Reining in Health Care Costs

The cost of health care coverage continues to climb. For most firms, this means a further attack on the bottom line. Solutions are available, but too often they mean a reduction in benefits or shifting an ever-larger share of premium costs to the firms' employees. What if firms had a way to provide the same benefit protections, but at a lower cost to both the firms and their employees? Combining a high-deductible health plan with health savings accounts can do just that.

High-Deductible Health Plans

Most major insurers offer a choice of coverage programs, including long-popular indemnity plans, HMO plans and, more recently, high-deductible health plans. While premium costs for indemnity and HMO plans have increased significantly in recent years, some firms have achieved major savings by implementing a high-deductible health plan.

It is important to point out at the outset that a high-deductible health plan does not mean less favorable coverage for participants and their families. Such a plan provides the same general benefits as do indemnity or HMO plans, and there is no need for employees to change networks, physicians or hospitals to take advantage of the cost savings. High-deductible health plans generally cover fully most preventive care, such as annual physical exams, eye exams, immunizations and similar services, subject to a modest co-pay selected by the firm. All other medical services are subject to a deductible. Thus, the big difference between high-deductible health plans and indemnity and HMO plans is that covered participants are responsible personally for most charges up to the amount of the deductible, after which 100% of costs are covered by the insurer.

At first blush, one might ask what is so appealing about a plan that shifts to the participants personal responsibility for the first $3,000, let us say, of health care expenses incurred by the participant and his or her family for in-network services, and perhaps $6,000 for out-of-network services. The answer lies in the premium cost savings. While each insurer offers its own specific terms, a number of plans currently offered in the marketplace can reduce annual premiums by significantly more than 100% of the deductible amount. (In one recent case I am aware of, premium savings were double the amount of the deductible.) Even if the participant wants to go outside the network for a special referral (a need that seldom arises in a larger health care marketplace), the premium savings can result in a net savings in overall cost.

At the same time, a high-deductible health plan shifts greater responsibility to participants to spend their health care dollars wisely, a goal of the recent health care legislation in Washington. That is one reason why high-deductible health plans continue to grow in popularity. And the savings get even better, for both firms and participants, when a high-deductible health plan is combined with health savings accounts.

Health Savings Accounts

Health savings accounts (“HSAs”) are accounts that can be used for individual qualified medical expenses on a tax-favored basis. An HSA is a trust created exclusively for the purpose of paying the qualified medical expenses of the account beneficiary from funds deposited in the HSA by either the participant beneficiary or by his or her employer. HSAs are available not only to self-employed partners, but can be provided as well to a firm's associates and staff.

In order to qualify for favorable tax benefits, an HSA must have as its trustee a bank, an insurance company or another person who demonstrates to the satisfaction of the IRS that the manner in which the person will administer the trust will be consistent with the requirements for HSAs established by the Internal Revenue Code. There are many such providers in the market. A few other requirements apply as well. For example, no part of the trust assets in an HSA may be invested in life insurance contracts (the account beneficiary otherwise can control investment of amounts in the account), the assets cannot be commingled with other property except in a common trust fund or common investment fund, and the interest of the account beneficiary in the balance in an HSA must be nonforfeitable.

To be eligible to establish an HSA, an individual must be covered by a high-deductible health plan such as that described above. A deductible is considered high for this purpose only if it is $1,000 or more for self-only coverage or $2,000 or more for family coverage. In addition, to qualify as a high-deductible health plan, the annual deductible, plus other annual out-of-pocket expenses required to be paid by the participant under the plan (excluding premiums) for covered benefits cannot exceed $5,000 for self-only coverage or $10,000 for family coverage. A plan will not fail to be treated as a high-deductible health plan if it fails to have a deductible for preventive care, such as annual physicals.

The news gets even better. HSAs can be funded with tax-deductible cash contributions made by the account beneficiary or by his or her employer. That's one of the main benefits; contributions to HSAs are tax deductible. For this reason, there is a maximum annual contribution that can go into an HSA for an employee. For 2011 (apart from rollovers), that maximum contribution has been set at $3,050 for self-only coverage and $6,150 for family coverage. For taxpayers age 55 and over, the dollar ceilings are increased by $1,000 for 2011.

The account beneficiary of an HSA is free to withdraw amounts from the HSA at any time during the year to pay qualified medical expenses, subject to certain tax rules. Bearing in mind that tax-deductible monies deposited into the HSA are intended to be used exclusively for qualified medical expenses, funds withdrawn from an HSA are excludable from the account beneficiary's income only to the extent they are spent for that purpose. By way of example, assume that Mary Barnes has funded her HSA with $1,000. She receives a bill from her internist for $250 for services that constitute a qualified medical expense. Mary withdraws $250 from her HSA to pay her internist. She does not have to include the withdrawal in her income (but she also cannot otherwise deduct the medical expense on her tax return). Alternatively, Mary could arrange to have her HSA pay the bill directly. The result is that Mary's expenses effectively are converted from non-deductible (except to the extent they exceed 7.5% of her adjusted gross income, the threshold for claiming the deductions on Schedule A of her Federal Income Tax Form 1040) to fully deductible.

Qualified medical expenses are defined quite broadly by the Internal Revenue Code. They include any amounts spent for the diagnosis, cure, mitigation, treatment or prevention of disease or for the purpose of affecting any function or structure of the body. Although permissible expenses before 2011 included things like over-the-counter cough syrup, coverage has been narrowed for 2011 and later years.

What happens if Mary contributes more to her HSA in a year than she needs to meet her medical expenses for the year? The balance can be carried to the next year, and the year after that, and so on. Moreover, if amounts contributed to the HSA each year (up to the maximum deductible amount) are not used, the HSA can be converted to a retirement account. The amounts remaining in the account then can continue to grow tax free and be withdrawn after the participant reaches Medicare eligibility age to provide supplemental retirement income. In that case, the withdrawal is subject to income tax, but there is no penalty.

All of the aforementioned advantages make HSAs an easy sell to partner-owners of a law firm searching for relief from ever-increasing health care costs. The annual firm and employee savings, combined with the tax benefits passed on to the employee, make the case for implementing such a plan better than a Brandeis brief. There may be more resistance to change by employees, however, who may not view the savings as significant enough to merit giving up the status quo. Where that is the case, a firm may want to consider an incentive by funding all or a part of its employees' HSAs up to the amount of the deductible under the high-deductible plan, or perhaps half that amount. While the numbers will vary from plan to plan and will depend on a firm's contributory share of premiums, in many cases a firm still can realize premium cost savings that are greater than the HSA account contribution.

Conclusion

Combining a high-deductible employee health insurance plan with HSAs can offer firms, their partners and their employees an opportunity to control medical coverage costs while providing significant tax benefits for partners and employees. That's a winning combination every law firm should consider.

Michael E. Mooney, a member of this newsletter's Board of Editors, is the managing partner of Nutter McClennen & Fish, LLP, in Boston. His firm maintains an active tax and business practice, representing and advising domestic and international corporations in a broad range of tax issues, reorganizations, business combinations, and divestitures. He can be reached at [email protected].

The cost of health care coverage continues to climb. For most firms, this means a further attack on the bottom line. Solutions are available, but too often they mean a reduction in benefits or shifting an ever-larger share of premium costs to the firms' employees. What if firms had a way to provide the same benefit protections, but at a lower cost to both the firms and their employees? Combining a high-deductible health plan with health savings accounts can do just that.

High-Deductible Health Plans

Most major insurers offer a choice of coverage programs, including long-popular indemnity plans, HMO plans and, more recently, high-deductible health plans. While premium costs for indemnity and HMO plans have increased significantly in recent years, some firms have achieved major savings by implementing a high-deductible health plan.

It is important to point out at the outset that a high-deductible health plan does not mean less favorable coverage for participants and their families. Such a plan provides the same general benefits as do indemnity or HMO plans, and there is no need for employees to change networks, physicians or hospitals to take advantage of the cost savings. High-deductible health plans generally cover fully most preventive care, such as annual physical exams, eye exams, immunizations and similar services, subject to a modest co-pay selected by the firm. All other medical services are subject to a deductible. Thus, the big difference between high-deductible health plans and indemnity and HMO plans is that covered participants are responsible personally for most charges up to the amount of the deductible, after which 100% of costs are covered by the insurer.

At first blush, one might ask what is so appealing about a plan that shifts to the participants personal responsibility for the first $3,000, let us say, of health care expenses incurred by the participant and his or her family for in-network services, and perhaps $6,000 for out-of-network services. The answer lies in the premium cost savings. While each insurer offers its own specific terms, a number of plans currently offered in the marketplace can reduce annual premiums by significantly more than 100% of the deductible amount. (In one recent case I am aware of, premium savings were double the amount of the deductible.) Even if the participant wants to go outside the network for a special referral (a need that seldom arises in a larger health care marketplace), the premium savings can result in a net savings in overall cost.

At the same time, a high-deductible health plan shifts greater responsibility to participants to spend their health care dollars wisely, a goal of the recent health care legislation in Washington. That is one reason why high-deductible health plans continue to grow in popularity. And the savings get even better, for both firms and participants, when a high-deductible health plan is combined with health savings accounts.

Health Savings Accounts

Health savings accounts (“HSAs”) are accounts that can be used for individual qualified medical expenses on a tax-favored basis. An HSA is a trust created exclusively for the purpose of paying the qualified medical expenses of the account beneficiary from funds deposited in the HSA by either the participant beneficiary or by his or her employer. HSAs are available not only to self-employed partners, but can be provided as well to a firm's associates and staff.

In order to qualify for favorable tax benefits, an HSA must have as its trustee a bank, an insurance company or another person who demonstrates to the satisfaction of the IRS that the manner in which the person will administer the trust will be consistent with the requirements for HSAs established by the Internal Revenue Code. There are many such providers in the market. A few other requirements apply as well. For example, no part of the trust assets in an HSA may be invested in life insurance contracts (the account beneficiary otherwise can control investment of amounts in the account), the assets cannot be commingled with other property except in a common trust fund or common investment fund, and the interest of the account beneficiary in the balance in an HSA must be nonforfeitable.

To be eligible to establish an HSA, an individual must be covered by a high-deductible health plan such as that described above. A deductible is considered high for this purpose only if it is $1,000 or more for self-only coverage or $2,000 or more for family coverage. In addition, to qualify as a high-deductible health plan, the annual deductible, plus other annual out-of-pocket expenses required to be paid by the participant under the plan (excluding premiums) for covered benefits cannot exceed $5,000 for self-only coverage or $10,000 for family coverage. A plan will not fail to be treated as a high-deductible health plan if it fails to have a deductible for preventive care, such as annual physicals.

The news gets even better. HSAs can be funded with tax-deductible cash contributions made by the account beneficiary or by his or her employer. That's one of the main benefits; contributions to HSAs are tax deductible. For this reason, there is a maximum annual contribution that can go into an HSA for an employee. For 2011 (apart from rollovers), that maximum contribution has been set at $3,050 for self-only coverage and $6,150 for family coverage. For taxpayers age 55 and over, the dollar ceilings are increased by $1,000 for 2011.

The account beneficiary of an HSA is free to withdraw amounts from the HSA at any time during the year to pay qualified medical expenses, subject to certain tax rules. Bearing in mind that tax-deductible monies deposited into the HSA are intended to be used exclusively for qualified medical expenses, funds withdrawn from an HSA are excludable from the account beneficiary's income only to the extent they are spent for that purpose. By way of example, assume that Mary Barnes has funded her HSA with $1,000. She receives a bill from her internist for $250 for services that constitute a qualified medical expense. Mary withdraws $250 from her HSA to pay her internist. She does not have to include the withdrawal in her income (but she also cannot otherwise deduct the medical expense on her tax return). Alternatively, Mary could arrange to have her HSA pay the bill directly. The result is that Mary's expenses effectively are converted from non-deductible (except to the extent they exceed 7.5% of her adjusted gross income, the threshold for claiming the deductions on Schedule A of her Federal Income Tax Form 1040) to fully deductible.

Qualified medical expenses are defined quite broadly by the Internal Revenue Code. They include any amounts spent for the diagnosis, cure, mitigation, treatment or prevention of disease or for the purpose of affecting any function or structure of the body. Although permissible expenses before 2011 included things like over-the-counter cough syrup, coverage has been narrowed for 2011 and later years.

What happens if Mary contributes more to her HSA in a year than she needs to meet her medical expenses for the year? The balance can be carried to the next year, and the year after that, and so on. Moreover, if amounts contributed to the HSA each year (up to the maximum deductible amount) are not used, the HSA can be converted to a retirement account. The amounts remaining in the account then can continue to grow tax free and be withdrawn after the participant reaches Medicare eligibility age to provide supplemental retirement income. In that case, the withdrawal is subject to income tax, but there is no penalty.

All of the aforementioned advantages make HSAs an easy sell to partner-owners of a law firm searching for relief from ever-increasing health care costs. The annual firm and employee savings, combined with the tax benefits passed on to the employee, make the case for implementing such a plan better than a Brandeis brief. There may be more resistance to change by employees, however, who may not view the savings as significant enough to merit giving up the status quo. Where that is the case, a firm may want to consider an incentive by funding all or a part of its employees' HSAs up to the amount of the deductible under the high-deductible plan, or perhaps half that amount. While the numbers will vary from plan to plan and will depend on a firm's contributory share of premiums, in many cases a firm still can realize premium cost savings that are greater than the HSA account contribution.

Conclusion

Combining a high-deductible employee health insurance plan with HSAs can offer firms, their partners and their employees an opportunity to control medical coverage costs while providing significant tax benefits for partners and employees. That's a winning combination every law firm should consider.

Michael E. Mooney, a member of this newsletter's Board of Editors, is the managing partner of Nutter McClennen & Fish, LLP, in Boston. His firm maintains an active tax and business practice, representing and advising domestic and international corporations in a broad range of tax issues, reorganizations, business combinations, and divestitures. He can be reached at [email protected].