Health Savings Accounts: Financial and Other Hurdles
by James B. Bristol, Waller Lansden LLP, Nashville, TN
Health Savings Accounts, or HSAs, have been a growing part of the health benefit plan landscape since 2004. An individual who is in a high-deductible health plan (HDHP) is permitted to contribute the amount of the annual deductible to an HSA every year that he or she participates in the HDHP (2008 limits are $2,900 for single coverage, $5,800 for family). There are many financial advantages for employees who choose an HDHP-HSA arrangement, including portability of the HSA. The employee owns the HSA, not the employer. Withdrawals used to pay medical expenses from the HSA are always tax-free. After age 65, any amounts remaining in the HSA can be withdrawn for retirement income, much like an IRA. This plan design seeks to put the consumer in control of the majority of medical claims, as the vast majority of claims are under the annual deductible of an HDHP. This design is part of a trend known as "consumer-driven healthcare."
Growth in HSAs has been steady. For 2004, the first year of operation for HDHPs, there were about 140,000 returns filed where the taxpayer took an HSA deduction, representing 438,000 individuals covered. At the end of 2005, there were 3.2 million individuals covered in some type of HSA arrangement. More than 60 percent of those covered were individuals who were previously uninsured and small businesses that had not offered health benefits.
Although HSA arrangements are gaining a foothold, and there are clear financial advantages, the consumer-driven health plan model has not yet eclipsed traditional plan designs. Traditional financial relationships are a hurdle. First, consumer-spending habits for healthcare do not appear to be changing overnight. The perception of brokers and managers in the industry is that participants in employer-provided health plans continue to seek healthcare services with little regard for or knowledge of the cost. Second, there seems to be a financial disincentive for the insurance industry to swarm the market with innovative HDHP-HSA products. An HDHP typically has much lower premiums than a traditional health plan, due to the substantially higher deductible. A premium reduction represents lost revenue for an insurer. The funds that are diverted to an HSA are not invested in insurance contracts. Although forward-thinking insurance agents may understand the advantages of the HDHP-HSA design, commissioned agents have a financial disincentive to sell the product. Moreover, there has been little innovation to simplify and reduce the cost of claims administration that should be available in a consumer-paid system. Many HSA arrangements still require manual claims adjudication for expenses within the annual deductible. There is room for more product innovation and, perhaps, some realignment of traditional financial relationships.
Administrative Issues -- Preventive Care
The major objection the consumer makes to a high-deductible health plan is, naturally, the high out-of-pocket cost. Accumulating savings in the HSA is illusory for individuals who have chronic illnesses or need maintenance medications for disease management. As with the financial issues discussed above, product innovation can eliminate this hurdle. An HDHP can provide "preventive care" (as defined in the Social Security Act) that is not subject to the deductible. Preventive care includes periodic medical evaluations, routine prenatal care and well-child care, immunizations, smoking cessation, obesity treatments and disease screening. These items are included in a safe harbor provided by the Internal Revenue Service, meaning that other procedures could be permitted if shown to be "preventive care."
This is not a total solution. Preventive care does not include treatment of existing illnesses. There is a gray area in defining preventive care and the IRS has sought public comments to assist in developing guidance. For example, many plan administrators have taken the conservative position that insulin is prescribed for the treatment of an existing illness -- diabetes. A more aggressive position is that insulin is preventive care as it prevents the onset of more serious ailments, such as blindness and heart disease.
Perhaps the best approach is to provide treatment for chronic illnesses under a plan that covers only specified conditions. An employer can, for example, maintain a plan that provides first dollar coverage for chronic illnesses such as cancer, diabetes, congestive heart failure or asthma. The HDHP would simply exclude these chronic illnesses from coverage. This dual plan arrangement would allow employers to provide individuals with chronic conditions the same financial incentives to spend healthcare dollars wisely.
Avoiding ERISA Coverage
The last thing that most employers desire is to take on any kind of benefit program that is going to add to the burdens of regulatory compliance. An HSA can become subject to the regulatory burdens of the Employee Retirement Income Security Act (ERISA), unfortunately, if it is administered in such a way or includes features that make it part of the actual employer-provided health plan. Generally, ERISA coverage is imposed if the employer or HDHP vendor exercises too much control over the HSA. The HSA will be outside of ERISA-coverage if participation in the HSA is completely voluntary by employees, the employer permits employees to move funds to another HSA, and the employer does not influence investment decisions or receive any payment or compensation in connection with an HSA. The following is permissible:
- Employers may select one or more HSA vendors for receiving payroll deductions but can't limit the ability of employees to move funds to another HSA.
- Employers may select and limit the HSA vendors it will allow to market to employees in the workplace.
- HSA investment options may mirror the 401(k) plan.
- Employers may pay HSA administrative fees on behalf of employees.
- HSA vendors may provide cash incentives to employees for opening HSAs (deposit must go to the HSA, not the employee).
- The HSA may provide a debit/credit card for expenses.
Numerous plan designs are possible within these parameters that avoid additional ERISA compliance burdens.
Even though HSAs can be managed to avoid ERISA coverage, they are subject to the prohibited transaction rules of the Internal Revenue Code, much like IRAs. If the above guidelines on avoiding ERISA coverage are followed, an employer should not be an interested party to an HSA. Thus, an employer should be able to encourage use of HSAs by providing cash incentive contributions to the HSA. The most important prohibited transaction concern, however, is the requirement for depositing employee payroll contributions to the health plan. The U.S. Department of Labor takes the position that, because of the inclusion of HSAs in the definition of the term "plan" in the prohibited transaction rules, HSA contributions are subject to timing rules similar to those that govern 401(k) plans. This rule only applies to HSA contributions made through payroll. The deposit to the HSA must be made as soon as practical following each payroll date. This does not apply to HSA contributions that are made voluntarily outside of the payroll system.
Healthcare Savings Incentives vs. Portability Concerns
Many employers that move to an HDHP find that they can enjoy premium reductions of 30 to 40 percent in comparison to a traditional health plan design. Obviously, part of these savings are due to the shift in cost from the insurer to the employee in the form of a higher deductible requirement. Some employers, therefore, have encouraged employees to participate in a HDHP by offering to contribute some of this cost savings to an HSA. The ability to accumulate portable savings is a financial incentive that undergirds consumer-driven healthcare. However, the unfettered ability to make HSA withdrawals for non-medical purposes is perceived by some employers as too great a temptation for their workforce, or "too much" portability.
An alternate arrangement is to combine a health reimbursement arrangement (HRA) with an HDHP rather than an HSA. Unlike an HSA, the employer only contributes to the HRA as medical expenses are incurred. An employer can include certain financial incentives in an HRA arrangement. For example, employees can be allowed to carry over unused dollars in the HRA from one year to the next. This is an important design feature as the economic purpose of consumer-driven healthcare is defeated if the employee has no financial incentive to spend healthcare dollars wisely. On the other hand, a health flexible spending arrangement through a cafeteria plan (an FSA) offers little or no financial incentive for wise spending of healthcare dollars. Although FSAs are familiar to many employers, employees forfeit contributions if they fail to incur sufficient medical expenses in a year. IRS regulations refer to this as the "use it or lose it" rule. Accordingly, combining a HDHP with an HSA or HRA is far preferable to using it with the familiar FSA arrangement.
The existing system for distributing health plan products seems to be biased against HSA plan designs. Nonetheless, demand for consumer-driven designs remains high as U.S. employers are stymied by runaway healthcare inflation. The hurdles outlined herein are not insurmountable, but are areas where improvements can be brought to the existing system.