Medical Savings Accounts

Abstract

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 Funds can be withdrawn without penalty only for medical expenses, for the purchase of health or long-term care insurance, or for other expenditures that are stipulated in the tax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