What Should Be Done About Health Savings Accounts?

 In a frequently cited June 2022 article in Health Affairs, Sherry A. Glied, Dahlia K. Remler, and Mikaela Springsteen argue that health savings accounts (HSAs) are no longer functioning as originally advertised and suggest that we abolish them as tax-favored accounts.

Fortunately, there are better options. Instead of abolishing these accounts, we could turn them into vehicles for patients to get more cost-effective, higher-quality care—including the management of chronic illness.

What Is An HSA?

An HSA is a type of savings account that lets you set aside money on a pre-tax basis; you may then withdraw the money tax free to pay for “qualified medical expenses,” including deductibles, copayments, coinsurance, and some dental, drug, and vision expenses. Once you reach age 65, you can withdraw HSA funds for non-medical purposes without penalty, but you must pay ordinary income taxes on these withdrawals, akin to withdrawals from a 401(k) account or an IRA (individual retirement account).

To qualify for an HSA, you must be enrolled in a high-deductible health plan (HDHP); in 2024, the minimum deductible is $1,600 for individuals and $3,200 for families. The HDHP must also have a maximum annual out-of-pocket cost of $8,050 for individuals and $16,100 for families.

How Should HSAs Be Treated Under The Tax Law?

The most forceful argument made by Glied, Remler, and Springsteen is that HSAs are regressive. That’s because the monetary advantage of the accounts rises as the owner’s marginal tax rate rises. The ability of employers and employees to make tax-free deposits to an HSA is clearly of less value to someone facing a 15 percent federal tax rate—paying, say, only the FICA payroll tax—than to a highly compensated employee facing, say, a 45 percent marginal tax rate (when federal, state, and local income taxes are combined).

Glied, Remler, and Springsteen say that the tax break enjoyed by HSA holders totaled $12 billion in 2020 alone. True enough. What they do not say is that the tax treatment of the entire employer-based health insurance system cost the government $170 billion that same year. Since the exclusion from taxation of all health expenses is just as regressive as the exclusion of HSA contributions, in complaining about the latter, Glied, Remler, and Springsteen are ignoring a problem that is 14 times worse!

This is not an esoteric observation. For the past 30 years or so, every major private-sector proponent of HSAs has also favored a completely different tax regime for HSAs and all other health care costs. In particular, they have argued for fixed-sum tax credits that do not become more generous as income rises. Mark Pauly and I, for example, proposed this approach in Health Affairs more than a quarter of a century ago.

The principle of fixed-sum tax credits was the core of the John McCain health plan in the 2008 election. It was also included in legislation proposed through the years by Paul Ryan and Devin Nunes in the House and by Tom Coburn and Richard Burr in the Senate. It was the central idea in the Pete Sessions/Bill Cassidy health care bill, previously described in this forum. Sessions has introduced an updated version of the bill in this session of Congress.

Yet, ironically, many opponents of HSAs seem to have no problem with a very regressive tax treatment of employer-provided health insurance as a whole. In fact, Glied herself defended the current system against McCain’s tax credit approach in a 2008 Health Affairs article.

This suggests that the real problem many people have with HSAs is not regressivity. It’s the whole idea of patient power.

Are HSAs A Guise For Tax-Free Saving?

If the account holder remains healthy and has few medical withdrawals, HSAs turn out to be the best savings account there is. They are better than IRAs and 401(k)s, for example. That’s because during the years of retirement they are the only account that can be used to pay Medicare premiums with no tax consequences.

There is nothing wrong with that. As Ron Greiner points out in a comment to the Glied, Remler, and Springsteen article, Fidelity Investments estimates that a couple retiring in 2022 can expect to spend $315,000 on health care over their remaining years of life. Why not allow the couple the opportunity to save for that expense?

That said, the current design of the HSA is more appropriate for the needs of the healthy than the sick. Let’s see how that can be changed.

Why Do We Need A High Deductible?

Current law requires HSA holders to have an across-the-board deductible. With a few exceptions described below, the law forbids HSAs from distinguishing between services that we want to encourage (by imposing no deductible or maybe even supplying a subsidy) and services that are clearly discretionary and that we might want to cover less generously. Almost every proponent of HSAs believes this restriction should be removed. In a 2005 article, for example, my colleagues and I at the National Center for Policy Analysis argued that health plan sponsors should be completely free to design plans in a way that maximizes efficient health care choices, and that HSAs should be allowed to wrap around third-party insurance plans without restriction.

A number of positive changes have already been made. The Affordable Care Act (ACA) allowed HDHPs to provide preventive services with no cost sharing without jeopardizing the individual’s right to have an HSA. This was fleshed out and implemented through Internal Revenue Service (IRS) guidance. Additional guidance issued by the Trump administration went even further: People who use HSAs are now exempt from the high-deductible requirement for drugs for 13 chronic conditions. This means that the employer or insurer can now provide first-dollar coverage for certain drug therapies (such as insulin) without running afoul of the deductible restriction.

These changes are a good start and should be codified through formal regulation, making them harder to change and thus allowing people to rely on them more in planning their lives. More needs to be done, however.

How Can HSAs Meet The Needs Of The Chronically Ill?

There is mounting evidence that patients suffering from diabetes, heart disease, and other chronic illnesses can (with training) manage a lot of their own care with results as good as, or better than, traditional doctor-driven therapy. If people with chronic conditions are going to manage their own care, they should also have the opportunity to manage the money that pays for that care.

Accordingly, health plans should be able to deposit any amount they choose into the accounts of patients with chronic conditions who agree to manage their own care. The division between third-party payment and self-payment could vary from patient to patient and disease to disease. The tax law should not interfere with the design of optimal health care.

Is There A Successful Model That Could Be Used For Chronic Care?

There is a model, and, surprisingly, it is part of the Medicaid program in most states and has been around for several decades. The “Cash and Counseling” program allows home-bound, disabled patients to manage their own budgets. They can hire and fire the people who provide them with services, and any money they save on expenses can be used for other needs.

This program appears to save money for Medicaid; it improves health outcomes; and it has some of the highest patient satisfaction scores found anywhere. Also, as I reported in an earlier Health Affairs Forefront article, there is an international trend toward “self-directed care.”

How Can HSAs Be More Effectively Used For Primary Care?

What used to be called “concierge care” is now more commonly called “direct primary care” (DPC), and the cost has come down to the point where it could easily be integrated into garden-variety health plans. Atlas MD in Wichita, Kansas, for example, offers round-the-clock care by means of phone, email, Skype, Zoom, and Facebook as needed. The cost: $10 a month for a child with at least one parent membership; adult costs start at $50 a month for those up to age 44, rising to $100 a month for those older than age 65. This model not only offers patients the entire range of primary care services, it helps them make appointments with specialists and get discounted prices on magnetic resonance imaging (MRI) scans and other medical tests. It even provides generic drugs for less than what Medicaid pays in some instances.

Direct primary care is one of the fastest-growing segments of the medical marketplace, and it is increasingly popular with employers. Yet, although employers can pay for DPC for their employees, under current law the employer cannot put money into an account and let the employees choose their own DPC doctor. The Trump administration tried but failed to persuade the IRS to change this restriction administratively.

If Congress wants to improve HSAs, allowing HSA funds to pay for DPC should be a no-brainer.

How Can HSAs Be Used In Conjunction With Reference Pricing And Medical Tourism?

In addition to objecting to HSAs’ regressivity, Glied, Remler, and Springsteen complain that HSA holders appear to be no more price-sensitive than people with high-deductible insurance and no HSA account. Nonetheless, we know that employees can be induced to be very price-sensitive with “reference pricing.” The most dramatic illustration of that occurred in California about a decade ago.

In that experiment, CalPERS: California Public Employees’ Retirement System and Anthem Blue Cross announced to California public employees, retirees, and their dependents a change in the way the cost of hip and knee replacements would be covered. Although the cost of these procedures varied widely across the state’s hospitals, going forward the insurance plan would pay no more than $30,000 (the reference price). Any charge above that amount would be the responsibility of the patient. The response? Within two years, virtually every hospital in the state was charging $30,000 or less.

In the years since then, reference pricing has been used by many employers for many different medical services, and the results are encouraging. It is easy to understand why reference pricing makes patients so much more price-sensitive than HSAs do. For almost any hospital procedure, the HSA deductible will be reached almost immediately, and a typical patient will quickly lose interest in the subject of price. With reference pricing, however, the patient remains financially at risk, even for very expensive procedures.

Why not combine the two concepts? A defect of reference pricing is that while it incentivizes patients to avoid any price above the reference price, it does nothing to encourage them to prefer prices below the reference price. If we want the medical marketplace to be truly price-competitive, patients need to lose every dollar spent above the reference price and keep every dollar of spending below the reference price. A logical place for the savings to go is into an HSA.

A similar principle applies to medical tourism. Many Canadians come to the United States for joint replacements that they cannot obtain in a timely manner in their own country. They benefit from price competition as well as quality competition, and they get a package price that is not much different from what Medicare pays.

In general, the patient must do three things: be willing to travel, pay upfront, and assure the provider that an insurance company will not appear several months later and question why the procedure was done in the first place.

If employers wish to pay Medicare rates, they and their employees can do what the Canadians are already doing. But to get employee compliance, it is likely that the employees are going to have to get a share (maybe the lion’s share) of the savings. And the best place for those savings to go is into an HSA.

Why Can’t Seniors Have An HSA?

Once seniors become eligible for Medicare, they are no longer able to make deposits to HSAs. Although this restriction is baffling to many seniors, there is a good reason for it.

As noted, HSA funds can be used to pay Medicare premiums. If seniors were allowed to make tax-deductible contributions to an HSA and then use those funds to pay Medicare premiums, that would be the virtual equivalent of allowing retirees to deduct their Medicare premiums. Regardless of the merits or demerits of that idea, it’s a tax break Congress has been unwilling to grant to Medicare enrollees.

Even so, there is another way to allow seniors to manage more of their own heath care dollars. It’s called a Roth HSA, and the idea was first introduced by Mark Pauly and an ideologically diverse group of coauthors, including me, in Health Affairs. With a Roth-style savings account, there would be no tax subsidy for HSA deposits. Instead, deposits would be made with after-tax funds, and withdrawals for any purpose would be tax-free.

Why Can’t People In The ACA Exchanges Have An HSA?

To integrate HSAs into the ACA exchanges in an efficient way, we need to fundamentally reform the way the exchanges operate. There is a growing consensus on how to do that: Make the exchanges more like the Medicare Advantage program.

In the ACA exchanges, insurance plans are not allowed to specialize. They are required to offer a full range of services to all enrollees. Yet, if health plans are not allowed to focus and get good at meeting specific patient needs, they are likely to be mediocre when they try to meet all patient needs.

By contrast, Medicare Advantage Chronic Condition Special Needs Plans can specialize in one of 15 chronic conditions, or a group of related conditions. These plans can exclude applicants who don’t have a relevant condition. They can also ask health questions and request medical records. Furthermore, this is the only place in the entire health care system where a doctor who discovers a change in a patient’s medical condition can forward the information to the insurer (in this case Medicare) and secure a different premium for the patient’s health plan.

Congress needs to apply the same concepts to the reform of the Obamacare exchanges. With proper risk adjustment, plans would compete to attract the chronically ill, instead of competing in a race to the bottom in which they try to attract the healthy and avoid the sick.

With that reform in place, we could incorporate HSAs into the exchanges in all the ways described above. And, as in the case of seniors, the appropriate account to combine with ACA tax credits is a Roth account.

Why Do We Need Three Different Types Of Medical Savings Accounts?

We don’t. Currently, we have widespread use of HSAs, health reimbursement arrangements, and flexible spending accounts (FSAs). Each has advantages over the other two, and each has disadvantages.

For example, FSAs are use it or lose it accounts, which encourage low-value spending. On the other hand, they can more easily meet patient needs without the complicated regulations surrounding the other two accounts. HRAs have the type of flexibility I argued for above (no required high deductible). But, in general, employees cannot take unused funds with them when they leave their employer. That reduces the incentive for patients to be prudent spenders.

As I pointed out in a previous Health Affairs Forefront article, we could combine these into a single account that includes the advantages and avoids the disadvantages of all three.

Conclusion

When HSAs were first allowed under the tax law, they were an experiment. None of us knew what to expect. Now that we have almost three decades of experience, it is time to make sensible improvements in the regulations and leave the market free to find even better uses for them.

John C. Goodman, PhD, is president and CEO of the Goodman Institute and senior research fellow at the Independent Institute. The Wall Street Journal calls Dr. Goodman “the father of Health Savings Accounts.” Modern Healthcare says he is one of four people who have most influenced the changes shaping our health care system.

https://www.healthaffairs.org/content/forefront/should-done-health-savings-accounts