14.2 Consumer-Driven Health Plans (CDHPs)
Consumer-driven health care (CDHC) is designed to give individuals greater control over how their health care dollars are spent. It uses a structured three-tiered approach to fund medical services and treatment, encouraging informed decision-making and cost-conscious behavior.
Under this approach, individuals are responsible for managing and allocating health care funds across different levels of coverage. Consumer-driven health plans support this process by offering tools and financial structures that allow individuals to decide how and when their health plan funds are used.
Common options within consumer-driven health plans include:
- Tier 1: Pretax Funding Accounts
- This first tier consists of pretax accounts used to pay for qualified medical expenses. These include a Health Savings Account, Archer Medical Savings Account, Health Reimbursement Arrangement, and Flexible Spending Account. Funds in these accounts are typically contributed on a pretax basis, reducing taxable income while allowing individuals to cover eligible health care costs.
- Tier 2: Out-of-Pocket Spending
- The second tier represents the portion of medical expenses that the individual pays out-of-pocket after funds in the pretax account have been exhausted but before the health plan’s deductible has been satisfied. This phase requires individuals to directly manage and pay for their health care costs.
- Tier 3: High Deductible Health Plan (HDHP)
- The third tier involves a High Deductible Health Plan, which provides insurance coverage after the deductible has been met. These plans are specifically designed to work in coordination with pretax accounts, helping individuals manage overall health care spending while maintaining protection against significant medical expenses.
High Deductible Health Plan (HDHP)
A High Deductible Health Plan functions similarly to traditional health insurance plans; however, it is subject to specific requirements regarding minimum individual and family deductibles, as well as maximum annual out-of-pocket limits.
To qualify as a High Deductible Health Plan, a plan must meet minimum annual deductible requirements and cannot exceed the maximum annual out-of-pocket limits established by the Internal Revenue Service.
With the exception of preventive care—which must be covered without cost-sharing—most covered health care expenses are paid out-of-pocket by the insured until the deductible is satisfied. After the deductible is met, the plan begins to share costs. Depending on the plan design, the insured may have minimal out-of-pocket expenses or may continue to pay a portion of costs through coinsurance until reaching the plan’s annual out-of-pocket maximum.
High Deductible Health Plans are also subject to limits on the amount an individual may contribute to associated pretax accounts, including a Health Savings Account, Archer Medical Savings Account, Health Reimbursement Arrangement, and Flexible Spending Account.
Health Savings Accounts (HSAs)
A Health Savings Account may be established by an employer or an individual for the benefit of an eligible account holder (the taxpayer, including a spouse or dependents) who is covered under a High Deductible Health Plan.
HSAs are funded with pretax dollars, grow on a tax-deferred basis, and allow for tax-free withdrawals when used to pay for qualified unreimbursed medical expenses. Withdrawals used for nonqualified expenses before age 65 are subject to a 20% penalty, in addition to ordinary income tax.
Once the account holder reaches age 65, funds may be withdrawn for any purpose without penalty; however, withdrawals not used for qualified medical expenses are subject to ordinary income tax. The penalty is also waived in the event of the account holder’s death or disability.
There are no income restrictions for establishing an HSA. However, contributions are only permitted for months in which the individual is enrolled in a qualifying HDHP.
An eligible individual or employer may establish a Health Savings Account with a qualified custodian or trustee, typically a bank or an insurance company.
Contributions to the account may be made by the individual, the employer, or both. Individual contributions are generally tax-deductible, while employer contributions are excluded from the employee’s gross income.
Any funds remaining in the account at the end of the calendar year may be carried forward to the next year and used for future qualified expenses without incurring a penalty.
Medical Savings Account (MSAs)
Archer Medical Savings Accounts are similar in structure to Health Savings Accounts; however, they differ in contribution limits, minimum annual deductibles, and maximum out-of-pocket requirements. MSAs were specifically designed for small businesses and self-employed individuals who are not eligible to establish Health Reimbursement Arrangements or Flexible Spending Accounts.
An Archer Medical Savings Account is established in conjunction with a High Deductible Health Plan. It is typically set up by an employer on behalf of an employee. Premiums paid by the employer are tax-deductible to the business, and distributions used for qualified medical expenses are not taxable to the employee.
Nonqualified distributions from an Archer Medical Savings Account are included in the employee’s gross income and are subject to a penalty if taken before age 65. Any unused funds remaining at the end of the year may be carried forward to the following year for future use without incurring a penalty.
Health Reimbursement Arrangements (HRAs)
A Health Reimbursement Arrangement is an employer-funded health benefit that reimburses employees for qualified medical expenses. These arrangements are funded entirely by the employer, and there is generally no statutory limit on employer contributions. Employees are not permitted to contribute, and funding cannot be derived from salary reduction agreements.
Cash payouts are not permitted under a Health Reimbursement Arrangement; however, a former employee may be eligible to continue coverage for subsequent periods, depending on plan provisions. Employer-provided coverage and reimbursements for qualified medical expenses are generally excluded from the employee’s gross income.
With a Health Reimbursement Arrangement, unused funds may be carried over from one plan year to the next; however, the employer has full discretion over the rollover provisions. The employer may allow all, some, or none of the remaining balance to carry forward, and may also require that all unused funds be forfeited at the end of the plan year.
If an employee terminates employment, any remaining funds in a Health Reimbursement Arrangement generally revert to the employer. The employee does not have ownership rights to employer-funded contributions.
Health Reimbursement Arrangements are not required to be paired with a High Deductible Health Plan and may be offered independently of such coverage.
Flexible Spending Accounts (FSAs)
A Flexible Spending Account is an employer-established plan that allows employees to set aside a specified amount of income on a pretax basis into a designated account. These funds may be used to pay for unreimbursed qualified medical expenses, such as eyeglasses, elective procedures, deductibles, copayments, and coinsurance, which are part of the individual’s out-of-pocket health care costs.
The Internal Revenue Service establishes an annual limit on the amount an employee may elect to contribute to a Flexible Spending Account. The employer makes the full elected amount available at the beginning of the plan year, and then recovers the employee’s contributions through prorated payroll deductions over the course of the year until the total election is satisfied.
Contributions to a Flexible Spending Account are generally subject to a “use-it-or-lose-it” provision under a voluntary salary reduction agreement. If the employee does not use all allocated funds by the end of the plan year, any remaining balance is typically forfeited to the employer.
Employers may, at their discretion, offer a grace period of up to 2½ months into the following plan year, during which employees may use any remaining funds.
A Flexible Spending Account may be established independently and does not require enrollment in a High Deductible Health Plan or any other health insurance plan.
Quiz
1. Which tier in consumer-driven health care includes pretax accounts such as HSAs and FSAs?
A. Tier 1
B. Tier 2
C. Tier 3
D. Tier 4
Correct Answer: A
Rationale: Tier 1 consists of pretax funding accounts (such as HSAs and FSAs) specifically designed to pay for qualified medical expenses using tax-advantaged dollars.
2. What must an individual have in order to contribute to a Health Savings Account (HSA)?
A. Flexible Spending Account (FSA)
B. High Deductible Health Plan (HDHP)
C. Health Reimbursement Arrangement (HRA)
D. Medicare Part A
Correct Answer: B
Rationale: An individual must be enrolled in a qualifying HDHP to be eligible to contribute to an HSA, as required by IRS guidelines.
3. Which statement best describes a Health Reimbursement Arrangement (HRA)?
A. It is funded by employee salary reductions
B. It is jointly funded by employer and employee
C. It is fully funded by the employer
D. It requires an HDHP to be valid
Correct Answer: C
Rationale: HRAs are entirely funded by the employer, and employees are not permitted to contribute under any circumstances.
4. What happens to unused funds in a Flexible Spending Account (FSA) at the end of the plan year?
A. They are automatically rolled over
B. They are paid out in cash to the employee
C. They are forfeited to the employer
D. They are transferred to an HSA
Correct Answer: C
Rationale: FSAs generally operate under a “use-it-or-lose-it” rule, meaning unused funds are forfeited unless a limited grace period is offered.
5. How are nonqualified distributions from a Medical Savings Account (MSA) treated before age 65?
A. Tax-free with no penalty
B. Subject to penalty only
C. Included in income and subject to penalty
D. Deferred until retirement
Correct Answer: C
Rationale: Nonqualified withdrawals from an MSA are included in gross income and are also subject to a penalty if taken before age 65.