Health Savings Account (HSA) /
Consumer Directed Healthcare (CDHC)

At a Glance
Faced with spiraling health care costs and consumer demand for greater flexibility, many organizations are now considering a move into consumer-directed health care (CDHC). CDHC is defined as a system where consumers, rather than their employer or insurance provider, determine how and where to spend their health care allotments. Recent legislative changes allow employers to be more flexible with their health care-related dollars.

For example, legislative changes by the federal government created health savings accounts (HSA) effective January 2004 and health reimbursement arrangements (HRA) available since 2000 for individual and family health insurance. Subject to some state variability, HRAs allow employers to make contributions to employee accounts to reimburse their employees tax-free for amounts spent on qualified medical expenses including individual or family health insurance premiums. Health savings accounts provide employees with tax-advantaged accounts that allow them to withdraw funds tax-free for qualified medical, dental, and vision expenses. Funds roll over each year if not used and are portable so that the employees may take the funds with them if they leave the company.

CDHC is a tax-advantaged strategy for employers and individuals to purchase health care—as opposed to a specific product or service. To meet market demand, insurers, brokers, and administrators have crafted custom solutions to deliver CDHC services to employers and individual consumers.

As such, there is no single CDHC approach. When considering a CDHC strategy at your company, you should evaluate various vendor solutions against your specific business needs to determine the optimal solution for your company.

How It Works
A consumer-directed health care plan consists of a banking component combined with an insurance component:

1. Banking: A savings account to pay for routine health care expenses. A healthcare reimbursement arrangement (HRA) is funded exclusively by the employer. A healthcare savings account (HSA) may be funded by the employer, employee, or a combination of both. An HSA is completely in the control of the employee and any balance in the account is portable. Funds in the account may be carried over from year to year. HRA funds, on the other hand, are not portable, and unused funds remain with the employer.



2. Insurance: A high-deductible health plan (HDHP) protects against major health care expenses. Insurance premiums may be paid fully by the employer, the employee or split between the employee and employer. A qualified HDHP is required in order to open an HSA, but not required for an HRA.

Until the deductible is met, the employee pays for health care expenses out of his/her savings account, or out of pocket, if the account balance is insufficient to cover the charges. Once the deductible has been met, high-deductible health plans provide typical PPO or HMO plan benefits

A CDHC program enables business owners to help manage their total employee benefit expenses by contributing a portion of their HDHP premium savings into a fixed monthly tax-free contribution to an HRA or HSA. Business owners have some flexibility in design and contribution amounts, allowing them to focus on their business, not their benefits. Also, business owners may experience annual increases in group health plan rates that are lower with CDHC plans.

Next, let's take a more detailed look at the components of a CDHC in the following sections:

• Health Savings Accounts;


• Health Reimbursement Arrangements; and
• High-Deductible Health Plans.

Health Savings Accounts
It is an unfortunate fact that more than half of all small business owners do not offer health benefits. The health savings account (HSA) provides a new way to make affordable health insurance possible.

The U.S. government established the HSA in 2004 as a new tax-free savings account to help with the rising costs of health care. As a tax-favored savings account, it is used in conjunction with a qualified high-deductible health plan (HDHP) to make health care more affordable and to allow one to save for medical expenses in retirement.

To establish an HSA, the following four conditions must be satisfied:

1. You must be covered under a qualified high deductible health plan;



2. You may not be covered under any plan that is not a qualified high-deductible health plan;



3. You may not be enrolled in Medicare; and



4. You may not be claimed as a dependent on someone else’s tax return.

In 2007, employees and owners enrolled under individual coverage may contribute up to $2,850 and up to $5,650 if enrolled with family coverage (employee plus one or more dependents). These amounts may also be deducted above the line from federal and most state taxes (please check with your personal tax advisors).

The individual never has to pay income taxes on withdrawals from the HSA used for qualified medical expenses. If funds are withdrawn for reasons other than medical, you must pay a 10 percent penalty as well as income tax. Once you go on Medicare, you may no longer make contributions to the account but you may continue to use funds tax-free for qualified medical expenses. You may then also use the funds for non-medical expenses, and you are subject to income taxes only.

By offering qualified HDHPs, employers may reduce their monthly expenses since the premium for these plans are typically much lower than traditional group plans. Unspent HSA amounts accumulate and earn interest tax-free for future health care expenses. The HSA can be used to pay for doctor visits, prescriptions, and even some over-the-counter medications.

Benefits of the Health Savings Account

• Savings Rollover: All HSA money not spent in the current year rolls over to the following year to use for future medical, dental, or vision expenses; or to save for retirement.


• Tax Advantages: Both the employee and employer receive a 100 percent "above the line" federal (and in most states) deduction to the extent of their contributions. Interest and dividends accrue tax-free federally as well as in most states. Withdrawals for payment of qualified medical expenses are never taxed.


• Lower Cost: Using the HSA to pay for the first few thousand dollars of health and wellness expenses allows the employee to enroll in a premium savings high-deductible health plan.

Qualified Health Savings Account Expenses
Most health care and medical expenses, such as doctor visits, prescription drugs, and chiropractic treatments, qualify as an HSA expense. The HSA can also be used to pay, tax-free, for:

• periodic health evaluations (annual physicals);


• screening services (e.g., mammograms);


• routine prenatal and well-child care;


• child and adult immunizations;


• tobacco cessation programs;


• certain over-the-counter medications;


• dental services, including orthodontics (braces);


• eyeglasses, contacts, and even LASIK surgery;


• weight-loss programs supervised by a medical professional;


• transportation to and from medical providers;


• COBRA premiums, during periods of unemployment;


• Medicare premiums; and


• long-term care insurance premiums, which cover chronic illnesses and old age care (subject to IRS limits)

Health Reimbursement Arrangements
The health reimbursement arrangement (HRA) is sometimes called a "Section 105 plan" after the section of the federal income tax law that governs them. The HRA is a tax-free employer arrangement from which the employee can be reimbursed for individualized health insurance premiums and other qualifying medical expenses.

The employer is in complete control of the cost and can establish the HRA specific to its needs. Companies utilize an HRA to control the costs of their health benefit programs while offering their employees access to the tax-free reimbursements for qualifying medical expenses, including health insurance.

Advantages of HRA

• The HRA provides the opportunity to define a specific contribution amount per participant.



• All employees, including part-time, seasonal, and temporary employees are eligible to participate.



• The HRA generally covers everything an FSA (flexible spending account) can cover as well as eligible expenses selected by the employer without the "use it or lose it" provision.

Additional uses of the HRA
The HRA also allows for:

• individual and family health insurance premiums


• Medicare and long-term care insurance premiums;


• preventive care such as weight loss and smoking cessation;


• a wider list of medical items like over-the-counter medicines.

High-Deductible Health Plan
The high-deductible health plan is the insurance component that protects the consumer against health care expenditures above and beyond the amount that can be funded through his/her personal health savings account or out-of-pocket expenses. It is designed to provide insurance protection against catastrophic health care expenses.

A high-deductible health plan is a PPO or HMO plan with higher deductibles. Because CDHCs are tax-advantaged, federal tax law imposes several requirements on the high-deductible health plan. Here are the 2007 requirements:

• Self-only Coverage: Deductible must be at least $1,100 with an out-of-pocket maximum of not more than $5,500.


• Family Coverage: Deductible must be at least $2,200 with an out-of-pocket maximum of not more than $11,000. Additionally, the insurance cannot begin paying for an individual until the $2,200 family deductible is satisfied.

Because of the high deductible, premiums for high-deductible plans are significantly lower than those for conventional low-deductible health plans.

Consumer Directed Healthcare FAQs

Q. What is consumer-directed (or consumer-driven) health care? (CDHC)

Consumer-driven health care (CDHC) is a new way to finance and manage health care. Most traditional fee-for-service or managed care health plans provide low deductibles, small co-insurance payments, and low out-of-pocket costs. As such, these plans don't give the consumer an incentive to shop for the lowest cost of services or make judicious use of health benefits.

CDHC plans, on the other hand, delegate greater decision-making authority to the consumer. Further, they provide financial incentive to keep health care expenses low.

CDHCs typically consist of a banking component and an insurance component:

1. The first component is a savings account to pay for routine health care expenses. This type of account takes the form of a healthcare savings account (HSAfunded by employer, employee, or both) or a healthcare reimbursement account (HRAfunded exclusively by the employer).
   
   An HSA account is completely in the control of the employee, and any balance in the account is portable. Also, funds in the HSA may be carried over from year to year.
   
   
2. The second component is a high-deductible health plan. Premiums may be paid by the employer or split between the employee and employer. Until the deductible is met, the employee pays for health care expenses out of his/her savings account, or out of pocket, if the account balance is insufficient to cover the charges. Once the deductible has been met, high-deductible health plans provide PPO or HMO plan benefits.