Flexible benefit plans can provide a variety of benefits, one of which can be an effective cost containment tool.
Cafeteria Plans
The term cafeteria plan refers to an employee benefit plan in which choices can be made among several different types of benefits. Section 125 of the Internal Revenue Code provides favorable tax treatment to a cafeteria plan under which all participants are employees who may choose among two or more benefits consisting of cash and qualified benefits. Qualified benefits include most welfare benefits ordinarily resulting in no taxable income to employees if provided outside of a cafeteria plan. Employees have taxable income only to the extent that they elect normally taxable benefits cash and employer-paid group term life insurance in excess of $50,000. In general, a cafeteria plan cannot include retirement benefits except for a 401(k) plan. Some benefits cannot be provided under a cafeteria plan, for example, scholarships and fellowships, transportation benefits, educational assistance, no-additional-cost services, and employee discounts.
A common type of cafeteria plan is one that offers a basic core of benefits to all employees, plus a second layer of optional benefits that permits an employee to choose benefits beyond those of the basic package. These optional benefits can be purchased with additional contributions or dollar/credits given to the employee as part of the benefit package. Another cafeteria plan is one in which an employee has a choice among a limited number of predesigned benefit packages. The predesigned packages may have significant differences or they may be virtually identical, with the major difference being in the option selected for the medical expense coverage. For example, the plan may offer two traditional insured plans, two HMOs, and a PPO. The increased choices provided covered employees naturally lead to some adverse selection. As a result, more and more employers are integrating flexible benefits and managed care to maximize employee incentives to elect and use cost-effective managed care programs.
Flexible Spending Accounts
In addition to normal cafeteria plans, Section 125 also allows employees to purchase certain benefits on a before-tax basis through the use of a flexible spending account. A flexible spending account (FSA) allows an employee to fund certain benefits on a before-tax basis by electing to take a salary reduction, which can then be used to fund the cost of any qualified benefits included in the plan. FSAs are used for medical and dental expenses not covered by the employer’s plan and for dependent care expenses. FSAs can be used by themselves or incorporated into a more comprehensive cafeteria plan. The cafeteria plans of most large employers are designed with an FSA as an integral part of the plan. The amount of the salary reduction must be determined prior to the beginning of the plan year. If the monies in the FSA are not used during the plan year, they are forfeited and belong to the employer. The growing interest in cafeteria plans on the part of employers can be traced generally to a belief that (1) employees better perceive the value, nature, and relative costs of the benefits being provided; (2) a flexible benefit structure meets the varying and changing needs of individual employees; (3) because cafeteria plans may involve a limiting of employer contributions, this approach provides opportunities to control escalating benefit levels and costs; and (4) it is an effective way to direct employees into managed care with limited access to providers.
Medical Savings Accounts
A medical savings account is a tax-exempt, custodial account established for the purpose of paying medical expenses in conjunction with a high-deductible ($1,500 to $2,250 for single individuals and from $3,000 to $4,500 for families) major medical policy. The account is a savings account into which the insured (or an employer) can deposit money to be used for medical expenses not covered by insurance such as deductibles, eye glasses, or routine office visits. In contrast to FSAs, funds not used are allowed to accumulate and grow to help offset future expenses. Any funds not spent from the MSA eventually revert to the insured. This provides an incentive for the insured to spend carefully because the MSA funds are, in effect, his or her own money.
MSAs may be established by self-employed individuals or any employees of businesses with 50 or fewer employees who are covered under an employer-sponsored high-deductible health insurance plan. This program, established by the Health Insurance Portability and Accountability Act of 1996 (HIPAA), is a four-year “pilot” program ending on December 31,2000, at which time Congress will evaluate the success of the program. Some believe that MSAs may make sense when used with traditional indemnity plans but not with managed care plans. An argument against MSAs is that employees will focus on receiving cash at the end of the year by minimizing treatment for minor medical expenses and preventative care. This could lead to major expenses that could have been avoided or minimized with earlier treatment. Proponents argue that any technique that lowers costs for employers will encourage some small employers to provide coverage that would have previously been unaffordable. The most significant unresolved issue regarding MSAs is the challenge of incorporating them into a managed care environment.