Optimum Allocations to Health Care Flexible Spending Accounts

Colin Ramsay and Victor Oguledo

North American Actuarial Journal, 2011, vol. 15, issue 3, 448-467

Abstract: Models used to derive optimal contributions to health care flexible spending accounts (FSAs) typically assume an employee’s household annual out-of-pocket health care expenses are an absolutely continuously random variable. This assumption, however, ignores the fact that some employees may be able to accurately predict a portion of their household annual out-of-pocket health care expenses and often actually incur only those expenses during the plan year, implying that a mixed random variable may be more appropriate. In addition, data have shown that employees are setting contributions at lower levels than existing absolutely continuous models would suggest is optimal. Using a mixed model of household annual out-of-pocket health care expenses we prove that it is often optimal for employees to contribute an amount equal to their household annual predictable out-of-pocket expenses, thus avoiding the risk of forfeiture. We also propose a practical rule of thumb that employees may use for setting their FSA contributions. Overall, we recommend that employees use their FSAs to cover only their highly predictable out-of-pocket health care expenses rather than use their FSAs as a contingency fund to pay for unlikely or unexpected outof-pocket health care expenses.

Date: 2011
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DOI: 10.1080/10920277.2011.10597630

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