Every employer who offers health benefits struggles with ever increasing costs.  Higher premiums must be absorbed or passed on to employees, who balk at the reduction in take home pay.  One solution to this problem can be found in a Health Reimbursement Arrangement or HRA.  It is a form of defined contribution health plan that can not only reduce plan premiums but also encourage employees to manage health care costs more efficiently.
HRAs are straightforward.  They can only be used to reimburse substantiated medical expenses incurred by the employee or the employee’s spouse or dependents during the plan year. They are funded entirely by employer contributions.  Hence, they must be kept separate from any cafeteria or flex plan benefit that entails an employee salary reduction agreement.  However, unlike a cafeteria plan “use it or lose it” limitation, unused balances in an HRA account can be rolled over into the next plan year. Employees will like this feature.  Employees who husband their HRA can build an account balance that will serve as a cushion against unexpected doctors’ bills or be used to pay for anticipated but significant medical expenses that are not otherwise covered by insurance.  Unused HRA balances can even be used by former employees to help transition into retirement or a new job.

At first glance, HRAs might not seem all that appealing to an employer since it must bear the full cost.  The trick here is to see the big picture.  Although it can be a stand alone benefit that will be very attractive to employees, an HRA can also be used together with a plan providing high deductible health coverage to reduce employer costs.  Since premiums for high deductible health coverage can be significantly lower, the employer can even use some of the savings to fund employee HRA accounts.  This could not only curb those constant premium increases, but also help stabilize this volatile cost of doing business. 
Naturally, there are special IRS rules that govern the use of HRAs.  In order to ensure that the benefit is a deductible business expense—and is excludable from employee income—, HRAs can only be used to reimburse substantiated medical expenses.  However, this could include payments for vision and dental care and even health insurance premiums.  Salary reduction arrangements cannot be used directly or indirectly to fund HRA accounts.  This can be tricky if a cafeteria plan is used to pay for high deductible health coverage that is commonly used in conjunction with an HRA account.  However, proper planning can avoid this result and preserve the favorable tax treatment conferred on HRAs. 

An HRA cannot be used to reimburse the same expenses as those that are reimbursable under a salary reduction funded health Flexible Spending Account (FSA).  This usually means that the health FSA account must be used up before the HRA account can be tapped to reimburse the same covered expense.  HRAs are also ERISA plans, and they must be offered as part of any COBRA continuation coverage.  Finally, unused HRA balances cannot be cashed out or used as the basis for severance payments to departing employees. 

HRAs can be a valuable management tool.  They offer an employer an opportunity to reduce health care costs by combining the HRA with a lower premium high deductible health plan.  HRAs also encourage employees to manage their accounts in ways that minimize medical costs and build unused balances that can be carried forward from year to year for either unanticipated expenses or planned medical treatments.  For the finish, an HRA can help control one of the most pernicious causes of increased costs for both employer and employee.