Faced with alarming increases in health care costs, employers are turning to consumer-driven health plans to help rein in expenditures.
Such consumer plans include Medical Savings Accounts (MSAs), Health Reimbursement Arrangements (HRAs), Flexible Spending Accounts (FSAs), and defined-contribution plans that give employees a fixed amount of money with which to purchase their own health policy. Many consumers and employers are confused about the differences among plans and which approach is best.
The Washington Post recently reported the American Postal Workers Union is giving its employees a “Medical Spending Account” option. Not to be confused with Medical Savings Accounts (MSAs), the postal workers were getting an HRA option. Indeed, current federal MSA legislation makes it illegal for the union to establish a tax-free MSA.
Medical Savings Accounts
Medical Savings Accounts are health plans combining a high-deductible health insurance policy with a savings account. The high-deductible policy protects the insured from the cost of a catastrophic illness, prolonged hospitalization, or a particularly unhealthy year. The savings account is controlled by the insured and is intended to pay routine health care expenses.
Deposits to federally qualified MSAs (often referred to as Archer MSAs) are tax-free income for the employees whose accounts receive it. MSA funds not spent by year’s end may be withdrawn or rolled over to the next year, accumulating with interest. Those who withdraw MSA funds for purposes other than health care expenses must pay the taxes they avoided plus a 15 percent penalty.
Congress authorized federally qualified MSAs under the Health Insurance Portability and Accountability Act of 1996 (HIPAA). At the same time, it imposed a number of restrictions that reduce the workability and appeal of MSAs. For example, only the self-employed and employees working for small businesses can have a tax-free MSA. Employers or employees, but not both, can contribute money to the MSA.
Flexible Spending Accounts
Congress authorized FSAs under the Revenue Act of 1978. FSAs allow employees to contribute some of their own salary to an account to pay for health care expenses or their share of health insurance premiums. Like Archer MSAs, contributions to an FSA are exempt from both income and payroll taxes. However, under the tax code, only employers can establish FSAs for their employees, so the self-employed and millions of employees whose employers don’t offer FSAs are prohibited from creating accounts.
The biggest downside of FSAs is the use-it-or-lose-it provision. While employees contribute the money, employers can keep any unspent balance at year’s end. Because it is difficult for a family to predict its annual medical expenses, employees often over-fund their accounts and by December find themselves spending on unnecessary or frivolous health care so they will not have to forfeit the remaining money to their employers.
Health Reimbursement Arrangements
HRAs–the A is for “arrangements,” not “accounts”–are the newest form of consumer-driven health plan. In June 2002, the IRS authorized them and published guidance regarding their tax treatment.
HRAs allow an employee to use employer’s money solely for medical expenses. The funds are owned by the employer, not by the employee, and they may not be withdrawn for non-medical expenditures.
If an employer permits withdrawals for non-medical expenses, its HRA plan will be disqualified for all employees, who will owe taxes on all amounts paid out of the HRA, including all prior medical reimbursements.
Unspent HRA balances may accumulate from year to year, and employers may or may not allow departing employees access to the balances after they have left the company. In practice, most employers do not make the funds available to former employees.
It’s All about Incentives
The accompanying table offers a side-by-side comparison of the pros and cons of MSAs, FSAs, and HRAs. One of the main differences between them is the financial incentive to be a value-conscious health care consumer. HRA and FSA funds do not belong to the employee, and therefore they offer the employee little incentive to control spending. Indeed, the only way to gain value from HRA or FSA funds is to spend. Such programs might actually increase health care spending rather than reduce it.
Congress could, however, change the FSA’s use-it-or-lose-it rule to a use-it-or-save-it provision. It could also give employees an ownership right to their HRA funds. Better yet, Congress could eliminate the restrictions on Archer MSAs so that all employers and employees would have access to a wide range of MSA plans.
Victoria Craig Bunce is director of research and policy at the Council for Affordable Health Insurance, CAHI. She can be reached by email at [email protected]