Questions Raised on the Value of HSAs

As experts pore over recently issued guidelines, Health Savings Accounts are losing some of their luster.

By Martha Lynn Craver, Associate Editor, The Kiplinger Letter

December 9, 2004

Health Savings Accounts (HSAs), created under last year's Medicare drug law and touted as a boon for small businesses, may not be quite as helpful as was once thought.

Rules coming out of the Internal Revenue Service require plan owners to pay the full cost of prescription drugs until they meet a high deductible—news that could come as a shock to those who need high-priced brand-name drugs. And employers are concerned that the rules have no safeguards requiring that money socked away for health care actually be used for that purpose.

An HSA is a tax-protected savings account that is paired with a so-called catastrophic insurance policy—one that has a deductible of at least $1000 a year for individuals or $2000 for a family. Employees can contribute pretax dollars to the account, as can employers, if they wish. The idea is to use the money to pay medical costs that fall under the deductible, and anything left over at the end of the year can be rolled over. Workers can also take the accounts with them when they leave their jobs.

The accounts were created to encourage patients to become smart consumers of health care and to provide plans that even very small companies could afford for their workers. Experts say it's too soon to know whether HSAs will succeed, but a lot of companies reeling from double-digit increases in health care costs are eager to give them a try. In a survey of 1000 companies conducted by Mercer Human Resource Consulting, 70% of respondents said they were likely to offer an HSA option to workers in the next two years.

HSAs are expected to be most attractive to small firms that are struggling to offer coverage of any kind and to companies with a lot of high-salaried individuals who are looking to invest pretax dollars. They will also be popular with relatively healthy individuals who believe their health costs will be lower than what they would otherwise pay in health insurance premiums.

But the rules from the IRS contain several provisions that may undercut HSAs' value. The biggest is the one requiring that prescription drug costs be subject to the deductible starting in 2006. Instead of a standard copay for each prescription, anyone with an HSA will have to pay the full cost until the deductible is reached. Given the high cost of drugs, even relatively healthy people with HSAs will end up spending more than they had expected.

Another big negative, mainly for employers, is that workers can't be forced to use HSA money for medical expenses. "A worker [can] take the money and buy a motorcycle, and the employer [can't] do anything about it," says John Asencio of The Segal Company, a benefits consulting firm. Of course, the employee has to pay tax and a penalty for doing so—the funds are tax free only if they're spent on a medical expense.

Both of these issues are beginning to get the attention of benefit consultants and employers. It's likely they will lobby for changes, but it's too soon to know whether they will succeed.

On the other side of the ledger is a plan that would make HSAs MORE attractive. President Bush is pressing Congress to provide a credit for small businesses that make contributions to their workers' HSAs. If Congress goes along with the plan—and the chances of that are good—it will be a big help to small firms.

Mercer's Ray Herschman says that employers who want to offer HSAs should require all employees to actively select which plan they wish to participate in and not wind up in a plan by default. This will put employees into a more active decisionmaking role, almost forcing them to learn more about how the plans work, he says.

Large firms trying to decide whether to offer HSAs as an option or as a total replacement should consider the possibility of "adverse selection," says Tom Billet of Watson Wyatt Worldwide, a benefits consulting firm. Young, healthy 25-year-olds might opt for HSAs, while older workers with chronic health problems might stay in their traditional plans. That could end up costing the company money—not just in higher premiums for the traditional plans, but also in the contributions employers make to HSAs for employees who don't have health care expenses.

Herschman says that employers should shop carefully when selecting a vendor. It's especially important to choose one that has developed and thoroughly tested its benefits administration, communicates well and has good customer service. They should also check which vendors cut the best deals with health care providers and which offer information on provider costs so that consumers can shop around.

Finally, employers that offer HSAs should set aside time and money to educate their workers. If they're planning to adopt HSAs in January 2006, for example, then communication with employees should start no later than September 2005, says Andy Anderson of Hewitt Associates, another benefits consulting firm. "If employees don't understand that they will pay the first $1000 themselves, all hell will break loose....These are radical changes that must be communicated thoroughly to employees."

Most BlueCross BlueShield plans have an HSA option. Other leaders in the field include UnitedHealthcare, Lumenos and Aetna.