Published: 04-10-08
Health Care Update from the House Republican Study Committee
Reports surfaced this week that the Democratic majority may be attempting to enact new restrictions on Health Savings Accounts (HSAs) as part of upcoming health legislation.
The proposal being discussed would require that all HSA account holders submit information showing what portion of their HSA expenditures in a given year have been independently verified as constituting qualified medical expenses.
Available data suggest that the percentage of HSA funds being used for non-medical expenses is comparatively low—particularly upon close examination.
For instance purchases in a grocery store may at first blush appear irrelevant to HSA use—but in reality many of these transactions could involve permissible medical items (over-the-counter pharmaceuticals prescriptions medical supplies etc.). And in those instances when individuals do use their HSA funds to make major non-health expenditures the Internal Revenue Service has audit procedures in place to ensure that account-holders pay income taxes on non-qualified distributions—plus a 10 penalty to discourage such behavior.
When drafting the regulations implementing Health Savings Accounts in 2004 the Treasury Department attempted to create a framework that would ensure that HSA funds would be used for bona fide medical expenses while avoiding burdensome regulations that would inhibit the growth of this innovative consumer-driven health product. The proposal under discussion places an additional burden on account holders to document their purchases—even the $3 bottle of cough syrup an individual might choose to buy at a grocery store like Safeway rather than at a CVS or other pharmacy—and may have a similarly chilling effect on insurance carriers and banks currently offering account-based products to individuals and employers.
Some conservatives may be concerned that this proposal represents the first of many impending attempts by the Democrat majority to enact burdensome and bureaucratic regulations undermining HSAs which in a few short years have proven successful at slowing the growth of health costs and insurance premiums for millions of individuals and small businesses.
Some conservatives may also be concerned that this particular provision brought to the attention of the Democratic Ways and Means Committee staff by a former Republican staffer-turned-lobbyist may constitute a legislative “earmark” drafted specifically to benefit one company (Evolution Benefits) seeking to market its substantiation technology to HSA administrators.
The following policy brief explains the issue in further detail. The RSC will continue to monitor this or any similar attempts to enact burdensome restrictions on HSAs and will weigh in to protect the important consumer-driven health programs which Republicans have succeeded in establishing in recent years.
HSA Q & A
APRIL 2008
Democrats on the House Ways and Means Committee may soon include in pending legislation provisions placing additional restrictions on Health Savings Accounts (HSAs). In anticipation of such an effort the RSC has prepared the following document providing context and background information on the proposal.
What change to Health Savings Accounts are Democrats proposing?
Democrats are considering requiring “substantiation” of all HSA transactions from an independent third party to ensure that money withdrawn from an HSA pays for qualified medical expenses. This oversight of every single account transaction would make HSAs similar to Flexible Spending Arrangements (FSAs) an earlier consumer-driven health care model.
How are FSAs and HSAs different?
One of the prime differences between the two account-based models lies in the control source for the funds in the account. The Internal Revenue Code makes clear that FSA accounts are held by employers while HSA funds remain exclusively the property of the employee. This distinction explains why unused FSA funds in an employee’s account at the time of departure revert back to the employer while HSA funds always remain with the employee and remain portable from job to job and into retirement. Some conservatives may be concerned about the potential implications of transferring a “substantiation” system designed for employer-owned FSAs to individually-owned HSAs—both in terms of the legal liabilities placed on employers and administrators to verify transactions and the restrictions placed on individuals to control their HSA account dollars.
How are HSA and FSA withdrawals administered?
Right now most HSA transactions take place using point-of-sale debit cards that make electronic fund transfers directly from the account. Conversely most FSA transactions remain paper-based requiring out-of-pocket spending by the individual and subsequent reimbursement from the FSA after approval by an administrator. Some conservatives may be concerned that the Democrats’ proposed change would revert HSAs to an archaic model of account reimbursement making the HSA model—which has developed millions of users since its introduction in January 2004—less attractive to consumers.
What penalties are currently in place to ensure HSA funds are spent on qualified medical expenses?
Under the Internal Revenue Code non-qualified withdrawals from an HSA are subject to individual income taxes as well as a 10 penalty. HSA account activity is subject to audits from the Internal Revenue Service and account holders are advised to retain their receipts documenting qualified medical expenses in the event of an audit.
What measures do HSA administrators currently have in place to ensure that withdrawals from the account are made for qualified medical expenses?
Right now some banks that administer HSAs have electronic debit cards that can “read” the merchant code where the transaction is taking place (e.g. a doctor’s office). If a request for transaction is occurring at a location not normally associated with qualified medical expenses the debit card can decline the transaction.
Some administrators are currently developing more advanced technology to differentiate product codes within a merchant’s offerings—for instance accepting grocery store transactions for cough syrup (a permissible over-the-counter drug) while rejecting attempts to purchase items within the same store for items without a clear medical use such as beer or wine. This advanced technology could be on the market within a few years; however new legislation requiring “independent” verification of HSA expenses may give banks and account administrators less incentive to develop these types of programs.
Does the fact that some HSA withdrawals are made at places like grocery stores mean that these withdrawals are not for qualified medical expenses?
Not necessarily. The list of qualified medical expenses is quite broad and generally includes most items reimbursable from a Flexible Spending Arrangement or deductible on an individual tax return if total medical expenses exceed 7.5 of an individual’s adjusted gross income. Under certain circumstances legal expenses (to authorize mental health care) lodging and travel expenses (related to medical treatment) and even the cost of a telephone (for the hearing impaired) can be considered medical expenses.
Some conservatives may be concerned that the proposal under consideration would essentially shift the burden of proof from the government (to prove that an expenditure was improper in the context of a tax audit) to the consumer to prove compliance at the time of withdrawal causing additional inconvenience to the HSA holder.
Employers contribute money to their employees’ HSAs. Shouldn’t they have a right to know that their contributions are being spent for medical purposes?
Unlike FSAs which are considered as being held by the employer an HSA is considered the employee’s property and any cash contributions immediately accrue to the worker. Thus an employer has no more or less right to know the employer’s contributions are spent on qualified medical expenses than a business has a right to determine that the employer’s share of 401(k) contributions is ultimately spent on retirement expenses. In both cases the penalties for a non-qualified distribution are the same—income taxes owed plus a 10 penalty.
In an advisory opinion on the status of HSAs the Department of Labor (DOL) held that an employer’s transfer of cash contributions into an employee’s HSA does not constitute group coverage under the Employee Retirement Income Security Act of 1974 (ERISA) precisely because of the employer’s inability to control the funds in the employee’s account. Many small businesses—who have heretofore not been able to finance health insurance coverage for their workers—have used the flexibility provided by the DOL opinion to place cash contributions into their employees’ HSAs without triggering the regulatory burdens imposed on ERISA group health insurance plans benefiting both the business and the worker.
Does this proposal constitute an earmark?
It is the RSC’s understanding that the prime sponsor of this proposal is Evolution Benefits a company that currently provides third-party administration of Flexible Spending Accounts. Some conservatives may be concerned that the language of this initiative may be construed as a legislative earmark designed primarily to increase Evolution Benefits’ business while undermining the innovations that banks and other administrators have established to ensure HSAs’ integrity.
What may be the practical implications of this proposed change to HSAs?
In addition to increased inconvenience for end users introducing a new step of independent “substantiation” may well increase costs for banks and account administrators who are likely to pass these costs on to employers and/or consumers. While Democrats have complained in recent months about the charges which banks and other commercial lending institutions pass on to their customers this provision carries a strong likelihood of increasing those costs further. In addition some conservatives may also be concerned that should this proposal pass an HSA mechanism created to reduce the growth of health care costs—and which has achieved some noteworthy successes in the time since its introduction—would lead to increased costs for businesses and individuals.
RSC Staff Contact: Chris Jacobs christopher.jacobs@mail.house.gov (202) 226-8585
