Embodied in the recently enacted Medicare Modernization Act of 2003 were provisions to establish Health Savings Accounts (HSAs) for the general population. These accounts, while not directly related to reforming the troubled Medicare program, do offer a new health care coverage option for the non-Medicare population. HSAs offer a variety of unique benefits, including more choice, greater control, and individual ownership.
There are two key components to a Health Savings Account: (1) a high-deductible health plan and (2) a tax-preferred savings account. However, in order to qualify for the tax-preferred savings, a high-deductible health plan must accompany the account. The law establishes some basic parameters for both of these design features:
High-Deductible Health Plan (HDHP). A high-deductible health plan is a health plan that establishes a higher deductible for an individual to meet before the insurance plan begins to pay. Such plans help to reduce the premium but still provide protection from unexpected, catastrophic health care expenses.
To qualify for an HSA, a high-deductible plan must have a minimum deductible of $1,000 for an individual policy and $2,000 for a family policy. The maximum annual out-of-pocket spending (including deductibles and co-pays) can be no more than $5,000 for an individual and no more than $10,000 for a family. Such HDHPs are able to have first-dollar coverage for preventive care and allow for higher out-of-pocket payments (co-pays and co-insurance) for non-network services.
Tax-Preferred Savings Account. A tax-preferred savings account allows an individual to make deposits and distributions for health care expenditures "tax free" without a tax penalty. An individual may establish this tax-preferred savings account in conjunction with the HDHP.
The law establishes several basic rules for contributing to such an account. The maximum that can be contributed is the lesser of (1) the amount of the high deductible or (2), as specified by law, $2,600 for an individual and $5,150 for a family. Besides the individual owner of the account, an employer and others can contribute on behalf of the individual. "Catch-up" contributions are allowed for individuals who are 55 and older; however, contributions must stop once the individual is eligible for Medicare.
The law also establishes rules for distributions from account funds. Primarily, distributions can be made "tax free" if used for "qualified medical expenses" as described in existing law. They may not be used to pay for other health insurance except for (1) coverage while unemployed, (2) COBRA, and (3) qualified long-term care insurance. For those who are eligible for Medicare, the accounts may be used for the following: (1) Medicare premiums and other out-of-pocket expenses relating to Medicare and (2) the employee share of employer-based (retiree) coverage.
The Evolution of Health Savings Accounts
Even before the enactment of Health Savings Accounts, efforts to give individuals greater control of their health care spending were well underway. A variety of "consumer-directed" approaches still exist today, albeit with some awkward constraints. Health Savings Accounts attempt to overcome those constraints by combining the positive features of the existing approaches while making them more accessible and useful for consumers.
Flexible Spending Accounts (FSAs). These tax-advantaged account options, offered through an employer, allow employees to set aside pre-tax dollars through salary reduction. The funds in these accounts can be used for medical and dental expense not covered by insurance. However, any funds left over at the end of the year are forfeited to the employer. Similar to FSAs, HSAs allow for the tax-preferred savings element, but they also permit an individual to carry over any unused funds from year to year, allowing those funds to accrue along the way.
Health Reimbursement Arrangements (HRAs). These employer-sponsored arrangements enable employers to make a financial contribution on behalf of their employees to help reimburse them for medical expenses. Any unused funds can be carried over from year to year but remain the property of the employer. Many employers combine these arrangements with a high-deductible health plan to ensure catastrophic protection. HSAs maintain the carry-over provisions of the HRA and require the high-deductible component; unlike HRAs, however, they grant ownership of the account and plan to the individual, not the employer, thereby giving the consumer full control and allowing for full portability.
Medical Savings Accounts (Archer MSAs). These accounts, similar to the new HSAs, were strangled by excessive and restrictive regulations. Not only were the accounts temporary, but the number available was limited to 750,000, and they were offered only to businesses with fewer than 50 employees and/or self-employed. Furthermore, contributions could be made only by the employee or the employer, not by both, and could not exceed 65 percent of the deductible for an individual policy and 75 percent for a family policy. The minimum deductible was set at $1,700 for an individual and $3,450 for a family policy. These restrictions, among others, confined the access and market opportunities of the Archer MSAs. As outlined earlier, the HSA keeps the basic framework of the traditional Archer MSA but gets rid of the numerous regulatory and design obstacles challenging MSAs in order to create a more conducive and stable marketplace for HSAs.
While HSAs are now law, their practical implementation is still critical. Several steps can be taken to ensure the success of Health Savings Accounts. For example:
Further rulings by the U.S. Treasury Department should remain broad and flexible. A variety of issues, such as the interaction between HSAs and HRAs/FSAs, remain unresolved and will need attention. Thus far, Treasury has been particularly accommodating in establishing the parameters within which these accounts can exist. It is important that such interpretations continue in order to encourage a responsive marketplace for HSAs.
States must make all legislative and regulatory changes needed to ensure that HSAs have market access. In some instances, state legislative and regulatory changes may need to be made in order to accommodate the availability of HSAs. For example, states may need to change their tax laws to adapt to the tax-free accounts. Changes or an exemption from state-mandated benefits may also be in order to ensure that HDHPs are qualified in the state.
All employers should integrate an HSA option into health benefit offerings for their employees. HRAs open up opportunities for businesses of all sizes to offer their employees a new coverage option. This includes federal and state employee benefit plans. With health care spending on the rise, an HSA helps to re-engage employees with their health care spending while giving employers the ability to make the transition from a defined benefit system, with open-ended costs, to a defined contribution system in which health care spending can be better managed.
Policymakers should encourage HSAs for the uninsured since they offer an alternative to more costly first-dollar coverage policies. Uninsured individuals will find that, due to the high-deductible component, the monthly premiums will be much lower than premiums for traditional policies. The HSA design ensures that individuals remain protected against unexpected, catastrophic medical costs while allowing them to save for future health care expenses tax-free.
Health Savings Accounts offer Americans a new coverage option for their health care needs. They give them a new choice in coverage design, greater control of their health care spending, and the ability to own their own health care plans. These are all key features in moving America's health care system to a consumer-based system.
To build a true consumer market, individuals should have access to all available coverage options. There should be a level playing field between each option, whether it is an HSA, an HMO, a PPO, or another form of coverage. Individuals should be able to choose, without penalty or artificial incentives, the policies they feel best fit their needs. Members of Congress should continue to look for ways to facilitate a system of consumer choice that will allow individuals to select the plans that best suit their individual medical and financial needs.
Nina Owcharenko is Senior Policy Analyst in the Center for Health Policy Studies at The Heritage Foundation.