Health spending accounts: a prescription for cost control

Money, money and more money… that’s probably what comes to mind for most HR professionals when they consider their company benefit plans.

Having a competitive benefits package is important but it isn’t easy providing a top-notch plan as costs continue to rise year after year with no end in sight.

The drivers for this include — among others — increasing usage, drug costs outpacing inflation by a wide margin and annual renewal rates frequently in the 10 to 15 per cent range.

With these factors as annual realities, it is no wonder plan sponsors continue to look for innovative benefit designs to try and reign in costs.

One of the innovations of the last decade that helps to provide some relief is the health spending account. It is one of the few “trendy” innovations that has proved to have some staying power.

One of the reasons for this survival is that health spending accounts have something to offer both the plan sponsor and the employee. Rather than just saving costs for the sponsor, the health spending account provides a level of flexibility and control that was previously absent in most benefit plans.

While there is undeniably a focus on controlling costs, there is also a built-in accommodation for different needs and circumstances which appeals to a lot of plan members.

Many options for plan design
Plan sponsors can introduce health spending accounts in several ways. They can be an adjunct to a traditional benefit plan or, as part of a flexible benefits plan, they can be used to deposit any flex credits not used to purchase other benefits. They can even be used as a stand-alone alternative to offering a benefit plan at all.

Plan sponsors may wonder how they can find more money to fund health spending accounts for each of their employees. Often, these funds become available as a result of redesigning the existing plan and allowing employees to choose where the benefit dollars go, rather than the sponsor paying for the same benefits for everyone. Sometimes the introduction of a health spending account does involve additional costs, but at least they are defined and fully at the discretion of the plan sponsor.

Similar to the defined contribution pension plan rationale, the health spending account enables plan sponsors to determine the total financial obligation to this part of the plan. Whether it functions as a stand-alone or as part of the overall benefits plan, sponsors determine how much money they will allot to the account of each employee for each benefit year. Essentially, these accounts then become personal “benefit bank accounts” where each employee can submit health and dental claims for reimbursement out of the total balance. As far as the plan sponsor’s financial responsibility, that’s it; there is no need to worry about annual renewal increases or plan deficits with the health spending account approach.

Currently, it is most common to find the health spending account offered along with some type of corporate benefit plan. However, this too, is changing. Some plan sponsors are beginning to see an advantage to stepping out of the plan design equation entirely. What’s more, health spending accounts are governed by the Income Tax Act. As a result, eligible expenses are much more widely defined than in most private plans. As well, the definition of dependent extends beyond the traditional family definition to include any person who is demonstrably financially dependent on the plan member, such as a disabled spouse, a parent or even a grandchild.

Plan members benefit too
A health spending account also works for plan members by allowing plans to accommodate different needs and circumstances. Its basic intent is to pay for those health and dental expenses that are not covered by the group plan.

Consider the following examples. A 20-something employee works in a company with a flexible benefits plan. She is in good health and visits the dentist only once a year for check-ups, if that. But she does wear contacts and has been considering laser eye surgery. In most cases, a traditional employer-sponsored plan would provide for comprehensive health and dental care, but for this employee it would be largely unused. Meanwhile her expenses for laser eye surgery would not be covered.

The advantage of the health spending account approach is that it puts the use of employer-funded benefits at the discretion of the employee. If, instead of traditional coverage, this employee could choose little or no coverage for health and dental care, but had access to a health spending account with a substantial amount, say $1,000, she could use that money to pay some of the cost of her laser eye surgery.

By choosing that option she would have a benefit that had more value to her than standard health and dental coverage that she didn’t use. Further, because a health spending account uses pre-tax dollars (with the exception of Quebec, where health spending account reimbursements are considered a taxable benefit) she would have more buying power with the funds in her health spending account than with her after-tax pay cheque.

Conversely, suppose another employee is a member of the “sandwich” generation. He still has children at home but is also supporting an aging and ailing parent. His spouse has good benefits, but they are limited to the traditional definition of family, that is, a spouse and dependent children. If he worked for the same employer as in the previous example, he could also choose the option with little or no coverage for health and dental care and use the $1,000 balance to reimburse expenses related to his dependent parent’s health and dental care.

Risk and return
Of course there is always a catch, and health spending accounts have theirs. To maintain the beneficial tax status, health spending accounts must involve some element of risk to the employee. The money can’t just be awarded tax-free. The way this risk has been incorporated in most plans is through a balance carry-forward process. Simply put, this means that while the plan sponsor allocates funds to the account annually, at the end of every 24-month period, any remaining balance from that initial deposit reverts to the plan sponsor. So if $500 was deposited in the account in January 2000 and another $500 was deposited in January 2001, and if no claims were submitted against the account, the maximum balance would be $1,000. In January 2002, if any of the original $500 still remained, that amount would revert to the plan sponsor.

Another way plan sponsors can incorporate risk in the plan is through an expense carry-forward approach. With this method, any balance in the account reverts to the plan sponsor at the end of each calendar year, but employees can accrue expenses and claim them against the following year’s allotment. This approach is less common; it may be because it is less intuitive for plan members.

The U.S. Difference
It is important to remember that Canadian employees are not allowed to cash out any unused funds, nor can they contribute their own money to increase the balance of their accounts. Canadian health spending accounts must be entirely funded by the plan sponsor.

Our neighbors to the south have taken a different approach to the health spending account. Calling it a “flexible spending account,” the American approach similarly leverages the advantage of using pre-tax dollars and of personal flexibility in coverage choices, but differs in one critical area: U.S. employees can direct their own money into the account through payroll deduction. Since information about American health issues is common in Canadian media, this distinction can lead to some confusion. It is very important that Canadian employees understand the rules that govern their plans.

The cost/benefit balance
At the end of the day, few health care innovations last if there isn’t some real benefit to be reaped from their implementation. That health spending accounts are still an integral part of many plans (and continue to be introduced) attests to their bottom-line results. Plan sponsors have seen that health spending accounts, used effectively, can help limit their benefits spending and, at the same time, create more awareness of their total contribution toward employee benefit plans. Through their involvement in administering these accounts, employees learn about the real dollar value of their benefits, as well as the ever-increasing costs of health and dental care. Further, because they are able to spend those dollars where it has the most value for their respective needs, employees can better appreciate their benefits plan, and the plan sponsor that offers them.

Jacqueline Taggart is a principal in the Communications Practice of the Toronto office of Morneau Sobeco. She can be contacted at (416) 385-2119 or [email protected].

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