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Combating High Health Insurance Costs with Health Savings Accounts

Originally published: 07.01.07 by Mike Coyne


HSAs can mean savings for employees, but company owners should weigh the pros and cons of these consumer-driven plans.

The cost of health insurance for workers is crushing employers. Between 2000 and 2005, premiums for health insurance increased a cumulative 73%, while wages increased only 15%. Because skyrocketing health-care costs frequently limit an employer’s ability to increase wages, both employers and employees would benefit from controlling such costs. Will health savings accounts (HSAs) be the answer? It is too soon to tell, but employers considering such plans have much to consider.

HSAs are the centerpiece of the newest strategy to attempt to control health-care costs: consumer-driven health care. HSAs are a sort of IRA (individual retirement account) for health-care costs. Individuals are allowed to have these accounts in connection with health-insurance policies that include high deductibles. Contributions to these accounts are tax deductible, and withdrawals to pay medical expenses are not taxed.

The idea is to give some of the money currently going to health-insurance companies directly to the employee in the form of a tax-sheltered savings account. The thinking is that although the employee must pay a high deductible under the insurance policy, the savings account will help to provide the

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employee with some of the funds needed to pay for health care. The hope is that employees will become more cost conscious consumers and be more careful in their health-care spending because they are spending more of their own money.

Although the current form of HSAs first became available in 2004, Congress has been experimenting with this concept for some time. In 1996, Congress enacted a pilot program that allowed employees with high-deductible health insurance policies to have medical savings accounts (MSAs). However, the pilot program was limited to businesses with 50 or fewer employees and covered up to only 750,000 individuals.

Unfortunately, the pilot program attracted so few participants that it was never possible to determine whether this strategy resulted in lower health-care costs. Nevertheless, Congress enacted the current program as part of Medicare legislation passed in 2003.

Here’s how an HSA works:

  1. The employer adopts a high-deductible health-insurance plan for its employees, meaning the plan must have a minimum deductible of $1,100 per individual with a cap of $5,500 on out-of pocket expenses. For family policies, the plan must have a minimum deductible of $2,200 with an $11,000 cap on out-of-pocket expenses. (The required deductible limits and caps on out-of-pocket expenses are adjusted annually for inflation. These numbers are for 2007.)
  2. Employees participating in this high-deductible health plan qualify to have an HSA. The employer or the employee may establish the HSA, and either the employer or the employee (or both) may make contributions. In either case, the employee is the owner of the HSA and will continue to be so if he or she leaves the company. Contributions add up from year to year if not used.
  3. Insurance companies, banks, or credit unions can set up HSAs. Any bank, credit union, or other entity that meets the Internal Revenue Service standards for being a trustee or custodian for an IRA or MSA can be an HSA trustee or custodian.
  4. Withdrawals from the HSA are tax-free, so long as they are for the purpose of paying for qualified medical expenses. If funds are withdrawn for any other purpose prior to age 65, they become subject to income tax and a 10% penalty tax. After age 65, any remaining funds in the HSA can be withdrawn for any purpose without penalty.
  5. The maximum amount that can be contributed for an individual to an HSA in 2007 is $2,850. In the case of family coverage, the maximum contribution is $5,650. People age 55 or older can also make a “catch-up” contribution of $800 in 2007. (The limit on catch-up contributions will increase to $900 in 2008 and $1,000 in 2010 and thereafter.)
  6. An individual with a high- deductible plan will not be eligible for an HSA if he or she also is covered under a non-high-deductible plan. For example, an individual will not be eligible for an HSA if he or she is covered under a spouse’s plan that is not a high-deductible plan. It is, however, possible to be covered under some types of insurance that do not have a high deductible. For example, accident coverage, dental care, vision care, and hospitalization insurance that pays a certain dollar amount per day of hospitalization will not make an individual ineligible for an HSA. Additionally, an employer’s health plan can provide coverage outside of the deductible for preventive care and for prescription drugs that are ordered for preventive reasons rather than for treatment of a specified illness. Examples of these would be annual visits to a gynecologist for women or a pediatrician for children, or cholesterol-lowering drugs.

HSAs (like MSAs) have been a bit slow to catch on, and there are some good reasons for both employers and employees to be wary. First, consider what it means to have a high-deductible health plan. Such a plan means the end of the $15 or $20 co-pays for doctor’s office visits that may not be covered by preventive-care coverage. It also means the end of a $10 or $20 co-pay for most prescription drugs.

Employees under high-deductible health plans will pay the full cost of a doctor’s appointment as well as the full price for prescription drugs until deductibles are met. (See the comparison chart above.) Although most high-deductible health plans offer better rates for health care and prescription drugs than are offered to the uninsured, these costs are significantly more than employees are used to paying. As one commentator has noted, “without insurance, even routine health-care costs can add up to hundreds or even thousands of dollars fairly quickly. Regardless of the tax advantages HSAs offer, users have to be comfortable with the practical reality of digging into their own pockets to pay for medical expenses.”

Another concern about high-deductible plans and HSAs is that they could create a potentially large gap in coverage, very much like the “doughnut hole” that received wide attention in connection with Medicare prescription drug coverage. Here is the problem: A high-deductible health plan providing family coverage must have a deductible of at least $2,200 and an out-of-pocket cap of not more than $11,000. Assume a policy is purchased that has just those limits. The most that can be contributed to an HSA in this case is $2,200. However, the family’s potential financial exposure is $11,000. (Although this is a possibility, it is not always the case. Individual policies vary, some paying 80% to 100% of costs after the deductible is met. Explore all extreme possibilities of policies under consideration.)

Many employers will be concerned about a negative backlash from their employees if they switch to a high-deductible health insurance policy. But that is not the only concern of employers. The switch from a lower-deductible policy to a high deductible policy should result in significant savings for the employer (generally, a 20% to 50% reduction in premiums). While some employers will see significant savings, other employers, particularly those with fewer than 20 covered employees, will likely see smaller savings. Additionally, a number of employers who were among the first to take advantage of HSAs complain that they are now seeing the same large increases in health-insurance premiums that they experienced prior to the conversion to a high-deductible health plan.

Even with these drawbacks, HSAs are worth some consideration. An employer who is trapped in a very expensive health-care plan might consider switching to a high-deductible plan with an HSA in order to bring health care costs back to a more manageable level. As noted earlier, high-deductible plans generally are 20% to 50% less expensive than traditional health plans. Employers who do not presently offer health insurance, but feel a need to offer insurance for competitive reasons, might wish to start with a high-deductible plan. Your employees may be better off with a high-deductible plan than no plan at all.

Before considering a high-deductible health plan and HSAs for your employees, ask your insurance agent to find out what types of high-deductible plans are available in your local market. Plans that are linked with good preventive care or wellness programs may be a little more expensive in the short-term but may provide some long-term benefits. You should also ask your agent about the experience of other clients who have adopted this type of health plan. Be sure to ask about the size of premium increases after the first year of coverage under the high deductible plan.

It is also a good idea to discuss changes in health care with your employees before implementing changes. One of the chief criticisms of consumer-driven health care is that consumers are not given the education or tools necessary to make good decisions regarding health care. There is some statistical evidence that the lack of education is leading individuals to avoid obtaining the care they actually need. A recent study by the Employee Benefits Research Institute found that about one-third of individuals with high-deductible plans reported delaying or avoiding necessary care compared with 17% in traditional health plans.

As a business owner, you might want to consider a high-deductible plan and HSA for yourself, even if it is not a good option for your employees. HSAs offer a tax-savings opportunity for the owner, both in the form of a tax deduction for contributions and tax-free accumulation. Eligible individuals can contribute to an HSA, even if they are not eligible to contribute to an IRA on a tax-deductible basis. Some individuals have adopted HSAs as additional retirement savings vehicles, foregoing withdrawals for payment of medical expenses in favor of tax-deferred savings.

It will probably be several more years before we can measure the effectiveness of HSAs in reducing health-care costs. In the meantime, high deductible plans with HSAs provide employers with a pretty good way of shifting from expensive health plans to more reasonably priced health plans. Thus, they do deserve consideration.

Comparin
Health-Insurance
Options
INSURER A
INSURER A
INSURER B
INSURER B HSA with Insurer A
high-deductible PPO plan
Low deductible
High deductible
PPO
PPO
HMO/PPO combination
PPO
nonPPO
PPO
nonPPO
HMO
PPO
nonPPO
HMO only
Calendar-year deductible
         
Individual
$250
$500
$2,500
$5,000
$0
$200
$600
$200
$2,000
Family
$500
$1,000
$5,000
$10,000
$0
$400
$1,200
$400
$4,000*
           
All other covered services
(after deductible)
PPO
NonPPO
PPO
NonPPO
HMO
PPO
NonPPO
HMO
PPO
NonPPO
Insurance company pays
80%
60%
100%
80%
100%
80%
70%
80%
100%
70%
Employee pays (co-insurance)
20%
40%
0%
20%
0%
20%
30%
20%
0%
30%
           
Maximum out of pocket (deductible + co-insurance)
       
Individual
$1,750
$2,000
$2,500
$12,000
$1,000
$2,200
$4,600
$2,200
$2,000
$4,000
Family
$3,250
$4,000
$5,000
$24,000
$2000
$4400
$9200
$4,400
$4,000
$8,000
           
Lifetime maximum benefits per person
$5,000,000
$5,000,000
Unlim/$2,000,000
Unlimited
$5,000,000
           
Emergency-room co-pay
$100 + 20%
None. Covered 100% after deductible
$100
$100
None. Covered 100%
after deductible
           
 
PPO
NonPPO
PPO
NonPPO
HMO
PPO
NonPPO
HMO
Preventive care covered 100%
Office visits
$20
Ded+co-pay
$30
Ded+co-pay
$10
$10/$30
Ded+co-pay
$25
Deductible + co-pay
           
Prescriptions
   
In-network
Out-of-network
   
Generic
$10
$15
$10
$15
$15
Deductible + $15 co-pay
Name brand
$30/$45
$35/$50
$20
$30
$30
Deductible + $30/$45 co-pay
Mail order
Yes
Yes
Yes
Yes
Yes
Yes
           
Monthly premiums
         
Husband and wife
$1,020.70
$817.70
$875.57
$578.47
$726.27
Single person
$368.70
$295.70
$354.21
$234.01
$320.27
Family of four
$794.70
$636.70
$751.33
$496.39
$641.97
Total monthly health-insurance costs**
$2,184.10
$1,750.10
$1,981.11
$1,308.87
$1,688.45
Dental coverage
(additional premium)
$209.60
$209.60
$157.63
$157.63
$262.97
Michael P. Coyne is a founding partner of the law firm Waldheger Coyne, located in Cleveland, OH. For more information of the firm, visit: www.healthlaw.com or call 440.835.0600.

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