Healthy Choice
An often overlooked medical plan can save your company money.
By Michelle Andrews

(FORTUNE Small Business) – President Bush has been aggressively promoting health savings accounts as an antidote to rising health-care costs, but so far relatively few small businesses are seeing such plans as a cure-all. Only 14% of the one million users who had established such plans through March worked for businesses with fewer than 50 workers, according to a trade-group survey. HSAs give consumers a financial stake in their health-care spending, which can help small businesses control costs. However, spurred by the publicity surrounding HSAs and consumer-driven plans in general, many small businesses have discovered that there is another type of plan that suits their needs better, one that is older and perhaps less sexy than an HSA but that gives them more flexibility and control: a health-reimbursement arrangement.

"From what we're seeing, the growth in HRAs is huge," says Ric Joyner, president of Eflexgroup.com, a benefits administrator in Madison, and also president of the National Association of Professional Benefits Administrators. "Somebody may call up asking about HSAs because they've heard of them on the news, but once they find out about them, they end up going with an HRA instead." By 2005, about 2.6 million individuals were covered by HRAs, far outnumbering those using HSAs, according to publisher Atlantic Information Services.

HSAs were created under the 2003 law that overhauled Medicare. They allow individuals or businesses to set up accounts to save for medical expenses on a pretax basis. The accounts must be coupled with a health plan that has a high deductible: at least $1,000 for an individual and $2,000 for a family. Often the employer covers some or all of the deductible by depositing money in the HSA, and the employee is responsible for any difference. Health-reimbursement arrangements, which date back to 2002, are somewhat similar to HSAs in that they also allow businesses to set up accounts that employees can access to cover their medical expenses. Typically businesses also couple the accounts with a high-deductible health plan. But there are key differences between the two types of plans that make HRAs attractive to many small businesses.

Structure

HSA: The accounts must conform to specific guidelines. For 2005, the maximum contribution is $2,650 for an individual or $5,250 for a family. The health plan attached to the HSA must have a deductible of at least $2,000 for families. The health plan's maximum out-of-pocket limit can be no more than $10,200 for families or $5,100 for individuals.

HRA: The employer has broad flexibility concerning how much the company contributes to the account and how the accompanying health plan is structured. For example, the health plan's deductible could be lower than HSAs allow.

Funding

HSA: Individuals or businesses can open an account. The account must be "fully funded," meaning an employer must deposit the money up front, either in a lump sum or over the course of the year, before employees can access it.

HRA: Only the employer can open and fund an account for an employee, which gives the business owner more control over the company's health spending. Until an employee incurs medical expenses, the employer need only pledge the money for the account rather than actually deposit it, a boon to managing cash flow.

Ownership

HSA: Money in the account belongs to the individual and goes with him if he leaves the job.

HRA: If the employer chooses, money in the account may revert to the employer when an employee leaves the job.

Coverage

HSA: Money in the account can be used to pay for any "qualified medical expenses," as defined by the IRS, which includes a wide array of procedures, services, and products.

HRA: The employer determines which qualified medical expenses are covered. "In most cases, employers restrict coverage in one way or another," says Alexander Domaszewicz, a principal at Mercer Human Resource Consulting. "They may choose not to cover Lasik eye surgery, for example, or fertility treatments or acupressure," all of which are considered qualified medical expenses by the IRS.

Withdrawals

HSA: Employees can withdraw money from the account for nonmedical expenses, paying a 10% penalty if they are under 65.

HRA: No withdrawals for nonmedical expenses are allowed.

So which plan is for you? Both are worthy alternatives, but consider the case of business owner Kevin Bredthauer, 50. Nearly all of Bredthauer's 20 employees get health coverage through his company, Central Iowa Grain Inspection, in Iowa Falls. When it came time to renew his HRA earlier this year, he briefly pondered switching to an HSA but didn't.

Bredthauer had already reduced his premiums sharply by switching to a health plan with a $4,000 deductible two years ago when he instituted the HRA, and setting up an HSA wouldn't lower premiums any further. Indeed, he worried that he might actually lose money if he switched. His company covers the first $2,000 of an employee's deductible medical expenses through the HRA account. But last year several employees didn't use any of that allotted money, says Bredthauer. Since his HRA doesn't pay out until there is a medical claim, the company isn't out a penny on those employees. If he had contributed the same $2,000 up front to an HSA, it would belong to the employees, whether or not they had any medical expenses. Even though the HRA money belongs to Bredthauer's company, employees are motivated to watch their spending because they know if they go over the amount contributed by the employer, they'll have to pay from their own pocket--in this case, $2,000--for medical expenses until they reach the $4,000 deductible.

Bredthauer was also concerned that he would have much less control if he switched employees to an HSA. "Once you put that money in the account, it's the employees', and if they decide they want to take it out and buy a motorcycle with it, they can," he says. Helping an employee pursue an Easy Rider fantasy isn't how Bredthauer wants his health-care contribution used.

Because money in the HRA can remain with the employer when an employee leaves, those types of accounts may be more attractive to companies that have high turnover. At the same time, an HRA balance may actually encourage an employee to stay with his current employer. "Employees who have built up $1,000 or $2,000 in their accounts are less likely to go across the street for an extra quarter an hour," says Mercer's Domaszewicz. On the other hand, because HSA account balances belong to the employee and not the company, "they don't encourage longevity at a company," he says.

Still, HSAs may be popular with very small employers that can't afford to offer insurance to their employees, says Gary Claxton, vice president for the Henry J. Kaiser Family Foundation, a nonprofit health-care research organization in Menlo Park, Calif. An employer can set up the HSA and contribute a small amount to the account, contingent on employees' buying insurance on their own. Although paperwork can generally be handled by an insurance company or a third-party administrator, employers with HSAs can pass those administrative fees on to employees--a choice employers with HRAs do not have.

Since HRAs seem to hold so many advantages over HSAs, why have they been virtually ignored in the debate about how to reduce health-care spending? In a recent interview, Hector Barreto, administrator of the Small Business Administration, called HSAs "a very important deliverable for small businesses" in their efforts to lower health-care costs. He noted that President Bush has proposed a small-business tax credit of as much as $500 a worker on HSA contributions. But he said he knew little about HRAs, and said he didn't think that small businesses were very aware of them either. No small-business tax incentives have been proposed to encourage the use of HRAs.

Political philosophy rather than pragmatics may be at work. President Bush has long talked of his desire to move toward an "ownership society," in which individuals take more financial responsibility for their own retirement and health care. The current system of employer-sponsored health insurance doesn't support that goal. "If your idea is that individuals should have these accounts to save for their own future, then HRAs aren't a good way to do that," says Kaiser's Claxton.

But some employers see HRAs as a good way to make a gradual transition to health plans that require consumers to be more accountable for their spending. Richard Brown, 38, controller for Siegel Properties, a real estate firm in Beachwood, Ohio, says his company decided to set up an HRA this year partly because management worried that an HSA might be too radical an adjustment for employees accustomed to a traditional employer-sponsored plan. The company's health plan has a $2,500 deductible, and it reimburses the first $500 through the HRA. If employees use up the $500, they are responsible for the next $2,000 in expenses until the deductible is met. "We think that by letting our employees decide how to use the money that we're putting out there, maybe they'll start paying attention to choices," says Brown. But he's not ruling out an HSA in the future, and he doesn't think the company will ever return to a traditional employer-sponsored plan. "We stuck our toe in the water this year," he says. "The days of employers' paying 100% of health care are gone."