July 21, 1998
Medical Savings Account Proposal Poses Serious Risks
To Insurance Market and to less Healthy Individuals
While Providing New Tax Shelter for High-income Taxpayers
Republican proposals recently introduced in both the House and Senate as part of managed care legislation risk driving up health insurance premiums for individuals who are less healthy than average in order to fund a proposal that is, in significant part, a tax cut for the affluent. This is the likely result of the provisions included in House Republican "Patient Protection Act" (H.R. 4250) and the Senate Republican "Patient Bill of Rights" (S. 2330) that would allow universal access to Medical Savings Accounts and remove a number of safeguards included in the MSA demonstration project currently underway.
The bipartisan Health Insurance Portability and Accountability Act of 1996 established a demonstration to test and evaluate Medical Savings Accounts, which are tax-advantaged personal savings accounts that may be used by persons covered by high-deductible health insurance policies. The demonstration is designed to provide information about the effects of MSAs on workers, employers, and insurers without creating widespread irreparable harm to any of the participants or to the insurance market as a whole. Participation in the demonstration is limited to no more than 750,000 participants who are employees of small businesses (businesses with 50 or fewer employees) and self-employed persons. The demonstration is scheduled to run through December 31, 2000, after which time Congress could consider the evaluation authorized by the 1996 law and determine future policy.
The House and Senate bills would end the MSA demonstration and make a number of changes to the current law governing use of MSAs.
- Both the House and Senate bills would open up MSAs to use by all individuals and employees, remove the numerical cap on participation, and eliminate the sunset date for MSAs contained in current law.
Universal availability for MSAs now before the impact of MSA policy has been studied under more controlled conditions would mean that any negative consequences MSAs may have for the insurance market could rapidly become pervasive and difficult to reverse. A significant body of evidence suggests that widespread use of MSAs will lead to "adverse selection" in the insurance market because young, healthy people with low medical costs will choose to use the high-deductible insurance policies and MSAs and thereby retain their unspent dollars in their own accounts. This would leave people who are less healthy and have higher medical costs in conventional, low-deductible health insurance plans.
Such a division of the market would drive up the cost of low-deductible insurance for the less healthy segments of the population who most need it. Research suggests that premiums for conventional insurance could more than double if MSA use is widespread.(1) According to the American Academy of Actuaries, a disproportionate share of those left in conventional insurance would be older employees and pregnant women.
- The Senate bill would permit taxpayers with MSA balances exceeding the amount needed to fund their current year's health insurance deductible amount to withdraw the excess funds for any purpose without incurring the 15 percent penalty that applies to withdrawals prior to age 65 for non-medical purposes.
Allowing penalty-free withdrawal of funds would increase the likelihood that healthier people will choose to use MSAs and deepen the extent of adverse selection.
- Both the House and Senate bills would increase the maximum amount allowed to be deposited each year in the tax-advantaged Medical Savings Accounts from $1,463 to $2,250 for individuals and from $3,375 to $4,500 for families.
MSAs are similar to conventional Individual Retirement Accounts; contributions are deductible from income, and tax is deferred on the amounts the accounts earn. While deposits and earnings are never taxed if MSA funds are used to pay medical costs, the tax advantages of MSAs can be substantial even if the funds in the accounts are used primarily or exclusively for non-medical purposes.
MSAs differ from IRAs in one key respect there are no income limits on MSAs that prevent wealthy people from using them as tax shelters. As a result, opening up MSAs to all individuals and increasing the amounts that may be deposited in them, as the House and Senate bills would do, would enable high-income taxpayers who cannot use IRAs because of the income limits to begin using MSAs as significant tax shelters.
The House bill would circumvent the rules under the current MSA demonstration that prevent employers from setting up MSAs in a manner that primarily benefits highly paid executives and effectively discriminates against lower-paid employees.
Under the MSA demonstration now underway, deposits can be made to an MSA account by either an employer or an individual, but deposits to a given account may not be made by both in the same year. The demonstration also includes nondiscrimination rules requiring employers to make comparable contributions for all participating employees. By contrast, the House bill would allow both employees and employers to make deposits to an MSA in the same year; that would make the nondiscrimination rules meaningless. An employer could make small, token deposits to the MSA accounts of all employees. Higher-income employees could add substantial additional funds to their accounts and exclude these additional amounts from their taxable income, but most lower-paid staff would not be able to afford substantial additional contributions.
Finally, by ending the MSA demonstration now, before enough time has elapsed for employers and individuals to gain experience with MSAs, the Republican leadership proposals would insure there is no way to evaluate the impact of MSAs. The MSA changes these bills would make would heighten the probability both of adverse selection that harms less-healthy people and of more extensive use of MSAs as tax shelters by the affluent. But without a demonstration and evaluation, these problems might not be evident to policymakers until the damage was largely done. By that time, the damage particularly to the availability and cost of conventional, low-deductible insurance could be irreversible.
1. Emmett B. Keeler, et. al., "Can Medical Savings Accounts for the Nonelderly Reduce Health Care Costs?" JAMA, June 5, 1996, p. 1666-71; Len M. Nichols, et. al., Tax-Preferred Medical Savings Accounts and Catastrophic Health Insurance Plans: A Numerical Analysis of Winners and Losers, The Urban Institute, April 1996; and American Academy of Actuaries, Medical Savings Accounts: Cost Implications and Design Issues, May 1995. The conclusions of these studies are summarized in Iris J. Lav, MSA Demonstration: Research Suggests Controls Needed To Prevent Adverse Affect on Insurance Market, Center on Budget and Policy Priorities, July 10, 1996.