Late last month, Treasury and IRS gave a bright green light to innovative health plan designs that use employer-funded, defined contribution accounts to pay employee and dependent health care expenses. Termed a Health Reimbursement Arrangement ("HRA") by the Treasury/IRS guidance, an HRA account may be used to pay both out-of-pocket health care expenses and health coverage premium costs. Any unused HRA balances may be carried forward from year to year. The guidance, issued as a combination revenue ruling and notice (Rev. Rul. 2002-41 and Notice 2002-45), dispels the gloomy expectations for defined contribution health plans based on early comments by the government and restrictive existing guidance for health flexible spending accounts ("FSA"). Indeed, the new guidance stands out for its reasonable positions and its inherent flexibility -- flexibility that should spark innovation through plan design freedom.
This Legal Alert summarizes the key features of HRAs as set forth in the written guidance. This alert also incorporates various Treasury/IRS comments ("Conference Comments") regarding HRAs that stem from a July 11th conference ("Conference") on Defined Contribution Health Care Strategies by the Employers Council on Flexible Compensation. (These comments are specifically identified where they appear below.) At the Conference, the Treasury Department’s Kevin Knopf, a key member of the team that developed the recent guidance, answered questions posed by a panel that included Kilpatrick Stockton’s Mark Wincek. Later, these answers were supplemented by the IRS’ Lorianne Masano, the principal author of the revenue ruling and notice.
What Benefits Can an HRA Provide?
An HRA is an arrangement that is financed solely by the employer, not provided pursuant to an employee salary reduction election, and that reimburses only Code section 213 medical expenses (including health insurance premiums and long-term care premiums),- Expenses incurred after the HRA is adopted and after an individual’s coverage begins,
- Expenses that are substantiated, and
- Expenses that are NOT deducted by the employee under Code section 213 and NOT reimbursed by another plan.
Who May be Eligible for HRA Coverage?
An HRA may reimburse medical expenses of current or former employees and the employees’ spouse and dependents. Based on the Conference Comments, an HRA may be specifically offered only to retirees, and the HRA coverage amount may be limited to the retiree’s cost of post-retirement health insurance premiums. In addition, an HRA may cover domestic partners if the employer verifies that the domestic partner qualifies as a Code section 152 dependent of the employee. Alternatively, based on the Conference Comments, if the value of the HRA coverage for a non-dependent domestic partner is taxed to the employee as compensation, the HRA can cover non-dependent domestic partners as well. This is in line with the IRS’ approach to taxing regular group health insurance coverage provided to domestic partners.How is an HRA Financed?
Amounts credited to an HRA must be provided solely by the employer and may not be attributable to employee salary reduction. Based on the Conference Comments, there are no dollar limits on the amount that the employer can credit under an HRA, and amounts may be contributed in a lump sum (such as on a one time or annual basis) or periodically based on the employee’s payroll period. In contrast to health FSAs, an employer may establish an HRA that only allows employees access to HRA amounts as they are credited to the account (i.e., uniform coverage is not required) and the HRA also may provide for the carryover of unused amounts at the end of the year (i.e., use-it-or-lose-it is not required). In addition, the Conference Comments indicated that unfunded HRA balances may also accrue interest, and that earnings may be allocated to an HRA surplus that is carried over to a subsequent year. Conference Comments reflect that the IRS/Treasury guidance is intended to address a "plain vanilla" unfunded HRA, but that the general HRA tax treatment described in the guidance should also apply to a funded HRA. However, Conference Comments reflect that if there are actual earnings on a funded HRA that the taxation of these earnings will depend on the tax status of the funding vehicle.How Does an HRA Relate to a Cafeteria Plan?
Although HRA credits must be financed solely by the employer and may not be attributable to employee salary reduction or so-called "cashable credits" under a flex plan, the guidance allows an HRA to be provided in conjunction with a cafeteria plan as well as another health plan that is financed through employee salary reduction. However, in order to ensure that no salary reduction for the other health plan is being used to finance the HRA, the salary reduction for the other health plan may not exceed the plan’s cost. Solely for this purpose, the guidance indicates that cost may be determined under the COBRA rules for determining the COBRA applicable premium, which is the cost to the health plan for such coverage (both employee and employer contributions), but without the 2% add-on for administration.In addition, the HRA also must not be indirectly financed through employee salary reduction. Indirect financing through salary reduction is deemed to occur if the HRA may pay for premiums under another plan that alternatively could be paid for by employee salary reduction, or if FSA forfeitures are credited to the HRA. Indirect financing also occurs if the HRA maximum reimbursement amount increases in correlation with an increase in the salary reduction for the companion health plan. The Conference Comments indicate that the existence of a correlation between the HRA maximum reimbursement amount and the amounts of employee salary reduction is a determination that is made based on all the facts and circumstances. Thus, an exact number correlation would violate the indirect financing rule, but a slight correlation may not depending on the circumstances. For example, if family coverage requires more salary reduction and results in a larger HRA amount than employee-only coverage, the Conference Comments indicate that these facts and circumstances would be looked upon favorably, as long as the employer was not violating the basic rule that salary reduction cannot exceed the cost of the regular health plan coverage. Further, if the HRA maximum reimbursement decreases as the employee salary reduction increases, such a "negative correlation" also appears to not violate the indirect financing rule.
How Does an HRA Relate to Other Health Plans?
Based on the guidance and the Conference Comments, HRAs may be offered independently of another health plan, or the employer may require employees to participate in a combination of an HRA and another group health plan. If an HRA is combined with another health plan, there are no rules regarding the type of plan that may accompany the HRA (i.e., the other health plan is not required to be a "high deductible" plan, in contrast to the requirement for medical savings accounts ("MSAs")). In addition, Conference Comments clarified that an employer could offer an HRA and a MSA at the same time. However, in such situation, the HRA could only provide coverage for benefits not covered under the high deductible health plan accompanying the MSA (e.g., the HRA could provide coverage for dental and vision benefits if the high deductible plan does not cover these).How Does an HRA Relate to a Health FSA?
Under applicable Treasury regulations, a medical expense may not be reimbursed from a health FSA, if the expense has been reimbursed or is reimbursable under another health plan. In interpreting such regulation, the guidance indicates that if coverage is provided under both an HRA and a health FSA for the same medical expenses, amounts available under an HRA must be exhausted before reimbursements may be made from the health FSA. However, the guidance also indicates that the above general rule will not be violated if before the plan year of the health FSA begins, the HRA plan document provides that coverage under the HRA is available only after an employee exhausts his or her health FSA account. Because HRAs are not subject to the use-it-or-lose-it rule, this allows employees to take maximum advantage of the HRA’s carryover potential. In addition to the non-application of the use-it-or-lose-it rule, most of the other rules applicable to health FSAs also do not apply to an HRA. For example, the rules requiring a mandatory annual period of coverage and that the maximum amount of reimbursement be available at all times during such coverage period do not apply to HRAs.What Happens to an HRA Account After Termination of Employment?
Based on the Conference Comments, when an employee terminates employment (including retirement and death), the HRA either may provide that the employee forfeits the balance in his or her HRA account or may continue to reimburse qualifying medical expenses incurred after termination. If the termination is caused by the employee’s death, Conference Comments indicate the employer may allow the employee’s surviving spouse and dependents to use up the balance in the HRA account, and the estate may claim reimbursement for pre-death expenses incurred by the employee.In addition, the guidance indicates that an HRA is a group health plan that is subject to COBRA continuation coverage requirements. If an individual elects continuation coverage, an HRA complies with the COBRA requirements by providing for the continuation of the maximum reimbursement amount (usually the employee’s HRA account balance) at the time of the COBRA qualifying event, and by increasing such amount at the same time and by the same increment that the employer would normally credit an HRA account for non-COBRA beneficiaries. HRA premiums are determined under existing COBRA rules. However, if the applicable premium is the same for qualified beneficiaries regardless of their total reimbursement amounts available from the HRA, the guidance deems this to comply with COBRA. For example, if the annual credit amount is $1,000 and the HRA account balance for two different qualified beneficiaries is $500 and $5,000, the applicable premium must be the same for each individual. Conference Comments clarify that this is a safe harbor for COBRA compliance, and in such case the premium reasonably could be the actuarially-determined cost that the employer is expected to incur for an average active participant during the year.
What Other Laws Apply to HRAs?
If the HRA is self-insured (as the guidance assumed), the HRA will be subject to nondiscrimination testing under Code section 105(h). In general, Section 105(h) would require the HRA to (i) not discriminate in favor of highly compensated individuals as to eligibility to participate and (ii) provide benefits that do not discriminate in favor of highly compensated individuals. Conference Comments indicate that it is probably permissible to test for benefits nondiscrimination based on the annual increment credited to the HRA, rather than the HRA’s total account balance (which would include carryovers). In addition, although not addressed in the guidance, an HRA would ordinarily be a group health plan that is subject to the Health Insurance Portability and Accountability Act of 1996 ("HIPAA"). This would mean that HRAs are subject to the portability, special enrollment, nondiscrimination and privacy rules of HIPAA. Indeed, Conference Comments reflect that the HIPAA nondiscrimination requirements may bar HRAs from reimbursing individual health insurance premiums because such coverage varies in cost based on the insured’s health. However, the Conference Comments note that this issue is still open and will not be addressed until a consensus with DOL and HHS is achieved. An HRA should also be an employee welfare benefit plan covered by ERISA, which means that (among other items) an HRA would be subject to annual reporting requirements and the Department of Labor’s new claims procedures for group health plans. (Because HRAs are structured as reimbursement arrangements, most likely the claims for HRA benefits will be treated as a post-service claim under the new regulations, thereby requiring an initial benefit determination within 30 days of filing a claim.)How Does an Employer Establish an HRA?
Although the guidance does not include a requirement for a written plan document, if the HRA is self-insured Code section 105(h) requires the adoption of a written plan document. Similarly, because an HRA should be an employee welfare benefit plan under ERISA, a written plan document, as well as the distribution of SPDs to participants, will be required by ERISA. Except for the general rule on HRA versus health FSA ordering of claims, the guidance contains very few default rules regarding the operation of an HRA plan. Therefore, as with other group health plan documents, the HRA plan document should establish rules regarding eligibility, participation and reimbursements of claims in addition to the establishment of the HRA account and employer credits.As discussed above, an HRA’s ability to carry over unused balances and to reimburse the premium costs of health and long-term care coverage give HRAs a fundamentally different role than health FSAs. Freed from the use-it-or-lose-it requirement of health FSAs, HRAs can be structured to encourage employees to become responsible managers of their HRA balance. The Conference Comments repeatedly pointed out the considerable latitude that employers have in designing HRAs, which will ensure that this innovative form of health plan design can be used to fill a range of roles and that it will continue to evolve in the years ahead.
Employee Benefits Legal Alert
is a bulletin of new developments and is not intended as legal advice or as an opinion on specific facts. For more information on employer health and welfare plans, please call any of the attorneys in the Employee Benefits Group including Mark Wincek or Mark Stember in Washington at (202) 508-5800, Sue Stoffer or Kathy Solley in Atlanta at (404) 815-6500, Lois Colbert or Martha Sewell in Raleigh at (919) 420-1700, or Bill Wright in Winston-Salem at (336) 607-7300 or contact us through our website www.kilpatrickstockton.com.
