Medical savings accounts (MSAs) were proposed in 1997 as a supplemental mechanism for financing health care services. Medical savings accounts are used to accumulate funds for health care expenditures just as individual retirement accounts (IRAs) accumulate funds for retirement. Changes in the Internal Revenue Service (IRS) Tax Code permit tax-deductible contributions by employees and employers to MSAs and allow interest and earnings to accumulate without taxation.
Funds can be withdrawn without penalty only for medical expenses, for the purchase of health or long-term care insurance, or for other expenditures that are stipulated in the tax code. Each person owns and controls his or her account, regardless of changes in employment, and therefore has a financial incentive to make cost-effective use of health care resources. Coupled with high-deductible health insurance, MSAs empower cost-conscious patients in health care decision making, increasing competitive pressures to reduce health care costs.
Administrative costs and paperwork associated with health insurance have also been reduced, and some persons who currently do not have health insurance have been able to obtain some financial protection. However, MSAs alone have not achieved the goal of universal access. The continued concerned is that MSAs have not helped unemployed persons or low- and middle-income persons who cannot afford to contribute to such accounts. These accounts, in some cases, have even resulted in reduced health insurance protection and greater out-of-pocket expenses for those most in need of health care services.
Problems of adverse risk selection have also taken place when a healthy person has chosen to establish MSAs and obtain high-deductible health insurance; this choice has sometimes caused premiums to become less affordable for persons who desire traditional health insurance. Medical savings accounts are tax-free or tax-deferred bank or personal savings accounts that can be used by individual persons and families to pay for their health care expenses.
Also known as health savings accounts, medical IRAs, or Medisave accounts, MSAs are viewed as a way to restore individual control over health care expenditures by linking such expenditures directly to a personal medical bank account. Proponents of MSAs argue that these accounts have encourage consumers to use routine health care services more economically because unused funds accumulate in the account and can be used for future health care needs without restriction. Individual persons and families therefore have a financial incentive to use routine health care services prudently.
Young, healthy persons and other members of low-risk groups who might not otherwise purchase health insurance or save for future health care expenses now have an incentive to make tax-free contributions to their own tax-sheltered MSA. Restoring consumers’ cost-consciousness and their control over routine health care spending is seen as the most effective way to reduce health insurance costs and overall health care spending, thereby improving access to health care services. Previous tax laws did not permit this type of tax-free savings accounts envisioned by advocates of MSAs.
In a medical savings account withdrawals can be made, without penalty, only for medical expenses as defined by the IRS. Federal and state legislative actions amended the tax laws which required contributions and interest earnings to be sheltered from taxation in 1997. Current federal income tax laws treat contributions to MSAs by employers as non-taxable income to the employee; any interest earned in an MSA is also considered to be non-taxable income. A few employers have experimented with arrangements that are similar to MSAs.
Currently, employers can establish flexible spending accounts that allow employees to have pre-tax dollars withheld from their paychecks to pay for anticipated medical expenses. Funds can be used for medical expenses (as defined by the IRS) but must be used during the same calendar year in which they are withheld. Unused funds cannot be accumulated from year to year and are forfeited to the employer or plan administrator to offset administrative costs. Consumers must spend all of the money in these accounts by the end of the year or forfeit it; therefore, such accounts cannot be used to save for future health care expenses.
Some employers (for example, Forbes, Dominion Resources, and Quaker Oats) have adopted programs that reward employees with year-end cash bonuses for not submitting health insurance claims or for having claims that are less than an annual target amount (1). In 2003, the United Mine Workers negotiated a contract in which they agreed to exchange a health insurance plan with no deductible for one with a $1000 annual deductible. In return, each employee received a taxable $1000 bonus at the beginning of the year, and the employee kept any unspent money at the end of the year (2).
These arrangements are often cited as successful examples of how MSAs can reduce health care costs, but they are not true MSAs. In these examples, account balances do not accumulate for health expenses beyond one year, unused funds can be used without restriction, and the accounts do not receive favorable tax treatment that would put them on an equal footing with contributions for health insurance. Coupled with high-deductible health insurance policies, MSAs provide a cost-saving alternative to first-dollar or low-deductible health insurance while providing protection for catastrophic expenses.
Typical health insurance policies with first-dollar coverage or low deductibles tend to shield consumers from the full effect of health care prices. They provide little incentive for the consumer to shop for services on the basis of cost. Advocates of MSAs argue that increased cost-consciousness on the part of the consumer and substantial financial savings could be achieved by purchasing low-cost health insurance policies with high deductibles and establishing MSAs to fund the deductible and co-payment amounts. Substantial savings in health insurance premiums may be achieved by switching from low- to high-deductible policies.
For an individual person or family buying a non group policy, the savings might be as much as the difference in the premium amount. Proponents argue that most employers could cut their health insurance premiums by one third with a $2500 deductible, even without changes in health care consumption. The savings in insurance premiums obtained from switching to a high-deductible plan could be used by employers to fund employee MSAs and might offset much, if not all, of the employee’s increased financial risk for the higher deductible amount.
Employees could then take those tax-free funds from their personal accounts to pay for routine medical expenses. As soon as the deductible from the catastrophic policy is met, the insurance would cover expenses for any additional services. Employers benefit from reduced health insurance premiums and can expect to curtail future costs. Employees benefit by accumulating unused funds for future health care expenses and by having greater discretion over health care spending done on their behalf. Example 1: An employer pays $4500 per year for each employee for standard health insurance coverage.
Under a MSA plan, the employer would take $1500, purchase a policy with a $3000 deductible for the employee, and deposit $3000 into the employee’s personal MSA. In this example, the cost to employer and employee remain the same. The employee has the same amount of insurance protection but now has an incentive to curtail health care spending. The employer’s costs have stabilized, and, if employees respond by reducing health care spending, less upward pressure will be exerted on future employer health care costs.
Example 2: A family purchases a catastrophic policy with a $2500 deductible and makes annual tax-free deposits of $2500 into an MSA. The family uses its MSA money to pay for the first $2500 in medical expenses. If the family meets the deductible for the catastrophic policy, any further medical expenses are covered by the health insurance. Any unexpended funds will accumulate and earn interest in the tax-free medical savings account. If the family has no medical expenses for 5 years, the MSA balance, at 6% interest, accumulates to $14 516.
The family then has savings that it would not have had if it had purchased a low-deductible health insurance policy. These savings can be used to pay future health care expenses. In addition, the family has protected itself from the risks of both routine and catastrophic health care expenses. Medical savings accounts have been used in Singapore since 1984 as part of a system of forced savings in which employers and employees are required to contribute to a government-controlled fund. Under this system, persons must generally rely on self insurance to cover health care, retirement, and disability expenses.
Employers and employees contribute 6% of the employee’s salary into each worker’s MSA until the balance reaches a certain amount (approximately US $8522 in 2002) (3). Once the balance (which is sufficient to cover most hospital costs) is achieved and maintained, additional contributions are placed in the employee’s ordinary savings account. This account is intended for retirement, disability, medical expenses, death, or the purchase of a home. Funds in the Singapore MSAs can be used only for hospital care at government hospitals. One effect of the Singapore system is over-reliance on hospital care compared with physician outpatient care (3).
There has been some success in reducing health care costs reported by companies that have instituted bonus or incentive plans that reward employees financially for decreasing their health insurance claims. Experiments involving incentives for employees to reduce their health care claims indicate that health insurance costs of the employer can potentially be reduced through the combined use of MSAs, high-deductible catastrophic coverage, and increased employee cost sharing. Medical savings accounts offer a way to encourage people to save for their own health care expenses and increase consumer involvement in health care decision making.
Coupled with high-deductible health insurance, MSAs allow people to save for their future health care needs and still receive protection from catastrophic health care expenses. Access to health care services has been improved by MSAs and more affordable (high-deductible) health insurance has become widely available. Some people who have no insurance can now obtain protection from catastrophic health care expenses while accumulating MSA funds that could be used to purchase routine health care services. Young, healthy persons and those who are self-employed have financial incentives to provide for their potential health care needs.
One of the major advantages of MSAs is their ability to provide, for individual persons and families, a source of funds that can be spent as desired for health care without approval from an insurance carrier or other third party. Consumers can use their MSA savings for health expenses that are now largely uncovered by traditional insurance (such as preventive, well-child, mental, and long-term health care). On the other hand, the financial incentives of MSAs that encourage cost-consciousness might discourage some consumers from spending their MSA funds on preventive health services.
Unused funds can be accumulated for future health care needs, such as supplementation of Medicare coverage or provision of long-term care. The tax code also permits unused funds to be used as death or disability benefits, to be part of the person’s estate, or to be restricted to provide only for the health care needs of surviving family members. Accordingly, families itemizing deductions and claiming children as dependents are allowed to make higher tax-deductible contributions to their MSAs to pay for childhood immunizations and other preventive services.
Increased cost-consciousness on the part of the consumer has somewhat exerted downward market pressure on health care prices and decreased use of health care services. Resultant reductions in health insurance premiums and tax code changes have allowed all employers (including the self-employed) to make tax-deductible contributions which encourages more employers to provide health benefits for employees and their dependents. The establishment of MSAs holds clear advantages for relatively healthy people who do not currently realize a favorable financial return from their (or their employer’s) investments in health insurance premiums.
Young adults 18 to 24 years of age represent more than 21. 4% (7. 9 million) of non-elderly uninsured persons (5). How many persons in this group would establish tax-sheltered MSAs? Middle- and upper-income persons and families would derive greater tax advantages from establishing MSAs, but they represent only a small portion of the uninsured. More than three quarters of non-elderly uninsured persons live in families with incomes that are less than three times the poverty level. Low-income persons and many middle-income persons are not likely to have funds available to set aside for future health care needs.
Consequently, MSAs have raised some questions about the inequities involved in providing relatively greater tax subsidies to upper-income tax-payers, because these persons are better able to allocate funds for their family’s health care. The coupling of MSAs with high-deductible insurance also raises concerns about the availability and cost of more traditional, low-deductible health insurance. Standard health insurance plans could face problems of adverse selection; persons who are healthy and at low risk would be likely to choose MSAs and high-deductible insurance arrangements.
If employees could choose either traditional insurance or an MSA in conjunction with a high-deductible policy, they could choose the MSA option and switch back to a low-deductible plan if they became seriously ill or started to incur substantial medical expenses. However, restrictions that have been imposed have limited these kinds of enrollment changes. Nevertheless, premiums for community-rated standard plans would increase, reflecting higher claims expected from a covered population at greater risk for illness. Health insurance costs for standard, low-deductible policies would then be less affordable for those who would need them the most.
It is often assumed that the insurance premium savings that result from exchanging low- for high-deductible health insurance could be used to offset, and perhaps even to fully fund, the higher deductible amounts. This may be true for persons purchasing insurance at non-group rates, but it is not generally true for large group insurance, in which premium savings would be closer to one third. The Congressional Budget Office found that the premium savings of MSAs were “implausibly large” and “unobtainable by typical workers nationwide.
The Hay Group, a benefits consulting firm, prepared estimates for the Congressional Research Service indicating that high-deductible insurance policies ($2500) would save a maximum of $500 to $600 annually (6). The Congressional Research Service concluded that premium savings from high-deductible insurance are inadequate to fund most MSAs. They found that MSAs “may be suitable only for people who are well-off or healthy”. The American Medical Association estimates that the premium savings are about 50 to 60 cents per dollar of increased deductible (6).
Consequently, some MSAs are established with insufficient funds to cover higher health insurance deductible amounts. Persons with standard coverage have increased out-of-pocket expenses as employers choose high-deductible insurance. Employees are then exposed to greater financial risk. Those with high medical expenses may never accumulate balances sufficient to meet the annual deductible amounts and would lose money under an MSA and high-deductible arrangement. Current differentials in insurance premiums might also change if sales shifted from low- to high-deductible polices.
Another concern is that consumers may become less cost-conscious as their account balances grow over time. A substantial MSA balance might enable consumers to obtain uncovered or unnecessary health care services that would otherwise be disallowed by utilization review or other efforts by third-party payers to control health care expenditures. Medical savings accounts are expected to reduce health care costs because patient cost sharing generally leads to reduced health care use, primarily by reducing the number of contacts rather than the intensity of services.
However, decreased use occurs for effective and necessary services as well as for ineffective and unnecessary services. Cost sharing can also have a greater deterrent effect on the use of services by poor and low-income families, which particularly affects the use of acute care services for poor children. Greater reliance on MSAs, involving increased cost sharing and self insurance, could therefore deter patients, particularly those in low-income families, from obtaining needed and effective medical care.
On the other hand, if persons who are currently uninsured have incentives to establish MSAs, they would have savings with which to pay for health care services that they might otherwise forgo or obtain as charity care. The Congressional Research Service estimates that more than half of aggregate health care expenditures in any given year are attributable to persons who have large annual health care expenditures (>or=to$2500) (6). These persons would incur out-of-pocket expenses equal to the high-deductible catastrophic insurance amount and might not be able to accumulate sufficient MSA savings to meet the annual deductible.
Although they may encourage mindful spending on health care services, MSAs would have little effect on most health care spending, even if everyone were enrolled in MSA plans. MSAs currently maintain the fee for-service payment system. Patients select providers of their choice and have funds with which to pay for services covered by insurance, services not covered by insurance, or disallowed charges. This gives patients more freedom but has sometimes also resulted in the use of more unnecessary and ineffective services.
Most consumers are unable to accurately assess the scientific and technical qualities of care they receive and some health care providers have responded differently, knowing that no third party was involved with payment. Because high-deductible insurance deters policyholders from filing small claims, administrative costs and paperwork has been reduced. Insurance companies do not have to make payments until patients meet their annual deductible, thus avoiding the processing costs for small claims. Policyholders who do not expect to meet their annual insurance deductible sometimes purchase services without involving third-party payers at all.
This also reduces the number of health insurance claims, administrative paperwork, and intervention by third-party payers. However, many policyholders still file insurance claims to satisfy insurance co-payment and deductible provisions. Thus, third-party payers need to continue making determinations of usual, customary, and reasonable charges to assess amounts that would apply toward the deductible. Policyholders also file claims to limit their financial exposure under participating provider agreements.
Economist Mark Pauly found that MSAs have yet to substantially improve the efficiency of medical care. He notes that the tax incentives to use MSAs are set at levels that induce widespread participation, until this is accomplished, total health care spending is likely to increase, not decrease. He argues that current tax exclusions for health insurance premiums are inefficient and inequitable, fostering insensitivity to health care prices and greater use of health care services, because persons in higher income tax brackets reap greater tax advantages than persons in lower income tax brackets.
Other economists disagree. They argue that third-party payments by conventional insurance providers insulate consumers from the costs of their health care decisions. They contend that MSAs are a way to restore consumer involvement in decision making about health care and that the most effective way to control health care costs is to rely on consumers to make informed decisions. It can be argued that MSAs may reduce or control health care costs, particularly for employers. However, whether MSAs can expand access to health care services is less clear.
Some individual persons and families might have improved financial access to health care services if they establish MSAs. However, the most likely beneficiaries would be young, healthy persons or those in upper income brackets–not most of the persons now uninsured. Proponents of MSAs contend that favorable tax treatment of MSA contributions and low insurance premiums for high-deductible health insurance might prompt some employers, particularly the self-employed and other small employers not currently providing health insurance benefits, to make some contributions on behalf of their employees.
Although MSA proponents have apparently overstated the premium savings that result from switching to MSAs and high-deductible insurance, the RAND study and the examples of cost reductions achieved by existing employee cost-sharing incentive plans indicate that MSAs potentially contain costs (7). Some additional employees could plausibly be offered health insurance coverage through their employers if MSAs and high-deductible insurance were to reduce health insurance premiums.
Medical savings accounts might also improve access to health care services by giving patients greater discretion over health care spending. Funds accumulated in an MSA would be retained by a person regardless of changes in employment. Medical savings accounts have also reduced administrative hassles for patients and physicians. With this system, patients pay for health care services with their own MSA funds and do not file insurance claims unless they expect to exceed deductible amounts. It is still unclear how MSAs have affected the use of preventive health services.
There is concern that increased cost-consciousness may deter some patients from spending their MSA funds on preventive services, such as periodic physical examinations, immunizations, or Papanicolaou tests. However, the RAND study showed that higher consumer co-payments decreased personal health care spending without resulting in any apparent harmful effects on health. Proponents assert that MSAs has enabled consumers to choose preventive health services and other health care services that often are not covered by normal insurance (7).
Concerns have also been raised about the potential effect of MSAs on the availability and cost of traditional health insurance. Premiums for low-deductible, community-rated plans could increase as a result of adverse selection, as young, healthy people switch to MSA and high-deductible arrangements. The persons who most need or desire health insurance may no longer be able to afford traditional coverage. However, some safeguards have been adopted in the Federal Income Tax Code to restrict switching of coverage between MSAs and traditional insurance and to minimize problems of adverse selection.
Another major concern that has yet to be totally realized is that MSAs could have a substantial negative effect on federal and state tax revenues. Tax revenues would decrease as funds are sheltered in MSAs. An annual limit on contributions to an MSA and a maximum amount that could be accumulated have addressed some concerns about social equity and reduced the potential tax shelter for affluent persons. Nevertheless, in a pluralistic society, many approaches may be required to give all persons access to health care.
MSAs are just one option that appeals to some individual persons and families who would not otherwise have health insurance or savings for health care expenses. Some employers who do not currently provide health benefits are now being induced to contribute to employee MSAs or to offer catastrophic health insurance coverage. It is important to remember that medical savings accounts alone will not achieve universal health insurance coverage. Comprehensive reform is still needed, although MSAs are considered as one alternative within an array of reforms intended to increase access to health care services, improve quality, and reduce costs.