient, enjoy no tax advantage at all.

The HRA ruling continues to rely on employers as the source of health care financing. But it does not require that financing be in the form of a health insurance program. Rather, it allows employers to make funds available so that employees can pay directly for services, and benefit from any cost savings they achieve. It gives employees wide latitude to choose the services and providers they prefer, without being confined by a specific benefit design. It gives workers a source of funds that may be used to continue their coverage after they leave a job, or help with their costs once they have retired.

Importantly, the IRS has allowed an enormous amount of flexibility in program design - far more than is allowed under other earlier efforts such as Medical Savings Accounts (MSAs) or Flexible Spending Accounts (FSAs), which were micromanaged by Congress to a degree that limited there availability and attractiveness. Because of this flexibility, it is hard to imagine an employer who would not want to offer an HRA in the next few years.

So what exactly is an HRA? An HRA is an amount of money allocated by an employer to the benefit of an individual employee. The HRA must be funded solely by the employer and the funds may be used solely for medical expenses. The account may never be "cashed out" to be used for non-medical expenses, but any amount not used within a year may be rolled-over into the following year and continue to be available to pay for health care services.

As long as those provisions are met, the money is not considered income and is as free of taxes as the rest of the employer's benefit plan. Importantly, the employer may continue to make the funds available even after a worker has retired or moved on to another job. Thus, the HRA amounts to a rainy day fund that could be used to pay for COBRA continuation premiums while unemployed or Medigap premiums when a worker is retired and eligible for Medicare.

And amazingly, beyond these broad principles, the IRS has left the program design up to the employer. There is no requirement for the underlying insurance program. One employer might have an insurance plan with a $4,000 deductible and put $3,000 into each worker's HRA. Another might have an HMO with a $25 co-pay for doctors visits, and put $100 a year into the HRA. Yet another might have a mix - co-pays for prescription drugs, a deductible for hospital care, first dollar coverage for preventive care, and a 20% co-insurance for physician visits, and set up an HRA to help cover all of those out-of-pocket expenses. Some employers might even offer no insurance plan at all, but put the entire contribution into an HRA so workers can choose their own plan.

Now if Congress could be half as responsive as the IRS has been, we might be able to open up MSAs and FSAs to wider segments of the market. They should give all three approaches a chance to find their own market niche and bring patient empowerment to all segments of America.