Today, HRAs powering standalone defined contribution plans (DCP) are a solution for millions of small employers unable to afford and/or administer a group plan.  However, from 2002 to 2011, it is esimated that less than 10% of U.S. Businesses adopted HRAs, or Health Reimbursement Arrangements. This relatively low level of growth and penetration during the first ten years of HRAs is surprising given the flexibility and benefits that HRAs provide to both employers and employees.  However, until now, four problems, none of them related to the HRA itself, prevented employers and employees from fully benefiting from HRAs.

Prior to World War II, many employees purchased their own individual or family health insurance policies, sometime called “personal” health insurance policies, just like they do today with homeowners, auto, and life insurance. As mentioned earlier, in 1945, to get around wartime wage and price controls, employers were allowed to give employees unlimited health benefits without having to report it as income.

In the late 1960s, as inflation and other factors increased the cost of employer-sponsored health benefits, employers began instituting annual deductibles and coinsurance on their health benefits plans, and/or excluding coverage for certain medical items that were legally allowed to be covered by IRS regulations (e.g. vision, dental, alternative medicine). Excluding these medical expenses effectively almost doubled the employee cost for these items on an after-tax basis.

The History of Health Savings Accounts, or HSAs, goes back to the 1980s and 1990s when Congress began discussing Medical Savings Accounts (MSAs)

In the 1980s and 1990s, Congress began discussing Medical Savings Accounts (MSAs) where any consumer could (1) pay for all medical expenses with tax-deductible dollars and (2) spend or save unlimited tax-advantaged amounts for current or future medical expenses.

At the beginning of the 20th century, when most employees worked at large manufacturing plants, larger employers provided self-funded, self-managed, onsite medical care in the form of a company doctor. This developed into today’s system in which employers pay for employee medical expenses through self-insured or fully-insured health benefits plans. These came to be known as defined benefit healthcare plans in which employees receive a defined benefit, typically unlimited healthcare, at uncertain cost to the employer.  For more information on HRAs, see What is an HRA?.

Why does your employer offer health insurance?  Is it because they care about your health? 

Prior to World War II, most Americans paid for their own medical care, either directly to their chosen provider or through Blue Cross nonprofit health insurance entities which were created by hospitals to offer individuals guaranteed service in return for a fixed fee. Back then, health insurance was really insurance—providing payment only for major items like hospitalizations that people could not afford to pay for themselves.

Many employees purchased their own individual or family health insurance policies, sometimes called personal health insurance policies, just like they do today with homeowners, auto, and life insurance.

During World War II, government leaders and economists were greatly concerned with potential postwar inflation. They had seen firsthand what happened in Germany after World War I, and blamed Hitler’s rise to power on Germany’s postwar inflation and economic ruin.

To avoid inflation, the U.S. Congress and President Roosevelt instituted wage and price controls during World War II and were determined to maintain them after the war.

In 1945, in order to politically grant a concession to labor without appearing to violate wage and price controls, the federal government exempted employer-paid health benefits from wage controls and income taxation—in effect allowing off-the-books raises for employees in the form of nontaxable health benefits.

This was economically equivalent to giving employees cash for their medical expenses, cash that employers and employees legally didn’t have to report to the IRS. This unreported off-the-books compensation in the form of health benefits created an enormous tax advantage for employer-sponsored group health benefits over personal health insurance policies and incidental medical expenses purchased by employees with their own after-tax dollars. Employers received a 100% federal, state, and city tax deduction for the cost, and health benefits received by employees were exempt from individual federal, state and city taxation.

This created an up to 2-for-1 tax advantage (depending on the income tax bracket of the employee) for employer health benefits provided by employers versus health benefits, including personal health insurance policies, purchased by employees themselves.

Today, most employers offer their employees group health benefits and typically pay 60%-100% of the cost for employees who participate. Group employer health care costs (and group insurance premiums) have been increasing the past five years at 3-4 times the rate of general inflation.

In response to the rising costs of group coverage, employers have been reducing health benefits, increasing the employee (and especially dependent) cost to participate, or even cutting out health benefits entirely. An increasingly popular way to counteract the rising costs of group coverage and to maintain employee benefits is with tax-advantaged benefit programs such as HRAs, FSAs, POPs, and HSA’s.

Last week during President Obama's address on health care reform, he stated that one of the major problems with the current system is that health insurance in the private market costs three times as much as insurance in the group market. This is one of the biggest misconceptions in health care. Health insurance in the private market is typically 1/2 to 1/3 the price of comparable coverage on the group market.