July 2004

Putting Health Savings Accounts into Practice: New Guidance from the Treasury

Health Savings Accounts (HSAs) have proven to be one of the most controversial provisions of the Medicare Modernization Act of 2003. Will HSAs blaze a trail to a more efficient health care system? Will they disrupt existing employer-sponsored insurance? Will they prove popular with health insurers, employers, and individual consumers? Or are they just another variation in the tax code that will be ignored by almost everyone? The future of HSAs, and their effect on health care markets, will depend greatly on how the law is interpreted by the U.S. Treasury Department's new guidance. At a July 16, 2004 health policy discussion, Roy Ramthun and William Sweetnam Jr. of the Treasury Department explained departmental efforts to develop HSAs within the provisions of the law. Three experts on HSAs and private health insurance markets shared their assessments of the Treasury's guidance and its effect on the future of health insurance.

Roy Ramthun
Department of the Treasury

The latest Treasury Department guidance on Health Savings Accounts (HSAs) is due out next week. It will be extremely comprehensive--answering more than ninety questions on the implementation of HSAs. The Treasury Department's first challenge was to consider how radical a change in health care was expected from HSAs. We concluded that they have the potential to transform the current system. This vision at times competes with practical implementation challenges, so program parameters must evolve with this new market.

The forthcoming guidance will address the treatment of preventive care, prescription drug coverage, and interaction between HSAs, Health Reimbursement Arrangements (HRAs), and Flexible Spending Arrangements (FSAs).

The Treasury Department's output on HSAs over the last eight months has been extraordinary. We have created a website to offer guidance, solicit questions, and receive general feedback. The website, along with an email address and voicemail account that also receive questions from the public, have generated immense interest. In fact, that input has shaped the formal guidance issued by the Treasury Department.

Even as the HSA market develops, outside observers believe more than fifty insurance companies currently offer HSAs and that there are close to twenty national trustees.

William Sweetnam Jr.
Department of the Treasury

An early objective for the Treasury Department was to restate the Archer Medical Savings Account (MSA) guidance for the new HSAs. This required adopting a new focus, as HSAs represent a much larger universe than MSAs.

Drafting the guidance for HSAs began with defining high deductible health plans (HDHP). While the statute has strict rules governing those plans, certain exceptions to deductibility required clarification. For example, preventive care is covered at the outset--not only after meeting the deductible--but the definition of "preventive" care is somewhat elusive. In the forthcoming Treasury guidance, some disease management programs will qualify as preventive services.

Prescription drug plans typically offer first-dollar coverage, so they do not qualify as high deductible health plans. However, since drug plans do not usually coordinate with general health insurance plans, Treasury decided to qualify the general insurance plans as HDHPs until 2006 even if individuals have separate drug plans as well.

State first-dollar coverage mandates on certain services were also sometimes in conflict with HDHP rules. For example, New Jersey requires insurance plans to cover from the outset lead poisoning screens and treatments. Diagnostic tests are preventive, so they would be covered from the first dollar by high deductible health plans. Treatment for lead poisoning, however, would not typically be covered until the deductible is met. In order for HSAs to thrive in New Jersey and other states with mandates, Treasury has issued transition relief that exempts state mandates from HDHP rules until 2006.

Anyone who currently qualifies to be a trustee or custodian of Archer MSAs is also eligible to hold HSAs. Trustees are not responsible for substantiating qualified medical expenses when disbursing tax-free funds. This is the employee's responsibility. So far, individuals have been able to find high deductible health plans but not health savings accounts. The original rules required an individual to have set up an HSA before claiming qualified medical expenses under the attached HDHP. Because people have not been able to find and enroll in HSAs, Treasury has allowed individuals to claim medical expenses to their health plan so long as they establish an HSA by April 15, 2005. During this transition period, any expenses incurred after enrolling in the HDHP but before establishing the HSA are reimbursable and tax-free.

Small banks and credit unions have expressed interest in becoming trustees of health savings accounts but have been unsure of their requirements. To facilitate their participation, Treasury has made available model documentation forms for HSAs. Financial institutions are free to use these templates in their entirety or use pieces of them in constructing their own.
 
Individuals can enroll in only one high deductible health plan to qualify for an HSA, but Treasury has recommended ways to use FSAs and HRAs in conjunction. These other accounts, for example, could be used for dental and vision expenses not covered by HSAs.

The forthcoming Treasury guidance will also address the coordination of HSA contributions with family coverage and issues of employer involvement. For instance, how will different types of coverage within a family mesh? Will employers be able to impose restrictions on HSAs and the services they cover? How will employer contributions to similarly situated employees be handled?

John Goodman
National Center for Policy Analysis

Health Savings Accounts will revolutionize the U.S. health care system. Individuals will substitute self-insurance for third-party insurance, and self-management for third-party management. Previously, one-half of third-party insurance premiums were subsidized by the government in tax advantages, encouraging the third-party payer scheme and penalizing self-insurance. With the introduction of HSAs, the playing field between self-insurance and third-party arrangements will finally be level.

HSAs have the potential to transform the health care market as individuals begin to know the prices of medical services. It may evolve to be more like the market for cosmetic surgery, where patients know beforehand package prices for services. In that market, prices for cosmetic surgery have fallen while all other health care service prices have risen.

The biggest change ushered in by HSAs will be the response of physicians. They will become not only medical but also economic agents for their patients. When a physician prescribes a medication, he will need to also consider generic formulations and therapeutic substitutes for their cost-effectiveness.

The population with the most to gain from HSAs will be the chronically ill, as they accrue valuable information about efficient health care use and continuously apply it. However, critics tend to wrongly regard HSAs as savings accounts and then conclude that chronically ill patients will be the most disadvantaged by the new scheme. In fact, HSAs are not likely to boost national savings, and they were not designed to do so. Their primary function is to promote efficiency in individual care management and in the health care system overall. Nonetheless, Congress has dictated a design for HSAs that is not ideal for the chronically ill. Instead of lawmakers, markets should determine their structure. South Africa has implemented HSAs for ten years. Health plans attached to their HSAs have zero deductibles for hospital expenses because they assume patients entering hospitals are not exercising discretion. Marketplace flexibility will best tailor health savings accounts to patient needs.

Paul Fronstin
Employee Benefit Research Institute

HSAs will not revolutionize our health care system, but they are not a bad addition. To seriously impact health spending, we must focus on the small body of high spenders-the one-quarter of the population responsible for 80 percent of all health spending. Even if HSAs did affect the behavior of high-spending patients, the contribution limits to HSAs are such that individuals would more likely delay when they reached their deductible in a given year, rather than contain their costs below it.

Contrary to critics' claims, HSAs will not attract only the healthy and wealthy. Their flexibility will attract people of all ages and health statuses. In fact, they may appeal most to people with chronic diseases who continually interact with the health care system.

It is difficult to predict how employers will respond to HSAs, particularly because their experience will be shaped by regulations that are not yet known. Large employers may prefer health reimbursement arrangements to HSAs because HRAs are not funded until an employee makes a claim. HSAs, on the other hand, require continuous contributions to all employees of similar standing. Small employers are generally slower to change their benefits, but rising health care costs have already driven them to revise other benefits, bonuses, wage increases, and hiring schedules.

HSAs require couples to combine their deductibles, which may discourage HSA take-up among families. This condition may especially deter couples where one person is markedly less healthy than the other.

Flexible spending arrangements may be difficult to mesh with HSAs. FSAs can only be used after meeting the HSA deductible and are confined by annual "use it or lose it" rules.

Because of HSA contribution limits ($2,600 each year), the maximum that an individual could accrue over forty years is $334,000. The maximum that a fifty-five-year-old could save in an HSA is $44,000. The average eighty-year-old would need to save $134,000 for medical expenses, but a ninety-year-old would need $257,000. Given these drastic jumps, the greatest risk individuals face in HSAs is outliving what the savings in those accounts can support.

If HSAs were used as a savings vehicle and 10 percent were withdrawn each year, an individual could save only $51,000 over forty years. Even modest withdrawal can have a huge impact on savings in that account.

Tom Policelli
iPlan, UnitedHealth Group

UnitedHealth Group provides health insurance to twenty-two million individuals nationwide. It also owns the infrastructure to sell HRA, FSA, and HSA capacity to other health plans. About one-half of its largest employers (Uniprise members) are currently pursuing HRA and HSA options for their employees. Company CEOs and CFOs are heavily engaged in this conversation. Following the passage of the Medicare Modernization Act last December, HSAs captured much public interest. Confusion about how they would operate caused that attention to wane, but we are now experiencing a major resurgence of interest. Even firms that had already established their health care offerings earlier this year are reconsidering their strategies to include HSAs.

Employers face important issues that distinguish HSAs from other arrangements, such as bold incentives for efficiency and transparency of quality and cost. Data from HRAs have already shown greater cost-sensitivity among enrolled individuals, such as increased use of preventive services. For individuals with predictable health care expenses, the ability to stack accounts (for example, an FSA on an HSA) is appealing. Employers are also striving to help their employees optimize all medical spending, not just covered expenses.

While these issues are increasingly capturing public attention, the idea of swipe cards to access funds in HSAs is becoming less popular. While the technology could facilitate enrollment and utilization, the paper substantiation of claims that must follow is cumbersome and negates the initial advantage. Instead, the Treasury Department should allow electronic substantiation.

iPlan currently has 100,000 individuals enrolled in HRAs and HSAs, 40 percent of whom are predicted to transition to HSAs. Previously, HSAs were anticipated to be most popular among well-compensated, high-tech employees. In fact, large service companies are exhibiting the highest take-up rates. This may be because they understand the need for a radical restructuring of their health plan offerings to employees.

To allow the HSA market to flourish, Treasury should allow a one-time HRA to HSA rollover. Otherwise, it will penalize the companies and employees that first ventured into these new arrangements. There should also be a mechanism to allow employers to recoup some of the funds they contributed to an employee's HSA if the employee leaves. Health plans should also be allowed to categorize health care services by tax status on behalf of its enrollees. Employers should be allowed to restrict certain expenses from HSA accounts if they contribute to them, and there should be flexibility to incorporate prescription drug plans.

HSAs provide a new opportunity for retirees to fund their health care and a new avenue to address the problem of the uninsured.

AEI research assistant Ximena Pinell prepared this summary.