Reform plans leave Health Savings Accounts in limbo

Andrew Field switched his 135-employee company to an HSA-based health coverage plan, and is a big fan of the flexibility it affords.

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NEW YORK (CNNMoney.com) -- While Washington wrangles over health care, the nation's last big reform innovation faces an uncertain future. Health Savings Accounts, the hybrid of flex spending accounts and IRAs that President Bush created in 2003, are an afterthought in the current proposals on Capitol Hill -- with strenuous debate over whether their demise would be a disaster or a welcome end to a program that never lived up to its promise.

HSAs, as they're usually known, are simple in theory but complex in practice. To be eligible, an individual must subscribe to a health insurance plan with a high deductible, the kind of bare-bones plan that typically carries lower premiums. For 2009, the minimum qualifying deductible is $1,150 for individuals and $2,300 for families, though the actual average annual deductible of HSA-eligible plans was nearly twice that, according to data compiled by the Kaiser Family Foundation. Employers or employees (or both) can then put pretax dollars into an HSA, which can be withdrawn tax-free for medical expenses, just like cash in a flexible spending account (FSA).

The twist is that while unused FSA cash disappears at the end of each year, unspent HSA money rolls over and continues to accrue tax-free interest. Like 401(k)s and IRAs, it's a plan intended to encourage users to save up big cash cushions they can tap later in life.

HSA advocates say that by encouraging consumers to spend their health care dollars more carefully (to avoid hitting the high deductible), HSAs present a market-driven solution to the current health-care dilemma. Whole Foods Market CEO John Mackey recently sparked a minor uproar when he advocated HSAs as part of the "Whole Foods Alternative to ObamaCare" in a Wall Street Journal op-ed (Whole Foods has offered HSA-style coverage since 2003), prompting tens of thousands of Whole Foods customers to threaten a boycott.

For small business owners struggling to offer employees medical coverage, high-deductible plans paired with HSAs can offer an affordable option. "I think they're great," says Andrew Field, who switched his 135-employee company, PrintingforLess.com in Bozeman, Mont., from a traditional Blue Cross/Blue Shield plan to an HSA-eligible one three years ago. After initial "trepidation" among his employees, he says, "people have really embraced it. People are taking a more active role in managing their health care."

In particular, recalls Field, "I can think of one woman here who needed an ankle operation. So she waited until there was enough money in her HSA to completely cover it. Then she shopped around and found out if she drove down to not the nearest hospital but one 20 miles away she could get a better deal." Another employee whose wife had complications in childbirth, he says, was able to negotiate a payment plan based on the company's future $200-a-month contributions to the employee's HSA.

Though HSAs have expanded steadily since their introduction, they remain relatively rare. Around 355,000 tax filers in the U.S. had an HSA in 2005, up from 120,000 the year before, according to a Government Accountability Office study released last year. That represents a small fraction of the number of people who were qualified to open HSAs: A June survey by the insurance industry found that 8 million people are now covered by HSA-eligible plans, more than doubling in just three years.

It's a critical issue for small businesses because their employees are the ones most likely to have high-deductible plans. Last year, 8% of workers at companies with less than 200 employees were enrolled in HSA-eligible health care plans, compared to 3% of workers at larger businesses, according to the Kaiser Foundation's survey.

However, just because a plan is HSA-eligible doesn't mean that enrollees use them: Nine out of 10 people in eligible plans hadn't actually opened savings accounts, according to a 2005 study by the Employee Benefits Research Institute and the Commonwealth Fund. (While many HSA users opt into plans managed by their employers, anyone with eligible insurance can open an HSA account on their own, even if their company doesn't offer one.)

Those that do contribute have disproportionately deep pockets: In 2005, the average income for adult tax filers under 65 reporting HSA activity was about $139,000, compared with $57,000 for all other filers, the GAO found in its study.

It's figures like these that worry HSA critics like Edwin Park of the liberal Center for Budget and Policy Priorities. Since many small businesses already offered high-deductible plans as a means of coping with high insurance premiums, he contends, "a lot of the fact that small businesses started adopting HSAs was just shifting their existing high-deductible plans to make sure they conformed to HSA criteria." In that case, says Park, HSAs end up merely serving as a tax shelter for high-income individuals for the insurance plans they already have -- a charge bolstered by the GAO's finding that 41% of those who did make HSA contributions withdrew nothing for health expenses during the year.

What some high earners do is simply pay for their health costs out of pocket -- which allows them to leave their HSA contributions in the account, earning money tax-free. By comparison, Park says, "Lower-income people who are contributing to these accounts tend to use them on an in-and-out basis to pay for ongoing health expenses."

Though that's the intended use of HSAs, it means missing out on much of the tax benefit. Park and other HSA critics also worry that by appealing to healthy, well-off individuals -- you get the most benefit from an HSA, after all, if you never go to the doctor and just bank your savings -- the accounts leave other insurance plans with more high-risk cases, raising their premiums in return.

Field is typical of HSA users in that he doesn't consume much in the way of medical services. "I haven't been to the doctor in five years," he says. He uses his HSA for some expenses like contact lenses and trips to the dentist, but he isn't relying on his health insurance or his HSA to cover any expensive or chronic conditions: "I do it as a savings vehicle, if you want to know the truth. One guy in my accounting department said, 'I'll max out my HSA contribution before I max out my 401k.' Because [the HSA is] never taxed."

As for what will come of HSAs in the ever-shifting landscape of health reform, there's likewise disagreement. None of the bills currently under consideration in Congress so much as mention HSAs. But Daniel Perrin of the HSA Coalition, a nonprofit lobbying group, worries that savings accounts could still be crowded out by the effects of reform.

For example, says Perrin, most of the proposed reform legislation would require plans to offer a minimum level of benefits, which would make it harder for insurers to keep premiums low by limiting coverage. Those low-premium, high-deductible plans are the ones HSAs are intended to support.

"I'm going to get the same price for a plan with a $500 deductible or a $4,000 deductible -- why would I do that?" Perrin asks. This, he insists, is what transpired in Massachusetts when it implemented its health-exchange-based system in 2006.

Yet even if the benefit requirements pass unscathed -- Sen. Max Baucus, for example, has countered with a plan that would offer four benefit levels ranging from "Bronze" to "Platinum" -- Park notes that the Congressional Research Service estimates that most high-deductible plans could remain in place by increasing the benefits they provide.

And according to the Massachusetts Department of Revenue, which tracks HSAs through tax filings, the accounts have survived that state's reform -- which includes minimum benefit levels -- just fine. The number of HSA-using tax filers in Massachusetts rose from 2,195 in 2005, the year before the state enacted its new health insurance system, to 7,434 in the still-incomplete 2008 tax year, with more expected to file in the coming months.

Entrepreneur Andrew Field hopes that HSAs not only survive but can be improved. While he's pleased that HSAs have his employees "thinking like consumers," he admits that the medical system is not especially forthcoming about the prices on its menus: Finding information to comparison-shop for medical services "has not been great," he says. One of his top requests for health reform: "I would look at requiring pricing to be disclosed. That's a pretty-nonintrusive regulation."