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April 14, 2005

Health Savings Accounts: Are they the low cost alternative?

The cost of healthcare has continually sky rocketed out of control for the past few decades. With double-digit increases in insurance premium expenditures, individuals and employers along with their employees are realizing the benefit mechanisms of utilizing a health savings account (HSA) combined with a high deductible health plan (HDHP) over the traditional health insurance policy. In a report released on July 20 th 2004, the National Coalition on Health Care (NCHC) stated:

Looking ahead, a variety of independent studies and surveys anticipate that premiums will continue to increase at double-digit rates over the next several years. The Coalition projects that the average annual premium for employer-sponsored family health coverage will surge to $14,545 in 2006 — more than $5,000 higher than last year's average premium of $9,068 and more than double the average premium of $7,053 in 2001. (National Coalition on Health Care, 2004, p. 5)

With the massive number of well-documented “studies and surveys” showing dramatic increases in health care premium costs, the political position on health care has changed.

This shift in the political position on healthcare has recently stimulated the adoption of new legislation. On December 8th, 2003, President George W. Bush signed into law the Medicare Prescription Drug Improvement and Modernization Act of 2003. From this legislation, HSAs were established. Previous attempts at healthcare legislation have been tried, the Health Insurance Portability and Accountability Act (HIPAA) of 1996, introduced the Medical Savings Account (MSA).

Although the HIPAA legislation was adopted in 1996 forming the MSA, it was limited by the same Congressional legislation and referred to as a “demonstration project”. MSAs were quite confusing; the legislation was full of operational and procedural rules to follow. Additionally MSAs had availability limitations associated with these accounts, since they were only available to self-employed individuals and small employers with 2 to 50 employees. Notwithstanding the incumberments associated with the MSA legislation, the accounts still proved to be a worthy alternative to high priced insurance premiums.

The modern day HSAs are unarguably the next generation of MSAs, without the availability issues. HSAs were created to help individuals save for future qualified medical and retirement health expenses on a tax free-basis. One key aspect of the HSA is its portability; since HSAs are reminiscent of a savings account they are owned by the individual account holder, the individual can take it with them regardless of their employment status. The money in the account not used for qualified health expenditures rolls over from year to year, accumulating tax-free for retirement. Eligible individuals can open and fund the HSA on a tax-free basis provided they do not exceeded the maximum funding limits associated with the HDHP.

Eligibility guidelines have been laid out by the U.S. Department of the Treasury. Individuals over the age of sixty-five who have applied for Medicare are not eligible for a HSA. On another note, individuals who are covered under another insurance policy, such as a spouses, or who have received VA health benefits within the last three months are also not eligible for a HSA. Most importantly, HSAs can only be utilized in conjunction with a HDHP.

HDHPs are considered a catastrophic insurance policy, similar to stop-loss insurance used with a group partially self-funded employer plan but at an individual level. HDHPs use terminology derived from the insurance industry. Such as, a deductible , which is simply the amount of money you must pay out of pocket before the insurance policy pays for any incurred medical expenses. There is also a maximum out-of-pocket qualifier for HDHPs. This is a dollar amount set by the insurance company, which puts a limitation on the amount the insured can pay for out of their own pocket for specific health care services during a predefined period. Examples of out of pocket costs are co-insurance and co-payments .

For a HDHP to qualify for use with a HSA certain requirements must be met. For instance, the minimum deductible, for a single only coverage plan is $1000. On the other hand, the minimum deductible for family coverage is $2000. Now the out of pocket maximums are set at $5,100 for single only coverage, and for family coverage $10,200. All of the deductibles and out of pocket limitations are indexed for inflation yearly. There is however, reasonable benefit designs which do not count towards the maximum out of pocket limit. These reasonable benefit designs can include the maximum number of covered days or visits, dollar reimbursements and pre-certification requirements; lifetime limits on benefits, which include limits to usual, customary and reasonable amounts, and limits on specific benefits.

The cost benefits associated with a HDHP are advantageous to any individual regardless of their income, employment, or family status. The expenditures associated with a HDHP are far less than the traditional health plan since the insurance company does not assume the risk of paying health related claims until the deductible has been met. Since the claims below the deductible can be paid from the HSA, administration costs are also lowered, because there are fewer claims that need to be adjudicated. A general rule for any type of insurance is the higher the deductible the cheaper the insurance premium.

Another associated benefit of a HSA qualified HDHP is the fact that preventive care is included and can be utilized before the deductible has been met. Nonetheless, preventive care does not include services or treatments for pre-existing injuries, illnesses or conditions. Some types of drugs can be considered preventative care if they are for certain possible conditions, which have not surfaced, but do have developed risk factors. The U.S. Treasury Department has issued a “safe harbor list” of preventive care that HDHPs can cover before the deductible has been met.

Now that the majority of the HDHP guideline issues have been addressed, let us move on to the benefit mechanisms of a HSA; we will start with contribution levels. These contribution levels are set by the United States Department of the Treasury and are dependant upon the type of HDHP purchased.

The HSA contributions can be made by an employer, the employee or any individual or entity that wishes to contribute to an account holder's HSA. However, there are exceptions to this rule. The self-employed, partners and S-Corporation shareholders are typically not considered to have an employer and therefore cannot receive an employer contribution. Now there are limitations on the contribution amounts to fund the HSA. (see Table 1)

Table 1

The HDHP deductible compared to the maximum HSA deductible.

Note. From All About HSAs by the U.S. Treasury Department, p. 17

Any excess contributions to the HSA beyond the allowable limits must be withdrawn by the account holder or become subject to a six percent excise tax. The contribution rules to the HSA are straightforward. One simple rule to remember is to not over fund the HSA, from any source whether it be from an employer, the account holder, family or any one else. However, the distribution rules are not as straightforward.

The HSA distribution rules allow for the HSA to pay for a myriad of health expenditures not covered under most health insurance plans. One of the most prevalent things to keep in mind is the “qualified medical expenses” which are covered under the health savings account and are not typically allowable under a traditional insurance plan. Any medical expenses you can take as a tax deduction under the IRS rules are considered allowable HSA distributions, without any tax consequences. Now these allowable HSA distributions can be used for any household family member whether or not they are covered under the HDHP.

HSAs cannot be used to pay insurance premiums unless they fall under certain circumstances. The HSA can be used to pay any health insurance premiums for continuing an employer sponsored HDHP under the COBRA laws.

The law — the Consolidated Omnibus Budget Reconciliation Act (COBRA) — gives workers who lose their health benefits the right to choose to continue group health benefits provided by the plan under certain circumstances.

COBRA generally requires that group health plans sponsored by employers with 20 or more employees in the prior year offer employees and their families the opportunity for a temporary extension of health coverage (called continuation coverage) in certain instances where coverage under the plan would otherwise end. (Department of Labor, n.d. ¶ 2)

The HSA can also pay for any insurance premiums as long as the account holder is collecting unemployment benefits. In addition, qualified long-term-care insurance premiums can be paid on a tax-free-basis from the HSA.

Since there are so many qualified expenses, which can be paid from a health savings account, the account holder should keep all the receipts from HSA disbursements. The account owner has all authority over the HSA, has the final say on what is disbursed, and is responsible for deciding what is a qualified medical expenditure and what is not. However, if a disbursement is deemed not a qualifying medical expenditure during an IRS audit, a penalty will be assessed. With the list of qualified medical expenses only to increase in years to come, the account holder must remember that not all qualifying medical expenses are eligible to be applied towards the deductible of the HDHP. The expenses, which are eligible, are outlined in the HDHP policy. For instance, if a disbursement is made from the HSA for eyeglasses, which is a qualified medical expenditure, the disbursement will not be applied to the deductible of the HDHP because it is not covered in the HDHP policy.

When everything is said and done, it all comes down to the question “What happens to the HSA when the account holder becomes deceased?” For the most part the HSA is treated comparably to an individual retirement account. If the account holder is married, the HSA will transfer to the spouse unless a will states otherwise. If the account holder is not married, the HSA will no longer be treated as such, and will become part of the estate and taxed accordingly.

As discussed earlier, the HSA is owned by the account holder no matter who contributes to the account. Since the HSA is owned by the individual, the account holder has all decision-making authority. The HSA owner decides when or whether they want to contribute to the HSA. Furthermore, the account holder decides what company will hold the account and what, if any, investments they will use to grow the account.

Now that the laws governing HSAs and some background information on HSAs and HDHPs have been specified, we are left with the controversial issues that surround them. It seems as though most of the controversies are political in nature, because Bush signed the legislation into law while the Congress and the Senate were predominantly Republican. The negative claims against utilizing the HSA with a HDHP are not based on legitimate research. It has been argued that lower income individuals cannot afford a HDHP combined with a HSA. It has also been debated that a HSA is nothing more than a tax shelter for the rich. On another note, it is alleged there is no advantage to unhealthy people or families utilizing a HSA. A small percentage of people who also believe HSAs will ultimately destroy the insurance industry and raise healthcare costs beyond the current affordable rates . This is absurd, plainly quite a bit of thought and research has been applied to the HSA legislation before it became a law, and then there is the fact that the HSA is based on a proven formula: the MSA.

Research always has a rebuttal for ludicrous or propagandistic opinions. For instance, a report issued by eHealthInsurance (2005), the largest seller of HDHPs, stated “…40% of people with lower incomes ($50,000 or below) … bought HSA-eligible plans between January and June 2004 and January and December 2004, with the most significant increase in the $0 - $15,000 income group” (HSA Purchasers by Income Level, p. 10). This report also refutes the debate that HSAs are nothing more than a tax shelter for the rich. As for the claim that HSAs are not advantageous for the unhealthy and families, first there is the undisputed fact, which is, the higher the deductible the lower the premium cost. Secondly, since the average premium with a traditional health plan is $9,068, the average HDHP premium for a comparable family plan is $3,329.40. The family deductible as discussed earlier can range from $2,000 to $10,200 (maximum out-of-pocket) but the average is closer to $4000. Whether or not the individuals are healthy, the major distinction between these two plans is the cost. With a traditional health insurance plan, there are also deductibles, co-insurance and co-pays that drive the total expenditures even higher. With an eligible HSA plan, there is an out-of-pocket maximum set by law. There is no maximum out of pocket rule for most traditional health insurance plans. For example, if the policy calls for an 80/20 co-insurance, where the insurance pays eighty percent of the covered health claim after the deductible has been met and the insured pays twenty percent co-insurance, the average claim for a heart attack is over $23,000 from admission to discharge. This would total an out-of-pocket cost of approximately $4,600 or more depending on the deductible amount and co-payments for aftercare drugs and post hospitalization check-ups. The annual median average out-of-pocket cost Americans pay per year is $2,182, combined with the average annual insurance premium cost of $9,068 drives the total to more than $11,200. One also has to remember that this total is just the average, fifty percent of the people pay more and 50% pay the average.

Now that we have looked at the history, benefit mechanisms, and the laws governing the HSA with respect to the qualifying characteristics of a HDHP, you can draw a simple conclusion. HSAs where not meant to be a cure all to the Health Care Crisis American businesses and individuals face each day, but what they were created to do was bring some relief to the high cost of health care. With health care costs totaling more than 1.6 trillion dollars per year, equaling approximately 16 percent of the gross national product, something had to be done. Most health care payments are made by a third party (insurance company or government) and the patient is shielded from the overall costs associated with medical services or treatments. We only have to look as far as our own relatives to see what this has done to society. It is like giving your teenager free reign to your retirement account. It seems to the teenager as an endless supply, but to the responsible party who worked so many years building this account with sweat and blood, it is a lot more than that, it is their future. This is exactly what is happening with the healthcare industry and the third party payer system. The only means we have to replace what is already set in motion is the HSA, bringing healthcare accountability back to the individual to empower them to make conscientious healthcare decisions. The incentive to stop the snowballing effect comes from the HSA. Money unspent after disbursements is still there, unlike a traditional insurance product where the money is forfeited. The conclusion can be surmised from the supporting evidence that strongly upholds the decisions individuals, employers and their employees are making when purchasing a health savings account combined with a qualified high deductible health plan over traditional health insurance,that it is the low cost alternative.

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