Employers of all sizes, but particularly small to medium sized employers have faced compounding premium rate increases under traditional insured group health and dental plans for the past decade, regardless of the actual claims experience of their own group. In recent years insurers have utilized arbitrary “inflation” and “trend factors” ranging from 15% to 20+% when calculating the renewal rates. When asked to justify the level of these increases insurers have been unable to do so.

Large corporate employers have been able to “self-insure” their benefit costs under what is termed an “Administrative Services Only (ASO)” arrangement with an insurer. While this may enable them to have some degree of control over the inflation factors utilized, they have to recognize that they will ultimately bear the full cost of their own group’s claims experience, plus administrative costs and applicable taxes.


Traditional solutions to the cost spiral have included restrictive drug formularies, increased deductibles and co-insurance factors, drug utilization reviews and restrictions on certain drug categories, as well as revised cost sharing arrangements placing a greater burden on employees. These measures have had limited success as employees have not been required to effectively manage the limited employer dollars available for healthcare. Over the years employees have developed an attitude that the employer’s program is there to be taken advantage of and have no comprehension of the true costs being borne by the average employer.

Insurers for their part have simply increased the premium rates at renewal to cover their losses and have included the aforementioned inflation factors to ensure they have adequate funds to pay the escalating claim costs and to meet their bottom line profit objective of at least 15% pre-tax.  Many employers have contributed to the problem by continuing to provide open-ended plan designs, which invite abuse and cost increases. There has been little or no communication with employees to make them part of the cost solution, rather than the problem.


Most large employers have added a “Stop Loss” insurance policy in an attempt to “cap” their potential liability. However, if the Stop Loss protection purchased is based on an individual employee’s claims in excess say of $5,000 per policy year it may not have any impact whatsoever if the average claim cost per employee is just below the point at which the Stop Loss becomes effective. . A new “Aggregate Stop Loss” policy covering all claims in excess of a predetermined amount per certificate is now available and may assist in controlling an employer’s ASO costs.

Smaller employers have not been able to afford this ASO approach because of the wide swings in cost that can occur from year to year. They have been forced to resort to the traditional insured plan with its compounding rate increase. A new approach to the provision of benefits, and in particular health and dental benefits, is therefore required.


Over the past 20 or so years major Canadian employers introduced Flex Benefit Plans in an effort to control costs. A study by an international benefits consulting firm, indicated:

• “Flex” meets employee needs, contains benefit cost increases
• Flexible benefit programs are more prevalent now than they were 4 years earlier
• 94% of respondents to the survey reported that flexible benefits met or exceeded employee expectations
• 71% indicated flexible benefits met or exceeded expectations in containing benefit cost increases

Under a true full Flex Plan literally every benefit component is subject to review and scrutiny, and employees are given the responsibility of selecting benefits to match their personal needs. Often a mandatory core program of life and disability benefits is required to be selected by each participant. Employees may also be allowed to trade the cost value of certain benefits and even vacation time in the design of their own program.

The implications of a full-Flex program for the employer usually includes increased benefit administration responsibilities and related costs, and most certainly effective ongoing employee communications to ensure that employees really understand the choices and implications of these choices on their financial security and that of their family. For the small to medium sized employer a full-Flex Plan is not a realistic or an affordable option in our opinion.


Employers in the United States, faced with even higher healthcare costs than for Canadian employers because of the lack of an underlying government program comparable to our Provincial Medicare to cover the basic costs, moved to a “defined contribution” approach. Under this arrangement a specific dollar amount is provided to all employees (usually) regardless of marital status (this because an employer does not pay someone more based on the fact they have dependents). Employees with dependents are required to pay the full additional cost of covering their dependents.

Many years ago American employers were sold on “Managed Care Programs” through Health Maintenance Organizations (HMO) and Preferred Provider Organizations (PPO) and their purported ability to control costs. Unfortunately, these solutions did not work as promised, thus the resulting trend to defined contribution and individual plans under which employees must take ownership for their own healthcare utilization and costs. The May 2004 edition of Fortune Small Business magazine confirmed the trend to implement individual “consumer driven” benefit plans incorporating a defined contribution Health Spending Account (HSA) and supplementary health plans with very high deductibles.

The spiralling costs of health and dental benefits are being impacted by a number of factors, including:

• Provincial cutbacks in Medicare benefits in order to reduce costs
• Increased drug utilization and higher pharmacy costs
• The cost of new drug formulizations
• Overall cost increases in all aspects of health and dental care services
• An aging population placing greater demands on the healthcare system and employer plans
• Increased stress in the workplace and resulting disability claims
  
  

Not just a short term problem:
Benefit costs can represent a significant percentage of an employer’s overall compensation costs, particularly where benefits are part of a collective agreement. Most employers (including self-employed entrepreneurs or contract workers) cannot afford to follow down the compounding cost increase road and must act more prudently in the provision of benefits, because of not only the immediate, but long term costs.

With the introduction of the Canadian Institute of Chartered Accountants (CICA) Accounting Standards in Canada in 2000, employers who have been providing post-retirement benefits are now reviewing the future cost of these benefits, and eliminating them wherever possible as they must be reported on their financial statements each year as a future liability.

The end of Mandatory Retirement is also impacting on benefit plans as the cost of providing health benefits to those 65 years of age and older rises dramatically.

The “Consumer Driven” Trend:
Several years ago a major US based consulting firm, Booze Allen Hamilton, produced a report indicating that the trend to defined contribution plans was now well entrenched, but more significantly, that a new trend had emerged whereby employers are utilizing “individual health plans” rather than “group plans” to provide employees with health and dental protection in order to avoid the compounding cost increases. These are often referred to as “consumer driven health plans” in US media publications.

If employers are to be able to afford health and dental benefits in the future we believe there has to be a fundamental change in the approach taken to the provision of these benefits in Canada. No longer can the “traditional group insurance plan” incorporating annual compound rate increases be afforded by most employers, and in particular small employers of fewer than 25 employees, which make up over 95% of all Canadian employers.

Employees have to become part of the solution, rather than the ones driving up claim costs as they have no realization of the true cost of the benefits provided and only look at benefits as an entitlement, rather than a part of their overall compensation.

The Defined Contribution approach addresses all of these concerns.


A “Health Spending Account (HSA)” enables an employer to define the annual employer contribution to the program providing health and dental benefits and therefore control the employer’s cost for health and dental benefits. The employer can vary the annual contribution by class of employee. Employees cannot contribute directly to the plan.  However, the employee and employee can enter into a “compensation arrangement” under which the employee requests that the employer direct pre-tax earnings to the employee’s Health Spending Account. The medical expenses that may be claimed are outlined in Section 118.2 (2) of the Income Tax Act and in IT-519R2, and are much broader than permitted under any group benefits program.

Tax Advantages:
Benefits received from the HSA (a “private health services plan”) are not considered taxable income in the hands of employees.  Often Health Spending Accounts are included as part of an overall “Flex Benefit Program”, but can also be offered independent of any other health benefit.  As the employer’s contribution is fixed on an annual basis there is the “risk” that some claims incurred by employees will not be paid due to the claims exceeding the amount available in the HSA.  This is the element of insurance CRA requires.

An employer can deduct the employer contribution to an HSA as a business expense as it is a contribution to a “private health services plan”.  Sole employees of their own corporation may have to prove that the deduction is being claimed as the result of being an employee and not because he is the significant shareholder. The CCRA T4002, Business and Professional Income Guide, outlines the basis under which a sole proprietor may deduct premiums payable to a PHSP.  It would appear that the sole proprietor who has no employees may deduct up to $1,500 for himself, plus $1,500 for a spouse and $750 for each child from his business income. If there are employees additional rules come into play.

The solution to most employer concerns is to adopt a “defined contribution” approach to the provision of health and dental benefits. This enables an employer to establish a defined amount per employee that will be contributed towards the cost of benefits in the form of a Health Spending Account (HSA), which will not be subject to “inflationary” cost factors normally imposed by a traditional group insurer.  Employers are able to effectively budget their future benefit costs under this approach.  Employees then know the amount they will have to spend on health and or dental benefits for themselves and any dependents, and can purchase optional individual Health or Health and Dental coverage to supplement the amount available under the HSA.





Administration Options:
An employer could self-administer the HSA according to CRA, or contract with a Third Party Administrator, or an insurance company to administer the plan. There is no reference in any CRA materials to a “trustee” being required. We would not recommend self-administration by an employer as this would require that all claims be submitted to the employer for approval and this would contravene the Privacy Act regarding the confidentiality of health information.