Health Savings Account Overview

Is the new wave in health insurance for you?

At first, McElroy had trouble finding any information about the new accounts. Although authorized starting Jan. 1, 2004, providers and details were scarce.

The more information she did find, though, the fewer clients were interested.

HSAs are complex and come with a big drawback: They can’t be used unless the client has a high-deductible health insurance plan, and many people don’t want to pay $1,000 to $5,000 out of pocket, even with tax-advantaged money.

“Most people don’t like that high deductible,” said McElroy, who works for an agency in Westlake Village, Calif. “It’s very confusing, and people did not understand how these worked.”

A new wave in health-care coverage
Some proponents still believe s will revolutionize health care and even play a role in bringing medical inflation under control. They predict large-company employers will start rolling out the plans in droves next year, supplementing a growing number of self-employed and small-business owners who have set up the accounts.

One couple’s experience
Architect Robert Payne of Richmond, Va., signed up for a Medical Savings Account -- the predecessor to the HSA -- as soon as Congress made them available in 1997. He bought a high-deductible insurance policy that required him to pay the first $3,500 of medical expenses for himself and his wife each year, and put that much tax-deductible money into an investment account offered by Health Savings Administrators, also of Richmond.

Payne figured he and his wife were in good health and unlikely to need much medical care. The high-deductible policy helped him lower his insurance premiums while preserving their coverage in case he or his wife suffered a catastrophic illness or injury.

“It’s a safety net for the ‘big one,’” Payne said. “That’s what I wanted protection for.”

Congress’ creation of the HSA to replace the MSA, in Payne’s opinion, just made a good situation better:
Contributors can now put aside up to $5,150 a year, an amount that will rise with inflation.

In addition to avoiding income taxes, the contributions are now free of Social Security and Medicare taxes as well.

People like Payne who are over 55 (he is 61) can contribute an extra $500 a year, an amount that is scheduled to rise to $1,000 by 2009.
Congress also vastly expanded who can qualify. While MSAs were limited to the self-employed and small businesses with less than 50 employees, anybody who buys a compatible high-deductible policy can now open an HSA.

Even after surgery, a $30,000 balance
Most years, the Paynes haven’t had to take much out of their account, which is invested in low-cost Fidelity mutual funds. Even after back surgery last year, Payne still has a $30,000 balance.

“When you’re self-employed, it really couldn’t be any better,” Payne said. “You can put away money, and it keeps compounding.”

In fact, many account holders are so attracted by the idea of how much their tax-advantaged money can grow that they actually pay for medical expenses with other, after-tax dollars rather than tap their accounts.

“Sixty-eight percent of our account holders never touch the money,” said John Vellines, president of Health Savings Administrators. “The type of people attracted to this are looking to the future, knowing they can use it for retirement and have full flexibility in how they use the money.”

Theoretically, a couple that contributed the current maximum each year and never tapped the cash could have a nest egg of nearly $600,000 in 30 years, assuming their investments grew at an average 8% annual rate.

The nest egg may well be needed
That seems like a lot, but the Employee Benefit Research Institute warns that such a cash pile might be essential by the time many of today’s workers reach retirement age. The nonpartisan institute has estimated that people will need to have anywhere from $40,000 to $1.5 million saved to pay for out-of-pocket medical costs in retirement, not including the costs of long-term care, such as nursing homes.

Health and longevity will play a role in how much money you need, EBRI said, but so will Medicare and employer coverage:

Someone with employer-provided coverage who dies at age 80 would come in at the low end of the estimate, while those who lack such coverage and live to 100 would come in at the high end.

As longevity increases and help with health-care costs is harder to find, workers and retirees will face a rising need for cash to pay for treatments. Consider:
Medicare currently pays only half of retirees’ medical expenses, and that proportion may drop as the system runs aground. Medicare is expected to run out of cash in 2019. That’s more than two decades before Social Security is expected to suffer the same fate.


The percentage of retiree medical expenses paid for by companies is expected to continue falling, as well. Fewer than 40% of large-company employers currently offer retiree health benefits, and research firm Watson Wyatt has estimated employers will pay for less than 10% of retiree medical costs by 2031.


Even now, one of the big potential expenses of retirement -- nursing home care -- typically isn’t covered by either Medicare or private employer plans. The typical three-year stay in such a facility usually costs upward of $150,000, and the tab can be much higher in urban areas or if round-the-clock care is provided at home.
If medical inflation continues at its current breakneck rate of 14% a year, prospects for future retirees are even worse.

The goal: Using health coverage more wisely
It was medical inflation, in fact, that convinced Congress to launch the MSA pilot project and then replace it with HSAs. The idea was that unless consumers start paying more of their own health-care expenses, they won’t make the kind of dollar-wise decisions that will help rein in inflation.

“What we Americans have lost sight of is that the most important function of insurance is catastrophic protection,” said Wyatt’s Martingale. “We would all have been better off if, back when health insurance was introduced in the 1940s and 1950s, we had focused on the real issue of protecting against catastrophe … rather than creating an entitlement that offered coverage from the first dollar.”

Treating insurance this way doesn’t necessarily mean higher costs for consumers. High-deductible policies typically cost much less than traditional insurance plans -- sometimes so much less that the savings more than cover the higher deductible.

A healthy Los Angeles couple in their 40s with a child would pay about $475 per month for an HSA-compatible policy from Blue Cross of California, for example, compared to $1,000 for an all-inclusive HMO plan.

Critics: HSA's will draw off the healthiest
Critics worry, though, that widespread adoption of HSA's could undermine the health-care system. Healthy individuals could abandon traditional plans, which could founder under the costs of caring for the sicker remaining members.

That could lead to much higher premiums for the most vulnerable workers and retirees, according to the National Association of Retired Federal Employees. The group criticized the government’s plan to offer HSAs to about 3 million federal workers next year as “risky” and “premature.”

Stopping HSA’s momentum may be tough, however. Congress’ expansion of HSA eligibility has already had a profound effect on the health-insurance market.

Finding an insurance policy that would work with an MSA used to be difficult, Vellines said. Congress limited the number of potential MSA users to 750,000, and most major insurers considered that market too small to be worth the bother.

Since the program’s expansion, though, a number of big insurers, including Aetna and the Blue Cross and Blue Shield plans in some states, have rolled out HSA-compatible plans.

What the government requires
Not just any policy will work. Deductibles have to be at least $1,000 a year for singles and $2,000 for family coverage. The policy can’t offer “first dollar” coverage -- in other words, high-deductible policies that also have co-pays for all doctor visits won’t work.

The Treasury Department did recently rule that a compatible policy could offer “first dollar” coverage for wellness visits, which can include physicals, immunizations and prenatal and well-baby care. Since that’s a routine feature of many high-deductible policies, HSA proponents welcomed the ruling. Federal regulators also are temporarily allowing policies that offer prescription co-pays, but that exception is scheduled to end Dec. 31, 2005.

The interest by large employers also is creating more interest among brokerage firms in offering the investment accounts.

Fidelity Investments already is working with a few employers who are trying to roll out HSAs as early as July 1, said Pam Norley, senior vice president for the mutual fund company’s health and welfare practice. Others are aiming for a Jan. 1, 2005, introduction, and even more are shooting for 2006.

Getting buy-in from employees is a challenge
Employers are “really excited” about HSA's and their potential to contain costs, Norley said. Convincing employees of the benefits, though, might not be easy.

“The majority (of employers) have said they really need another 12 months,” Norley said, “to tackle the communication challenges these products present.”

If you’re interested in setting up an HSA, the growing buzz means you’ll probably have many more options to choose from in two years than you do today. For now, the dozen or so companies offering HSAs tend to come in two flavors:

Those that package the insurance policy with the account.

Those that let you “bring your own” by buying a policy from the insurer of your choice.

The National Small Business Association, for example, has an alliance with Assurant Health to offer HSAs. By contrast, people who use account administrators like Health Savings Administrators or First MSA Inc. of Reading, Pa., buy their coverage independently from an insurer like Blue Cross.

Premiums and account fees can vary, so make sure to shop around. Also, make sure that you can take your account with you easily in case you find a better option next year.