Consumer Choice Matters: HSAs and Some Devilish Details

Published February 1, 2004

Some readers will find the discussion below tedious, and I apologize for that. We’ll get back to fun stuff next month … but how well Health Savings Accounts (HSAs) work will depend on how the IRS regulations shake out. I’ll give you my best take on these issues, but this is all gray-area stuff. Keep in mind that the only opinion that really counts is the IRS’s.

Combining HRAs and HSAs

One of the implications of the new HSA reform is combining a Health Reimbursement Arrangement (HRA) with an HSA. Some people I respect highly have conjectured it would not be allowed because the HRA duplicates the benefits of the high-deductible health plan (HDHP), and an HRA would be allowed only if it does not duplicate those benefits. That is, the HRA might be allowed for peripheral benefits like vision or dental, but not for the core benefits the HDHP would otherwise cover.

That is not the way I see it. I believe the law says the minimum deductibles of $1,000/$2,000 are sacrosanct. There may be no coverage below those amounts, other than the HSA. But once you’ve broken through that threshold, benefit construction is wide open.

What I am reading says: “[To be eligible for an HSA] such individual is not, while covered under a high deductible health plan, covered under any health plan which is not a high deductible health plan, and which provides coverage for any benefit which is covered under the high deductible health plan.”

This says (as far as I can see) that an individual is disqualified from an HSA if he has coverage that duplicates the benefits of the high-deductible plan AND which is not a high-deductible plan. Both conditions must be present. Please correct me if I’m missing something, but I see no reason that an account-holder could not be covered by two plans if they are both high-deductible health plans.

So, an employer-funded HRA could be used to fund another deductible on top of the HSA-funded deductible, or the HRA could be used to cover coinsurance on top of the HDHP deductible. The HRA is, after all, just part of the HDHP. That is especially true for self-funded employers (it is all Section 105 money), but should be true for insured situations as well.

Converting HRA Funds

Many employers have asked about HRA conversions. If there is an HRA in place and the company switches to an HSA, can employees continue to access the HRA funds–in effect, “spend-down” the HRA money? Again, it would seem this should be allowable, provided the HRA money doesn’t fill the minimum deductible. Or, if the HRA plan document allows it, an employer could reclaim the HRA fund, and use that obligation as a source of HSA funding.

Carving out Rx Benefits

Some employers have told me they would like to carve out prescription drug benefits from the HSA/HDHP package, and continue to offer these on a triple-tier copayment basis, or fund it with an HRA. I cannot see any way the law would allow this. It is quite specific on what are “permitted coverages” below the deductible, and Rx isn’t one of them.


Another issue that has been raised is the application of non-discrimination rules. I hadn’t heard of this before, but I’ve been told if, in the course of setting up a Flexible Spending Account (FSA) program, it turns out only “highly compensated employees” choose to participate, the whole program can be disqualified after-the-fact.

The fear is that applying the same standard to an HSA program could be very messy, involving a return of worker’s contributions and re-enrollment in a different health plan even after the plan year has begun. There seems to be some relaxation of the non-discrimination rules for HSA programs, but it isn’t clear how far it goes.

Independent Substantiation

Much-discussed has been the question of independent “substantiation” of HSA withdrawals. FSAs and HRAs require that a withdrawal be certified as a qualified medical expense under Section 213(d). There are severe penalties on the employer if these moneys are used for non-qualified expenses. In the case of an HRA, it may mean losing the tax advantage of the entire benefits program. Non-medical withdrawals are absolutely forbidden.

That is not the case with HSAs. People are perfectly free to use HSA money for non-medical purposes, as they have been with MSAs. The only penalty is that the account-holder (not the employer) pays taxes on the funds, plus a 10 percent penalty.

The HSA trustee will issue a statement to the IRS about deposits and withdrawals, and the account holder is required to verify that the withdrawals were for qualified expenses.

This is also how the medical expense deduction works. People are free to claim anything as a medical expense on their tax returns. The claims are not independently verified. But if the taxpayer is audited, there are severe penalties for fraudulent claims. It seems to work pretty well in keeping people honest.

Adjudicating HSA Withdrawals

Some employers would like to go beyond “substantiation” and have HSA withdrawals treated like any other insurance claim, i.e., submitted for adjudication and re-pricing so that the employee will get the “benefit” of network discounts and the employer knows whether the service is eligible for meeting the deductible.

This issue indicates many employers still don’t “get it.” The HSA money belongs to the worker, not the employer. The whole point is to get workers involved in the cost of the services they consume and begin to demand transparent pricing from the doctors and hospitals they deal with. So-called “network discounts” are fictitious. They are discounts from a “charge” that is never actually paid by anyone. HSAs will place more of the health care system on a cash basis, which is far more efficient than the existing third-party payment system. And it will begin to restore true prices that reflect value.

In the short run, some workers may very well spend their HSA money frivolously and be over-charged for services. But that is the precise learning process our entire system needs to go through to change the fundamental economic dynamics in health care. We cannot continue to treat adult Americans like hapless children who are unable to make decisions and value judgments in health care. People are able to learn from experience, and beginning in 2004, we have a tool that allows that to happen.

I welcome your comments on whatever the IRS has to say about these issues. Send your thoughts to me at [email protected].

Greg Scandlen is director of the Galen Institute’s Center for Consumer Driven Health Care and assistant editor of Health Care News. His email address is [email protected]. The opinions expressed here are those of the author and my not reflect the opinions of The Galen Institute.