Health savings accounts (HSAs) are about to lose much of their value under the Patient Protection and Affordable Care Act (PPACA), commonly known as Obamacare (see this AdvisorOne article on implications of the recent Supreme Court ruling upholding the law, and our previous blog on how to help clients prepare for the PPACA’s investment tax).
HSAs currently allow individuals to control their health care costs by paying for deductibles and routine medical expenses with tax-free dollars set aside in an HSA, reserving use of health insurance for major medical events. Patients have realized significant savings through use of this strategy because insurance companies have been able to offer high-deductible health plans (HDHPs) with low premiums for patients willing to fund routine health expenses independently. The PPACA threatens this approach by imposing minimum reimbursement rates on all health insurance plans—ensuring that premiums for HDHPs will increase when the new law becomes fully effective.
The Current System
By using HDHPs and HSAs in conjunction, individual patients may effectively control exactly how much they spend on health care expenses. HDHPs are insurance plans that, as the name suggests, make the patient responsible for paying a relatively high deductible before insurance coverage kicks in. In exchange, the patient pays much lower premiums than he would with a more traditional plan with low or no deductibles.
These individuals can then contribute the money they save on premium costs to an HSA so that they are protected in the event that they have to pay those high deductibles. Funds are contributed to the HSA tax-free and similarly escape taxation when they are withdrawn to pay for qualified medical expenses. Because the funds never expire, over the years, an individual can accumulate a substantial cushion for future medical expenses.
Many healthy patients find this approach extremely attractive because they simply do not use their health insurance often enough to make high premiums worthwhile. The system allows them to pay for only the health coverage that they need, depositing the funds they would have spent on premiums into a type of tax-deferred savings account.
The PPACA prescribes certain minimum coverage thresholds that insurance plans must satisfy in order to operate once the new law becomes fully effective.
One of these requirements is the actuarial value threshold, which is used to divide health insurance plans into tiers. For example, in the individual and small-business markets, a health insurance plan providing a gold level of coverage must have an actuarial value of 80%, meaning that plan must pay for 80% of each insured’s health expenses. The lowest permissible level is the bronze level, which must have an actuarial value of 60%.
HDHPs are at risk under the new actuarial value requirements because they, by definition, cover a lower percentage of an insured’s health care expenses. The Department of Health and Human Services recently issued guidance on the calculation of a plan’s actuarial value. While a portion of employer contributions to an employee’s HSA may be counted in determining actuarial value, an individual’s contributions are not included. This is the case even though the individual is contributing funds that he would otherwise spend on lower health insurance deductibles. Because of this, many HDHPs will be required to provide higher reimbursement rates beginning in 2014—meaning that the plans will offer lower deductibles with correspondingly higher premiums, thereby eliminating much of the benefit that an individual can realize by using an HSA in conjunction with the HDHP.
The PPACA’s 80/20 rule provides a further disincentive for HDHPs to offer very low premiums because the rule requires that at least 80% of premiums collected in any given state be paid as benefits, or the insurance company must refund the difference. Some HDHPs charge premiums so low that their fixed administrative costs eat up a larger percentage of these premiums, thus causing them to run afoul of the 80/20 rule.
For example, if an insurance plan collects $500,000 a month in insurance premiums in Florida and the corresponding administrative costs are $100,000, then $400,000 a month—or 80 percent—of the premiums are paid in benefits and the plan remains within the limits of the 80/20 rule. A HDHP that collects monthly premiums of, say, $300,000 in Florida with the same administrative costs will violate the 80/20 rule because the administrative costs represent more than 20 percent of the $300,000 in premiums collected within the state. The insurer will then be required to refund the difference to Florida policyholders, eliminating much of the incentive for offering low premiums in the first place.
While the PPACA does not expressly seek to eliminate the use of HSAs, in practice it will make contributions to an HSA less valuable for many individuals while simultaneously increasing the cost of insurance for healthy individuals with no corresponding increase in benefits.
For additional information and practical steps advisors can take on the ramifications of the PPACA, also known as Obamacare, we invite you to register for two upcoming free web seminars hosted by our Summit Business Media colleagues:
Preparing Clients for Reality of Obamacare Investment Tax
For additional coverage of this issue and similar ones, we invite you to sign up with AdvisorOne’s Summit Business Media partner, National Underwriter Advanced Markets, for a free trial.