Consumer-Directed Health Plans (CDHPs)

Introduction

Consumer-directed health care is the latest approach to managing the spiraling cost of health care by engaging consumers to take a more active role in their health care decisions. Consumer-directed health plans (CDHPs) are typically a combination of a high-deductible medical insurance plan coupled with a health care savings plan that consumers access to pay for eligible medical care expenses. Account assets roll-over each year and compound over time, allowing consumers to save for future medical care expenses.

Two significant legislative actions allow for these new CDHP program structures:

•  Health Reimbursement Arrangements (HRAs), created by IRS guidance in June of 2002; and
•  Health Savings Accounts (HSAs), which were created as part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003.

These legislative actions were designed to encourage market growth by allowing tax relief for employers and employees who participate in these programs.

How do CDHPs work?

The health plan is generally a high-deductible medical plan that provides 100 percent preventive care coverage, for services such as annual physicals, mammograms, immunizations, and well-child care. These plans are typically less costly than current co-payment type medical plans. In addition to other funding mechanisms, the premium savings generated by moving to a high-deductible plan can be used to fund the health care savings plan for the participant. Contributions to the plan are made pre-tax while account balances accumulate and compound tax-free. Depending upon the type of plan, this can be employer-funded, employee-funded¹ or funded by both the employer and the employee¹. Unused account balances roll-over from year-to-year providing consumers with financial incentives to make wiser choices in seeking medical care services.

Consumers access their accounts to pay for any qualified pre-retirement and/or post-retirement medical, dental, or vision out-of-pocket expenses allowed by the IRS (deductibles, co-payments, co-insurance, uninsured expenses, etc.), plus post-retirement insurance premiums for medical, dental, vision, qualified long-term care premiums, Medicare Part B premiums, Medicare Part D premiums, and Medicare supplement insurance plan premiums². Reimbursement of expenses during active employment as well as after retirement are tax-free to the consumer.  Health care savings plans are the only vehicles that allow tax-free reimbursement of post-retirement insurance premiums and expenses.

Is there a consumer's need for CDHPs?

One of the greatest threats to retirement security is retiree health care premiums and expenses. According to Fidelity Investments, it is estimated that a couple retiring today at age 65, without access to an employer sponsored plan, will need about $215,000 in savings to cover lifetime post-retirement medical expenses. This amount is needed to cover Medicare Part B premium,  Medicare Part D premium, expenses associated with Medicare cost-sharing provisions, and the cost of services not covered by Medicare. For those choosing to retire early, the post-retirement medical obligation will be noticeably larger.

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Assuming a post-retirement tax rate of 25%, the tax savings alone generated from tax-free reimbursement of health care expenses through a fully-funded health care savings plan would be $53,750, as compared to a taxable withdrawal for payment of these same expenses from an IRA or employer sponsored retirement plan (e.g., 401(k), 403(b), 401(a), 457).

What about Government subsidies in the future?

According the U.S. Government Accountability Office (GAO), by 2020, the number of individuals in the 55 to 65 age group is projected to increase by 75% and, by 2030, those over age 65 are expected to double, creating the largest percentage of the U.S. population in retirement in America’s history³.

The Office of the Actuary in the Centers for Medicare & Medicaid Services (CMS) reports that Medicare is fiscally unsustainable as currently constructed. The Hospital Insurance Trust Fund, which provides funding for Medicare Part A, is expected to experience a growing annual cash deficit in 2019, just two years after Social Security outlays are expected to exceed tax revenues in 2017⁴.

The prospect of additional Government subsidization in the years ahead seems unlikely given the current financial state of Medicare and Social Security.

What can be done?

With Medicare available at age 65, there is some comfort in knowing that a subsidized, or pre-funded, form of insurance coverage exists. However, there are large financial “gaps” in Medicare coverage. These gaps include significant cost-sharing provisions (deductibles and coinsurance). Another gap is Medicare Parts B and D premiums, which are the responsibility of the participant. Currently, this collective financial gap accounts for 45% of total health care costs, or approximately $12,885 per year per couple, according to the GAO.

Given the present outlook, pre-retirees may want to begin planning for the health care expenses of their retirement years. Accruing a tax-free health care savings plan account as part of a CDHP program through America's VEBA Solution is one element of successful retirement planning that should not be overlooked. Contact us for more details >>

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¹Only HSAs allow employee contributions  back to where you were >>

²Medicare supplement insurance plan premiums are only reimbursable through an HRA  back to where you were >>

³GAO Medicare Report to the U.S. House of Representatives - 3/2000  back to where you were >>

⁴Board of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds - 5/2008  back to where you were >>