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What is a Medical Savings Account?

A Medical Savings Account (MSA) is a specialized bank account that receives tax-exempt treatment on both contributions and interest. In a broader sense, MSAs can be thought of as an insurance product. That is because those opening an MSA are required by law to purchase a high deductible health insurance plan (HDHP). By coupling together health insurance and a tax-free savings vehicle, consumers have another health insurance option that not only helps them fund their medical expenses with pre-tax income and eliminate financial risk due to unforeseen illness or injury, but that also places them at the forefront of financial decisions, which impacts the quality of their health care. Such decisions include which doctor to see, where to see a doctor, what price to pay for medical products and services, and generally, how to spend one's health care dollars. In the case of MSAs, the ability to choose among providers, spending one's own money, and the necessity of seeking out price information makes the individual a savvy consumer of health care and also leads to better quality outcomes and patient satisfaction. Plus, the individual keeps whatever money is not spent.

In the 1990s small businesses, small non-profits, and the self-employed lobbied Congress in order to establish MSAs. Congress decided to allow the creation of MSAs on a trial basis and as part of a four-year pilot program authorized by an omnibus health bill called the Health Insurance Portability and Accountability Act of 1996 (HIPAA). MSAs were highly regulated, limited to employers of less than 50 employees (a very small segment of the overall market), with strict requirements on the range of allowable deductible levels associated with HDHPs. Deductibles were limited to a range between $1,500 and $2,250 for individuals and slightly higher for families. Since 1997, over 100,000 MSAs were established and MSAs were renewed in 2000. Businesses and non-profits that had grown beyond 50 employees were "grand-fathered" and allowed to continue to offer MSAs to their employees.

What is a Health Savings Account?

A Health Savings Account (HSA) is an expanded form of an MSA (see question 11). HSAs were created as part of the newly passed Medicare Prescription Drug, Improvement, and Modernization Act of 2003. Basically, lawmakers took the original concept of an MSA and loosened up the regulations. Now, virtually all Americans are eligible to set up an HSA, thus expanding the market for this product from thousands to millions of potential purchasers. The HSA must still be coupled with a high deductible health plan; however the range of deductible levels were expanded from a range between $1,500 and $2,250 to a range between $1,000 and $5,000 for individuals and a range between $2,000 and $10,000 for families. Generally, the higher the deductible for these plans the lower the monthly premium. Rules on contributions have also changed so that contributions can be made by an employer, an employee, or by other individuals (presumably relatives and friends). Also, annual tax-free contributions can be made up to $2,600 for individuals or $5,150 for families or up to 100% of the annual deductibles below those amounts. HSAs are so similar to MSAs and at the same time offer more advantages in almost every way, that many insurance companies previously offering MSAs will only offer HSAs in the future and allow people with MSAs to roll their account balances over into HSAs.

What is a High Deductible Health Plan (HDHP)?

A high deductible health insurance plan (HDHP) is a type of health insurance that functions more like traditional health insurance and less like health insurance of the managed care organization variety. Low deductible health plans have annual deductibles typically in the hundreds of dollars, while high deductible plans have annual deductibles typically ranging from $1,000 to $10,000 or more. As annual deductible levels get higher, annual premiums get lower. That becomes important as HDHPs become coupled with HSAs, because by choosing a HDHP with lower monthly premiums, money saved on premiums can then be used to fund the tax-free savings account. That is typically what employers and the self-employed have done with MSAs and are most likely going to do with HSAs. In the case of a low deductible health plan, money spent on premiums is a sunk cost and the money is used to purchase the insurance product, regardless of whether the purchaser gets sick that year or not. In the case of the HDHP, when money in the savings account is not spent during a year of good health, then the money rolls over into the next year. Since most people only have a few years of high medical bills compared to many more years of low medical bills over the course of a lifetime, the net effect is to have savings build up over time to be used in the future, particularly during retirement for health care costs. It should also be noted that the purpose of the HDHP is to limit catastrophic financial losses due to illness or injury in a given year period. Without that insurance, the savings in an account-even savings well over the maximum deductible level-could be wiped out in a year of very bad health. Thus, a high deductible health insurance product serves its function as true health insurance by protecting the financial assets within the health savings account-limiting losses to $1,000 to $10,000 per year, depending on the deductible level chosen by the purchaser.

What are the benefits of HSAs for the account holder?

HSAs offer the account holder the ability to both fund their short-term health care needs and to offset financial risk related to illness or injury. In those two ways, HSAs serve the basic purposes of those seeking health insurance. However, HSAs are unique and offer other advantages to the purchaser such as the development of financial assets, tax-free savings for health purchases, flexibility during retirement, portability, leverage in price negotiation, the ability to comparison shop, the capture of savings for future health care purchases, and finally, protection against the insolvency of Medicare.

First, the account balances in an HSA belong to the account holder. That money is primarily intended to be used for annual expected medical costs and to save for future medical costs; when account balances become large enough, however portions can be invested to grow the accounts. Also, those accounts represent real, permanent financial assets, which can be used in times of financial necessity for purposes outside of medical expenses, after paying income tax and a ten percent penalty. The amount borrowed from the account could then be slowly repaid later on. There are other advantages around, during, and after retirement. By 2009, account holders age 55 to 64 can contribute an additional $1,000 per year to build up their reserves for retirement health care costs. During retirement, money from these accounts can be used to purchase medical services that are not covered by Medicare. Those could be elective procedures, or drugs and procedures deemed "not medically necessary." Thus, HSAs offer additional flexibility and security during retirement. Also, in the event of death of the account holder, the assets in the account can be passed on to a spouse without penalty, or passed on to heirs through an inheritable estate (though likely subject to estate and income tax).

HSAs also create incentives for account holders to become cost-conscious and savvy health care purchasers, choosing for themselves and with the help of their doctors what treatments are most necessary and capturing surpluses during times of better health for themselves, not a managed care organization. As more employers start to offer HSAs as one of several health benefit options, HSAs will become more portable. HSAs also offer self-employed individuals and the owners of small businesses permanent and affordable options for providing health care for themselves and their employees. HSAs also offer security against the insolvency of the Medicare program by providing account holders with savings protection in case Medicare goes bankrupt.

How will HSAs and HDHPs impact the health insurance market?

Whereas only hundreds of thousands of people were eligible for MSAs hundreds of millions of Americans are eligible for HSAs. One can expect that market penetration of HSAs and their HDHP counterparts will far exceed the 100,000 MSAs set up by 2000. As consumers and providers become more accustomed to the presence of HSAs and HDHPs larger employers may also begin to offer HSAs as one of several health benefit options, thus expanding the market. It is clear HSAs will create incentives for account holders to be more frugal with their health care dollars and therefore not over-consume beyond what they judge to be necessary or worth their money. In the area of prescription drugs it is reasonable to believe that consumers will reconsider whether to buy more expensive brand name drugs or generic and over-the-counter drugs, when the option is available to them. That suggests that HSAs could have some cost-controlling effects on the health care market.

Some economists, including Milton Friedman, have argued that the dominance of the third party payment system is the primary reason that annual health care expenditures have continuously increased at a rate much higher than the rate of inflation. That has led many health policy experts to argue that a return to more traditional forms of health insurance, such as HDHPs, might stabilize or reduce the rate of annual health care expenditures. Other economists contend that third party payments are not the primary driver of health care cost growth, merely one of several factors at play. While it is not perfectly clear from a macroeconomic perspective what impact the presence of HSAs will have on health care costs and the health insurance market, microeconomic analysis of HSAs suggests that there are many tangible benefits to be had for account holders, as described above (see question 14). Perhaps most important among those benefits is improving quality of care and patient satisfaction.

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