Consumer Directed Health Care

Consumer Directed Health Care
Health Reimbursement Arrangements (HRAs)
Health Savings Accounts (HSAs)
Flexible Spending Accounts (FSAs)
Qualified Medical Expenses

Consumer Directed Health Care (CDHC) is a broad definition incorporating several health care strategies that heighten consumer awareness of the cost and utilization of healthcare services through plan design incentives.

In practice, a CDHC could encompass any or all of the following strategies:

  1. Modifications to traditional HMO, POS, and PPO benefit plans using plan design elements such as high deductibles, coinsurance and co-payments to give incentive to plan participants to take a more vested interest in the cost and frequency of services used (utilization).
  2. Tiered Networks within an HMO, POS, or PPO network where participants pay higher co-payments or coinsurance when using higher cost providers.
  3. Health account based plan where a tax-advantaged account… a Health Savings Account, Health Reimbursement Account, or Flexible Spending Account is combined with a high deductible HMO or PPO plan to empower the plan participant with greater flexibility and financial responsibility in accessing care. Unlike FSAs, unused balances in Health Savings Accounts or Health Reimbursement Accounts may be rolled over into subsequent plan years.
  4. Information systems (web and voice) that provide consumers with greater price transparency in purchasing care along with tools to make informed and prudent decisions about accessing health care services.
  5. Provision(s) within a plan or an employee contribution strategy where the plan sponsor makes a Defined Contribution toward all or a portion of the cost of benefits.

    Why offer it?

  • Offers greater choice and empowers employees to select the plan that most closely meets his or her needs.
  • Gives incentives to employees to become more involved in making economic decisions about the utilization of health care resulting in more educated consumers  demanding lower cost and higher quality service from their providers.
  • Addresses cost and access problems within the current health care system by providing a lower cost option that allows open access to any provider.
  • Most plans encourage employees to maintain good health by providing first dollar coverage for preventive care services and additional wellness services.

What types of employers offer it?
Many types of employers are implementing strategies that are in some fashion consumer directed.  Health account based CDHPs are available to employers of all sizes.  These plans are often available as an option alongside traditional HMOs, POSs and PPOs, although some employers are fully replacing their traditional plans with CDHPs.  The Government Accountability Office (GAO) reported 3 million individuals enrolled in high deductible health plans as of January 2005, increasing to between 5 and 6 million in January 2006.  The US Treasury projects Health Savings Account holders to be over 14 million by year 2010.

What are the critical underwriting or participation requirements?
Underwriting and participation varies by employer size and vendor.  Adverse selection, where healthy employees move to consumer directed plans, while high users of the plan  will stay in more traditional plans, is a significant concern.  This can be a concern if the more traditional plan is offered alongside the CDHP.

How much does it cost?
Cost will vary based on a number of factors including plan design, demographic factors and/or plan experience, and cost sharing strategies.

Pros and Cons


  • Potential for lower plan cost
  • Rewards efficient purchasing/consumption
  • Allows significant flexibility for participants
  • Highest users pay highest cost
  • Lowest users can accumulate "nest egg" in health accounts that can be used for post-retirement healthcare


  • Immediate cost reduction often requires full replacement
  • Adverse selection potential and delay of needed care could increase total costs
  • Health care industry is not fully enabled for consumers
  • Communication challenges

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Health Reimbursement Arrangements (HRAs)

What is it?
Health Reimbursement Arrangements (HRAs) were created by an administrative ruling issued by the IRS in June 2002. This ruling reinterpreted existing regulations relating to Flexible Spending Accounts, and created accounts in which accumulated funds could roll over from one year to the next for the first time.

Health Reimbursement Arrangements consist of employer contributions to notional accounts kept on behalf of enrolled employees. Similar to Flexible Spending Accounts, employees can use HRA funds for reimbursement for eligible medical expenses. Unused funds can be rolled over from year to year, subject to limits established by the employer. The funds are owned by the employer and may be forfeited should the employee terminate or remove themselves from the plan.  The account can never be cashed out and taken as compensation by the employee.  If the employer permits withdrawals for non-medical expenses, the HRA will be disqualified for all employees, who will owe taxes on all amounts paid out of the HRA, including all prior medical reimbursements.

Why offer it?
HRAs can be used as the Personal Health Account component of a Consumer Directed Health Plan, although an employee does not need to be covered under any other health care plan to participate)

Funds in HRAs are controlled and potentially retained by the employer upon termination of the employee. Accumulated funds may act as an additional retention incentive.

HRAs offer more employer flexibility with regards to overlying medical plan design and rollover features than Health Savings Accounts.

What types and size of employers offer it?
Employers of all sizes may offer HRAs.

What are the critical underwriting or participation requirements?
Outsourced administration fees are based on the size of the group and plan participation.
The plan must meet basic non-discrimination requirements in order to obtain favorable tax treatment.

How much does it cost?
As with other plans, HRA cost is entirely up to the employer.  Important factors include:

  • How much money to contribute per year?
  • How much may be rolled over from year to year?
  • How the funds may be used (if at all) after the employee ceases employment?

The HRA has proven to be an effective cost containment tool when used as a component of a Consumer Directed Health Plan.

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Health Savings Accounts (HSAs)

What is it?
An HSA is a tax-favored savings account designed to integrate with a high deductible health plan (HDHP). Similar to a 401(k) or IRA, HSA balances are owned by the participant and accumulate earnings on a tax-free basis. Both employers and employees can make contributions to an HSA. Employee contributions to the HSA are tax-deductible or can be made on a pre-tax basis through a Section 125 plan. Employer HSA contributions (if any) are not taxable to the employee.

In most cases the HSA owner has full discretion to decide how to invest their HSA dollars. HSA balances roll from one year to another and are not forfeited when employment changes - there is no "use it or lose it" rule. HSA owners can withdraw funds tax-free from their HSA, provided the funds are used to pay for qualified medical expenses and certain permissible health care premiums. Withdrawals made for non-qualified expenses are taxable as income and if under age 65 subject to a 10% excise tax.

The core attributes of an HSA include:
An HSA may only be established in conjunction with a qualifying high deductible health plan (HDHP).  There are a number of guidelines that determine the plan design of a qualifying HDHP plan, but in general an HDHP plan must meet the following parameters:

HDHP Guidelines 2012 2013 2014
  Individual Family Individual Family Individual Family
Minimum Deductible $1,200  $2,400 $1,250
$1,250 $2,500
Maximum Out-of-Pocket $6,050 $12,100 $6,250
$6,350 $12,700
Contributions up to: $3,100 $6,250 $3,250 $6,450  $3,300  $6,550

Additional HSA Considerations:

  • Individuals age 55 and older (not enrolled in Medicare) can make “catch-up” contributions up to $1,000 in 2011, 2012 and 2013.
  • HDHPs can provide first dollar coverage for certain preventive and health screening services.
  • Persons covered under an HDHP cannot be covered under any other health plan that is not high deductible.
  • Co-payment based prescription drug plans are not permitted, unless they are subject to the medical plan deductible.
  • Most Flexible Spending Accounts (FSAs) are not compatible with high deductible health plans and cannot be elected by an HSA participant or his or her spouse. Certain limited purpose or post-deductible FSAs may be allowable.  Employees may enroll in an HSA during the grace period of the FSA (if applicable) provided that there is a zero balance by the end of the plan year or are planning on rolling over the funds into their HSA.  For more information please reference Revenue Ruling 2004-45 and H.R. 6111.
  • Wellness programs, including EAPs, may be offered by employers if they do not pay for significant medical benefits.

Any amount withdrawn to pay for non-qualified expenses are subject to taxation and/or penalty tax from the IRS.  Some HSA qualified expenses include, but are not limited to:

  • Medical and dental deductibles and co-payments.
  • Routine physical and gynecological exams.
  • Eye exams, eyeglasses, contact lenses, corrective Lasik eye surgery.
  • Professional services, hospital services, medical treatments.
  • Dental services, laboratory exams/tests.
  • Equipment and supplies.
  • Over the counter medications, with certain restrictions.

For a complete list of “qualified medical expenses” covered by an HSA, please visit the  Enter “502” in the Search Forms and Publications field.

Another good resource is

Insurance Exceptions
Insurance premiums are generally not considered eligible medical expenses.   However, there are four exceptions:

  1. Premiums for continuation coverage under COBRA or ERISA for the accountholder, spouse or dependents;
  2. A qualified long-term care insurance contract;
  3. A health plan maintained while the accountholder, spouse or dependent is receiving unemployment compensations under any Federal or State Law;
  4. Premiums for those over the age of 65, including Medicare or retirement health benefits provided by a former employer.

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Health Care Flexible Spending Account (FSAs)

What is it?
A Health Care Flexible Spending Account (FSA) is a type of cafeteria plan which allows participants to fund qualified un-reimbursed health care expenses with pre-tax contributions made to an individual health care FSA account.  Employees estimate their health care expenses prior to the start of the plan year and elect an amount to be deducted from their paycheck over the course of the plan year.  Expenses can be for the employee and their eligible dependents up to an annual plan maximum established by the employer.

Why offer it?

  • Minimal to no cost to the employer
  • Reduced employer liability for FICA and FUTA taxes, and workers’ compensation premiums in some states
  • Reduces employee’s taxable income
  • Provides tax-favored employee funding of certain benefits that the employer may not elect to cover (e.g., orthodontia, vision, chiropractic, etc.)

What types of employers offer it?
Employers wishing to offer additional employee benefits with little employer cost

What size employers offer it?
Generally offered by employers with 50 or more employees; plan must pass annual discrimination testing.  Smaller employers are more likely to have trouble meeting the non-discrimination testing requirements.

What are the critical underwriting or participation requirements?
Administration fees are based on the size of the group and plan participation.

The plan must meet non-discrimination requirements in order to obtain favorable tax treatment.

How much does it cost?

Most employers elect to outsource plan administration.  General fee ranges:
Set up/Renewal fees: $1,000-$3,000
Monthly per participant fees: $3 to $6

Other services such as: discrimination testing, plan document, summary plan description and Form 5500 preparation may be included in set up/renewal fees or charged on a per service basis.

Employer costs are fully or partially offset through savings from payroll reduction leading to lower FICA and FUTA taxes, and in some states workers compensation premiums.

Pros and Cons


  • Enhances benefit program at minimal to no cost to employer
  • Reduces employee’s taxable income
  • Outsourcing provides employer ease of administration
  • Many administrators now offer a debit card for FSA reimbursements, easing participant administration


  • Strict rules apply, which can create employee relations issues if not communicated properly
  • Employee contributions are "use it or lose it"
  • Potential liability to the employer in the event that an employee terminates employment prior to fully funding their account
  • Employees who participate in the health FSA are not eligible to participate in a Health Saving Account (HSA)

Health FSA must be offered as a COBRA benefit.
Employees can be reimbursed for expenses that are not yet funded through payroll deduction. For example:

Employee elects to contribute $1,200 annually ($50 per pay period) to their Health Care FSA beginning January 1.  Employee submits a Health FSA claim on February 1 for $1,200 in eligible expenses. Although the employee has only contributed $100 to their account year to date, the employee will receive reimbursement for the full $1,200.

Due to employer liability associated with the plan, most employers limit plan maximums to $2,000-$5,000.

The 2 ½ month “grace period” allowed by the IRS is optional to employers.

This information contained is designed to provide a general overview of the benefit program, service, or regulatory act it describes.  The information included in this document is not a substitute for legal or professional opinion relative to a plan sponsor’s particular fact pattern.  For more specific questions relative to its application for your organization please call Jerry Gregor at 973.290.9505 or email us at