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The HSA paradox

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Are you frustrated yet by the rapid rise in health insurance premiums?

How much longer can you accept annual premium increases in double digits when general inflation and wages increase by less than 4 percent per year? Are Health Savings Account-qualifying, high deductible health plans the answer?

A recent nationwide survey performed by Mellon Financial Services (NYSE: MEL) found that only 7 percent of respondents offered an HSA in 2005. However, 32 percent expect to offer an HSA-compatible medical plan to their employees in 2006.

Ninety-eight percent of the employers will offer the new program as an alternative to current plans rather than completely replace their existing benefits. Sixty-six percent of employers who are planning to offer an HSA program expect to contribute to their employees' HSA accounts.

Employers give many reasons to offer these new programs, but the most common objectives are to reduce costs, to encourage employees and their dependents to adopt healthier lifestyles and to encourage patients to be wiser consumers of medical services.

How does an employer influence his or her employees and dependents to change their habits when HMOs provide 100 percent benefits after small co-pays?

The apparent answer is to implement deductibles that exceed $2,000 for a family (the minimum allowed by law) and allow the employee to pay for expenses below the deductible with tax-free dollars.

Employers throughout the country are adopting these plans and reducing their premiums by 10 percent to 15 percent compared with their existing HMO and PPO benefits. These savings allow employers to contribute to an employee's HSA account and increase the attractiveness of the plans.

However, insurance companies are not offering employers in Southern California the same premium savings as elsewhere in the country.

Why are we different? The answer appears to be the different systems used by HMOs to compensate physicians for their services.

Throughout the United States, HMOs pay physicians through the same traditional fee-for-service system as they use with PPO plans: the physician is paid a fee for each service provided to the patient.

In Southern California, HMOs compensate physicians through a system called capitation. The physician's medical group receives a set amount every month for each patient enrolled with the group, regardless of the health of the patient or the frequency of services.

As a result, the physician and medical group have an incentive to keep the patient healthy and to provide the most cost-effective care. A comparative analysis of payment systems found that utilization of physician and diagnostic services increases by as much as 100 percent when the compensation system changes from capitation to fee-for-service.

This appears to be the reason why insurance companies do not offer premium rates for PPO plans in Southern California that are comparable to HMO premiums unless the PPO deductible exceeds $1,500 for individual coverage or $3,000 for family coverage.

In order to develop sufficient savings for an employer to also contribute to an HSA plan, the deductibles have to exceed $2,000 and $4,000, respectively. The loss of the capitation system is the answer to the paradox of why premiums do not dramatically decline when deductibles as high as $1,000 for an employee and $2,000 for a family are proposed.

In spite of the requirement to offer such high deductibles in order to generate premium savings, employers in Southern California might wish to consider HSA-qualifying, high deductible health plans (HDHP) for a number of reasons.

First, many employers no longer can afford benefit plans offered by HMOs and must implement high deductibles for the benefits to be affordable for both the employer and the employees. This is particularly true for employers with fewer than 50 employees.

Some employers might believe that their employees and dependents are so healthy that their total health-care expenditures will be less than the capitation payments to medical groups.

Some employers are so frustrated with the escalating premiums, and the rapid rise in HMO stock prices, that they prefer to self-insure their benefits and only buy stop-loss insurance.

Some employers would like to give their employees a choice of plans and let the marketplace and their employees decide which system offers the highest quality, most cost-effective care.

Many larger companies have locations outside California and do not benefit from the capitation system. An HDHP is an excellent option for their non-California employees, particularly if the company is large enough to self-insure the plan. Such employers generally will extend the offering to their California employees.

Whatever the reasons, employers should be aware of some possible consequences of offering an HSA-qualifying HDHP:

If the plan is offered as a companion to a traditional HMO and/or PPO, the new plan might attract primarily young, healthy employees who rarely use their benefits and would love to contribute tax-free dollars to an HSA.

If the older, less-healthy employees remain in the traditional HMOs and PPOs, these plans will go into a death spiral of rapidly increasing premiums and declining enrollment until the plans die, and all employees are forced into the HSA-compatible plan.

HMO medical groups will abandon capitation payment systems as the health of their HMO membership deteriorates, and the groups provide more care per patient in the HMO plans.

Once medical groups abandon capitation, it is unlikely that this lower-cost compensation system ever will return.

Many employees might not be able to afford to fund an HSA, and they might postpone necessary diagnostic tests and medical care until their condition dramatically deteriorates. This may result in dramatically higher costs in the long run.

HSA-qualifying plans have significant attractions. Some of the key advantages of an HSA are:

* Employees may contribute tax-free dollars into the account without the use-it or lose-it rule required with Flexible Spending Accounts (FSAs).

* Investment earnings are tax-free.

* Tax-free distributions can be made for all the normal health care expenses allowable with an FSA, plus premiums for COBRA medical insurance, Medicare, some long term care insurance and medical insurance while a person is receiving federal or state unemployment insurance.

* The account is vested with the employee so employees take it with them when they leave their employer.

* The account can be transferred to the surviving spouse of an employee without any tax consequences. If there is no surviving spouse, it is included in the employee's estate.

* Withdrawals for expenses other than non-qualified expenses may be made after reaching age 65 without the normal 10 percent penalty; however, such withdrawals are subject to federal and state income taxes.


Murphy is a principal emeritus in Barney & Barney's employee benefits department. For more information call (858) 587-XXXXXXXXX or e-mail DMurphy@barneyandbarney.com.>

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