By William G. (Bill) Stuart
Director of Strategy and Compliance
December 9, 2016
A business colleague recently called me to secure some information for his annual white paper on the reimbursement industry. He asked me questions about the future of Health FSAs, HRAs and HSAs. Here are the thoughts that I shared with him:
How is the reimbursement market in New England different from other parts of the country? I see several differences:
- We have more HRAs than HSAs in Massachusetts, New Hampshire and Maine, whereas the rest of the country has a majority (and growing) of HSAs. We’ve seen a real uptick in HSA sales in the New England market during the past two years, though they’re far from catching HRAs (and often don’t close the gap when an employer offers a Post-Deductible HRA alongside an HSA). Employers like HRAs because they can design the program, manage costs and pay a fraction of their total potential liability (because most employees don’t incur high deductible expenses).
- Our local market – particularly the greater Boston area – is disproportionately composed of health care provider networks and institutions of higher education. These industries have traditionally offered “rich” benefits to their employees. They’ve been the last employers to adopt consumer-driven health, or CDH, approaches. During the past two or three years, though, they’ve begun to realize that they can offer a “rich” benefit plan that includes lower premiums, high deductibles and tax-advantaged accounts. They’re adopting HSA plans, either as a third benefit option or in place of an existing PPO.
- Many insurers in the region have increased the member cost-sharing sharply on their nongroup and small group medical plans. HRAs are a natural way for employers to help employees manage these higher out-of-pocket expenses. HSA-qualified plans are a good fit for nongroup purchasers (lower premiums, plus no access to group reimbursement plans like a Health FSA or HRA) and small employers (lower administrative fees than a health FSA).
- No single HSA administrator has become the dominant player in the region. A number of national administrators have gained business in New England, but few have committed the resources to an in-region presence and in-person support of employers and employees.
Does an estimated growth rate of about 5% annually sound accurate? Yes. Health FSAs have been around for 30 years. Most employers are familiar with them and either offer them (because of the tax benefits that they and their employees enjoy) or they don’t (because they’re one more program to administer, the fees are too high for a very small group or they fear employees’ spending their funds early in the year and leaving employment).
Describe a headwind and tailwind on Health FSA adoption in the future. The ACA’s Excise Tax on High-Cost Employer-Sponsored Health Coverage, more commonly known as the Cadillac Tax, is definitely the headwind. As the tax is currently written, the portion of salary (their election) that employees choose to receive through a Health FSA is considered a medical plan premium for purposes of imposing a 40% excise tax on all premiums above a certain threshold.
Implementation of the tax will kill Health FSAs in their tracks because few employers whose premiums exceed the allowable maximum will pay a 40% excise tax so that employees can save 20% to 35% on taxes. We are part of several initiatives (see one here) that seek changes in the law by either (1) repealing the levy [which has been delayed three times already] or (2) removing employee contributions to Health FSAs and HSAs from the premium calculation.
Implementation of the [Cadillac] tax will kill Health FSAs in their tracks. . .”
As a member of the American Bankers Association HSA Council and an active visitor to congressional offices, I work to educate lawmakers at the national level of the impact that the Cadillac Tax will have on middle-income families (the average FSA participant has a family income in the $60,000 to $75,000 range) with financial challenges stemming from a sick child, a spouse with a chronic condition or a child who needs orthodontic care.
Absent any change in the law, the Cadillac Tax will be applied beginning in 2020.
The tailwind is raising out-of-pocket medical, dental and vision costs. Health FSAs are still an effective way for a family to realize tax savings of up to $800 when they make the IRS maximum $2,600 election (2017 figure) into their Health FSAs.
Does an estimated growth rate of about 15% annually sound accurate? Yes, though it may be a little low for us. As members’ out-of-pocket responsibility continues to rise in all group sizes, employers are looking for ways to reduce premiums (which typically involves increasing deductibles and coinsurance) and helping employees pay those higher costs). Also, as employers increase plan deductibles to manage premium costs, a growing number are implementing a back-end HRA to pick up the additional costs, so that employees are “whole” – at least in the first year or two of the new plan.
Describe a headwind and tailwind on HRA adoption in the future. The Cadillac Tax is a headwind, but not as strong as with the Health FSA. Whether an employer offers (1) a lower-deductible plan or (2) a higher-deductible plan with an HRA, it’s all employer money going toward the Cadillac Tax calculation, and a higher HRA value is offset by a lower premium.
A tailwind is the growing member financial responsibility each year. Employers want to help employees offset these higher costs or even to increase the deductible and use an HRA to keep the net deductible unchanged. HRAs are attractive because employers control the design of the HRA (total value, eligible expenses, payment order, whether to allow carryover of unused funds, limits on carryovers).
Another tailwind is a bill before Congress to allow small employers who don’t offer employees medical insurance to fund an HRA to pay their premiums in the nongroup (individual purchase) market. Under current tax law, HRAs can’t be used by active employees to pay medical premiums (though they are an increasingly popular vehicle to fund employer contributions to retirees’ medical premiums).
If this plan passes, employers can provide a tax-free stipend to employees, who then can shop in the nongroup market and choose a plan that works for them. Employees would be able to use either their employers’ HRA funds, or if they qualify, an advance premium tax credit (premium subsidy financed by the federal government), but not both.
Does an estimated growth rate of about 25% annually sound accurate? Yes. I’ve seen other independent reports showing account growth and balance growth in the 20% to 25% range. HSAs are clearly the fastest growing of these three programs.
Describe a headwind and tailwind on HSA adoption in the future. The Cadillac Tax appears to be a headwind at first glance because employer contributions to their employees’ accounts and employee pre-tax payroll contributions are included when calculating the premium subject to the 40% excise tax. That’s a barrier to acceptance.
On the other hand, unlike with Health FSAs and HRAs, employees can make personal (after-tax) contributions to their HSAs and deduct the contributions when they file their personal income tax returns. Employers can make post-tax contributions to employees, who can then place the money in their HSAs and take the personal income tax deduction. In either case, employees can reduce their federal and state (if applicable) income tax liability, though they can’t recoup FICA taxes paid.
A possible headwind or tailwind is insurer pricing of HSA-qualified plans. These plans have lower claims costs than other medical plans. The question is whether the lower claims are a result of members’ becoming more prudent consumers of services or simply a result of healthier individuals enrolling in these plans. Insurers tend to be conservative in pricing these products, seemingly believing that the lower claims costs are a result of selection, which will even out over time.
Many employees are cost-sensitive and will enroll only if two factors – premium differential vs. another plan offered and employer contribution to an HSA – can reduce a substantial portion of the out-of-pocket cost difference between plans offered. Lower premiums on the HSA-qualified plan help reduce that net gap.
Building medical equity in an HSA is more advantageous than saving for retirement medical costs in a traditional or Roth IRA or 401(k) . . .
A tailwind, as with HRAs, is the growth of plans with higher out-of-pocket responsibility. HSAs allow both employers and employees to contribute to employees’ HSAs. Both parties enjoy tax savings.
Another tailwind is the growing media coverage of HSAs as investment and retirement medical savings accounts. HSA owners can accumulate funds (no use-it-or-lose-it) with triple tax advantages (pre-tax contributions, tax-free account growth and tax-free distributions for eligible expenses).
Building medical equity in an HSA is more advantageous than saving for retirement medical costs in a traditional or Roth IRA or 401(k), all of which are taxed at the time of contribution or distribution.
An additional tailwind is the consolidation of HSA administrators (read my November 10 blog post on this here) and a shift from banks to third-party administrators (like Benefit Strategies) that offer a full range of employer services under a single roof. This consolidation has two benefits.
First, employers will face less confusion with fewer voices crying for their attention.
Second, the move toward full-service TPAs will make it easier for employers to offer this service with an incumbent partner.
Are there opportunities to exploit with product innovation in the HSA market? Definitely. Few account owners are using their HSAs as investment accounts, despite growing balances and more articles in the popular financial press that focus on this approach (see here and here and here). The HSA administrator that can create a product or program that substantially increases account owners’ investment balances will be a winner.
Also, HSAs are potentially more susceptible to fraud than some financial accounts, for several reasons. First, individuals often open and close several accounts as they change jobs and move assets to their new employer’s preferred administrator. Also, HSA owners often don’t monitor their accounts as often as they do personal checking accounts – particularly when they’re healthy or savers and thus make few distributions from the account. HSA security will be an area of opportunity for administrators.
What We’re Reading
We’re always eager to receive the annual Employee Benefit Research Institute (RBRI) report on the state of HSAs. The 2016 version (2015 information) has some interesting information:
- 85% of HSAs have been opened since the beginning of 2011, demonstrating that HSA programs are growing in popularity.
- The average balance in an existing HSA increased from $1,332 at the beginning of 2015 to $1,844 by the end of the year.
- Only 3% of HSA owners are investing their balances. The Benefit Strategies HSA allows account owners to designate a threshold above which balances are automatically invested in owners’ chosen investments, which increases balances invested and allows owners to build their balances automatically.
- Account owners who contributed to their accounts deposited an average of $1,864. Employers who contributed to their employees’ HSAs gave an average of $948.
It’s worth taking the time to read the report to learn more about how these figures vary by account owner age, employer size, age of the HSA, etc.