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FSAs: Key to consumer-directed health?

By Rob Smith, Ceridian manager of Government Relations

According to the National Coalition on Health Care, out-of-pocket medical expenses have risen by 115 percent since the year 2000. In other words, a person who paid $1,000 in health insurance deductibles, copays and other health-related expenses in 2000 would face $2,150 worth of out-of-pocket costs today.

Given that health costs are predicted to double in the next 10 years while wages remain relatively stagnant, this financial squeeze will only become more severe. Indeed, a $5,000 annual out-of-pocket health bill would be a large expense for most people.

Rising out-of-pocket medical costs isn't a new problem, and the federal government has established several personal health accounts that Americans can use to pay these expenses with pre-tax dollars. Health savings accounts (HSAs) and health reimbursement accounts (HRAs) are two options that fit into the new generation of consumer-directed health plans that has been growing in popularity. However, the idea for these accounts goes back to the 1980s when Congress established flexible spending accounts (FSAs).

Big benefits, low enrollment
FSAs, technically "salary-reduction" plans, allow employees to divert a portion of their salaries on a pre-tax basis into an account they can use to pay for medical expenses. Because the money deposited into the account is not subject to payroll or income tax, FSA holders can potentially save 30 to 40 percent on eligible out-of-pocket expenses.

Not only can FSAs cut down on expenses, they help ensure that people are able to purchase the health products and services they need. FSA holders can use their accounts for most over-the-counter medications, medical supplies and medical equipment. FSA holders can also submit claims for mileage expenses related to medical care. FSAs can also be used for preventive care services that help employees choose to make better health decisions.

Over 80 percent of U.S. employers offer FSAs. With the significant savings and improvements in health care quality that FSAs can achieve, one would think employees would choose to enroll in them. However, this is not the case. Of the 25 million employees who have access to the accounts, only five million choose to use them.

Taken at face value, these numbers don't seem to make much sense. A recent New York Times poll found that 81 percent of respondents think health care costs are too high, but only a small number of those who are offered an FSA that can save them money sign up.

Loosening the "use-it-or-lose-it" rule
So why do less than 20 percent of those eligible for FSAs actually enroll? One major reason is a U.S. Treasury rule that requires participants to forfeit unspent end-of-year balances. While it's true that FSAs offer many advantages for managing health care usage, quality and cost, the onerous federal "use-it-or-lose-it" rule mandates that unused FSA funds be transferred to employers at the end of the plan year.

As one of the nation's largest FSA service providers, Ceridian estimates that 25 percent of its 400,000 FSA customers forfeited an average of $250 in 2006. On a national level, an estimated five million employees and their families contribute roughly $5 billion to FSAs, which works out to $1,000 per account holder. Based on these numbers, families across the nation in 2006 forfeited some $1 billion under the use-it-or-lose-it rule.

It's difficult for employees to estimate an entire year's worth of medical expenses in order to determine how much money to place in their FSAs during open enrollment or when they take a new job. And, unfortunately, the looming use-it-or-lose-it rule deters many from signing up for this valuable benefit.

"We have the greatest respect for the people who participate in the plans we serve. But too many are wasting their own money and missing an opportunity to better manage their health or the health of their families," said John Shade, senior vice president of Ceridian Benefits Services.

Proper planning is a key component to FSA use. Most companies that provide FSA services offer savings calculators to help employees estimate the amount they want to place in the accounts. While these are valuable tools and it's certainly in the employees' best interests to budget for their health expenses, the use-it-or-lose-it problem still remains.

Ceridian has worked with employer organizations and the employee benefits community to modify the use-it-or-lose-it rule and to educate members of Congress and policy makers regarding its negative effect on FSA enrollment. These efforts played a large role in the House of Representatives approving a provision in the Pension Protection Act of 2006, which would have allowed employees to carry forward up to $500 of unused FSA funds from one year to the next. Unfortunately, when House and Senate negotiators met to reconcile the bill with the Senate's own pension legislation, the FSA carry-forward provision was eliminated.

While the efforts to approve the $500 carry-forward provision were unsuccessful in 2006, there is growing bipartisan support in Congress to amend the use-it-or-lose-it rule.

At the beginning of the 110th session of Congress, Rep. Carolyn McCarthy (D-NY), introduced H.R. 298, the Flexible Spending Accounts Growth and Opportunities Act. If enacted, the bill would allow employees to carry forward $1,000 in unused FSA funds from year to year. As one of the 45-member New Democrats Coalition, Rep. McCarthy has stated that the FSA carry-forward is one of the group's top health care priorities.

The use-it-or-lose-it rule is poor public policy and runs counter to efforts to make our health care system more cost effective. Responsible employees who want to manage their health care and control their expenses more effectively shouldn't be penalized for taking these steps.

Bush proposal to connect FSAs and HSAs
The Bush Administration's budget proposal for 2008 included another promising measure to improve FSAs. Under this provision, individuals would be allowed to hold an FSA and an HSA concurrently as long as the combined amounts don't exceed the annual maximum HSA contribution limit. Current law prohibits HSA holders from having FSAs except in limited circumstances.

HSAs are tax-preferred accounts employees can use to save for medical expenses. Participants must enroll in a high deductible health plan (HDHP) with a deductible of at least $1,100 for single coverage and $2,200 for family coverage in order to qualify, And, participants are prohibited from having any other health coverage, including FSAs. Unlike FSAs, HSA funds carry over from year to year and can be invested in stocks and bonds, much like a 401(k).

High deductible plans generally carry significantly lower premiums than traditional coverage, but many potential HSA enrollees are wary of having to pay their medical expenses out-of-pocket until the deductible is reached and insurance coverage kicks in. While HSA funds can be used to pay pre-deductible costs, a person who has recently enrolled would have little money available in the account. Furthermore, drawing from the accounts at an early stage could severely limit the account's earning power in later years. Recent estimates show that the average retiree will incur $200,000 in medical expenses, so ensuring employees are able to use their HSAs to save for the future is particularly important.

Under the Bush proposal to coordinate FSA and HSA usage, employees could draw money from an FSA instead of using their HSA savings to pay for their pre-deductible costs, which would be a significant improvement for both accounts.

Rather than planning out a year's worth of medical expenses, participants could use their plan deductible as a benchmark for their FSA allocation. This would significantly reduce forfeitures under the use-it-or-lose-it rule. Also, since the entire balance of an FSA is available on the first day of the plan year, individuals would have immediate access to their funds. Under current regulations, HSA holders make monthly contributions to reach their annual allocation and only have access to the amount they have deposited.

While legislation to implement this FSA - HSA bridge has not been introduced in Congress as of yet, this idea is gaining considerable support.

No time like the present
Trends clearly show that our current employer-provided health system will continue to erode and health care prices will continue to rise. The Congressional Budget Office recently estimated that for every one percent price increase in health insurance, 300,000 people lose health coverage.

Our health system is in need of a major overhaul. The complicated, contentious debate regarding how this should be accomplished will undoubtedly rage on for many years. In the meantime, the pressure on employers and employees will continue to grow.

Consumer-directed health plans are among the best, if not the best, current options employers and employees have to reduce cost and maintain quality health coverage. And, FSAs are already widely available to millions of employees. Measures to modify the use-it-or-lose-it rule and to allow coordination among consumer-directed accounts would go a long way toward ensuring their success. Congress should take these small steps now to improve upon these existing programs. American families and businesses can't afford to wait.