United States: Health Savings Account Fever: A Blistering Pace For HSA Guidance Continues

On March 30, 2004, Treasury and IRS gave another lift to consumer directed health care by issuing additional guidance on Health Savings Accounts ("HSAs"). The March 30th guidance supplements and in one case temporarily supersedes the HSA guidance issued December 22, 2003. The December guidance took the form of Notice 2004-2 and addressed in question and answer format basic issues regarding the establishment and operation of HSAs. (HSA basics and the December guidance are addressed in detail in our January 2004 Legal Alert at http://www.kilpatrickstockton.com/publications.) The March 30th guidance consists of four separate releases – Notice 2004-23, Notice 2004-25, Revenue Ruling 2004-38 and Revenue Procedure 2004-22, and it addresses issues identified as priorities by the public during roundtable discussions on HSAs that Treasury hosted in February.

At the press event marking the release of the March 30th guidance, Treasury announced its plan to release a third round of HSA guidance in June 2004. Treasury also announced that, in the interim, information on HSAs would be available on a Treasury website. (The address is http://www.treas.gov/offices/public -affairs/hsa/.) In addition, Treasury has offered to take questions by e-mail or through calls to a telephone recording system, with a five-business-day response goal. The email address is hsainfo@do.treas.gov and the voicemail number is (202) 622-4HSA.

This Legal Alert reviews the March 30th guidance, including explanations and insights provided by Treasury representatives at the press event, and looks ahead to the issues that are likely to be addressed in the June 2004 guidance.

In general, individuals enrolled in high-deductible health plans ("HDHPs") may establish HSAs to receive taxfavored contributions. The resulting HSA balances may then be distributed on a tax-free basis to pay or reimburse qualifying health expenses, may be accumulated for future health expenses, or may be used (on a taxable basis) for non-health purposes—either currently or in the future. An HDHP is a health plan that satisfies certain requirements with respect to minimum deductibles and maximum out-of-pocket expenses. The minimum deductible ($1000 individual, $2000 family) plays a key role in making HSAs a vehicle that can deliver the promise of consumer directed health care, i.e., it involves individuals more directly in controlling their health care expenditures and provides an incentive for thrift. At the same time, embracing the traditional wisdom regarding an "ounce of prevention" and a "pound of cure," Congress wished to allow HDHP designs that emphasize preventive care. Therefore, the statute contemplates HDHPs that provide coverage for preventive care before the deductible is satisfied (Code section 223(c)(2)(C)). As a result, an HDHP may provide first-dollar coverage for preventive care or apply a lower deductible to preventive care than the minimum annual deductible that generally applies. At the same time, there is no requirement that an HDHP cover preventive care on more favorable terms, nor that it offer any benefits for preventive care.

A high priority question that emerged from the February roundtable was what care is preventive and thus not subject to the mandatory minimum deductible. Interested parties emphasized this was a central element of HDHP design and thus needed to be addressed early for HSAs and HDHPs to be widely implemented in 2005. In Notice 2004-23, the IRS establishes a safe harbor for the preventive care exception, stating that preventive care includes but is not limited to –

• Periodic health evaluations (such as annual physicals), including related tests and diagnostic procedures.

• Routine prenatal and well-child care.

• Child and adult immunizations.

• Tobacco cessation and weight loss programs.

• Screening services. (Notice 2004-23 provides a two-page listing of approved screenings, including cancer, health disease, infectious disease, mental health, obstetric, pediatric, vision and hearing screenings.)

Notice 2004-23 follows this list with a caveat: "However, preventive care generally does not include any service or benefit intended to treat an existing illness, injury or condition" (emphasis added). In this regard, we understand that one of the questions IRS and Treasury have pondered is whether drug treatment for high cholesterol should be considered preventive, because it is intended to reduce the risk of heart disease, or whether it should be considered treatment for the condition of having high cholesterol. Indeed, the notice requests comments on the extent to which drug treatment should be classified as preventive care and what standard could be used to distinguish preventive drug treatment from regular medical treatment that uses drugs.

Also left open by the notice is the status of employee assistance programs (EAPs), mental health programs and wellness programs, and comments have been requested on these benefits. Comments have also been requested regarding "the scope of treatments provided as benefits through counseling and health assessments." These are significant issues. For example, EAPs that provide immediate, no-deductible coverage are sufficiently ubiquitous and engrained that it would be an impediment to the spread of HSAs if such EAPs could not be offered along side an HDHP. Treasury and IRS appreciate this, and their zeal to support HSAs is evidenced by the heroic efforts they have made to issue guidance expeditiously. However, Treasury and IRS are doing what they traditionally do, which is to interpret the statute responsibly rather than sweep aside technical issues with a broad political gesture. They want a solid legal answer to this and other issues. However, they are being far more liberal with transition relief. It may be that EAPs and other items that are largely (but perhaps not always or clearly) preventive could still receive transition relief to allow time for the development of a consensus regarding their status or even the development of modified programs.

Another nagging issue in this area is the status of state mandated preventive benefits. State insurance laws often require health plans to provide first dollar coverage or coverage at a lower deductible for specific benefits. The notice makes clear that a federal definition of preventive will apply and, therefore, it does not matter if state mandated care is characterized as preventive by state law. This again is a significant issue. For employers with insured benefits that are subject to state mandates, this will currently bar the establishment of HSAs in some states. When representatives of Treasury were asked about this at the press event for the March guidance, the response was that the issue needed to be raised at the state level. Substantively, there is a specific legal basis for that answer. Unlike Archer MSA law, which references state law to define preventive care, the HSA statute contemplates a federal definition. However, changing state law takes time. Therefore, this may be another area where transition relief would be extremely helpful.

For now, therefore, Notice 2004-23 provides preliminary guidance with a safe harbor that answers important questions, just not all of them. Given difficult time constraints, IRS and Treasury have addressed what they could, and they will revisit the issue of preventive care, probably in the June 2004 guidance.

The December 2003 guidance on HSAs provides that only health expenses that are incurred after the HSA is established may be reimbursed from the HSA on a tax-free basis. However, because of the novelty of HSAs, many individuals who are eligible to establish an HSA (i.e., they have coverage under an HDHP) have found it difficult to locate a trustee or custodian that was able to establish HSAs as of January 1, 2004. Therefore, due to this problem, the IRS has granted generous transition relief in Notice 2004-25. Under the transition relief, for calendar year 2004, an HSA established by an eligible individual on or before April 15, 2005 may pay or reimburse on a tax-free basis otherwise qualifying medical expenses that are incurred in 2004 on or after the first day of the first month that the individual becomes an eligible individual (i.e., becomes covered under an HDHP). The general rule established in the December 2003 guidance would then apply for calendar year 2005 and beyond.

A key HSA requirement is that an eligible individual cannot be covered under any health plan which is not a HDHP and which provides coverage for any benefit which is covered under the HDHP. However, two important exceptions apply to this requirement. First, an eligible individual may be covered by "permitted insurance," while covered by the HDHP. Permitted insurance includes coverage under workers’ compensation, liability insurance, automobile insurance, insurance for a specified disease or illness, and insurance that pays a fixed amount per day (or other period) of hospitalization. Second, an eligible individual may also be covered by "permitted coverage," while covered by the HDHP. Permitted coverage is coverage (through insurance or otherwise) for accidents, disability, dental care, vision care or long-term care.

Revenue Ruling 2004-38 addresses whether prescription drug coverage could be provided by a separate rider to the HDHP or by another plan separate from the HDHP. Under this design, prescription drug benefits are not subject to the regular HDHP deductible and would be provided on a first-dollar or lower deductible basis. Many had argued that this should be permitted if the HDHP carved out prescription coverage, i.e., because the prescription rider or plan would not be providing coverage for a benefit covered by the HDHP. Revenue Ruling 2004-38 reviews the legislative history of HSAs and concludes that the only carve-out coverages that can be provided without satisfying the HDHP deductible are those that satisfy the permitted insurance or permitted coverage exceptions. Because prescription drug benefits are not included in either of these two exceptions, prescription drug benefits must be subject to the regular HDHP deductible regardless of whether they are provide by a separate plan or a rider to the HDHP.

However, a companion release, Revenue Procedure 2004-22 provides transition relief for periods prior to January 1, 2006. The revenue procedure observes that many employers and insurers have been unable to modify the benefits provided under their existing health pla ns to conform to the HDHP requirements, because of the short period between the enactment by Congress of the new HSA provisions and their January 1, 2004 effective date. In light of this, the revenue procedure suspends the holding of Revenue Ruling 2004-38 in certain cases for periods prior to January 1, 2006. The suspension applies to individuals who would otherwise be eligible individuals, but are covered by both an HDHP that does not provide prescription drug benefits and by a separate health plan or rider that provides prescription drug benefits before the minimum annual deducible of the HDHP is satisfied.

At the press event, Treasury officials clarified that this transition relief is not just a grandfather provision. The transition relief applies to prescription drug benefits provided by either a current separate plan or a separate plan that is formed in the future (e.g., for the 2005 calendar year) specifically to take advantage of the transition relief. We also had the opportunity to ask Treasury representatives for background on the requirement for a separate rider or plan. They indicated that the transition relief responds to complaints that it would be difficult to coordinate the HDHP with co-pay based prescription coverage that is a separate arrangement. Therefore, the guidance grants additional time to work out those coordination issues. However, it is not clear under the guidance what constitutes a "separate plan" of prescription drug benefits.

For insured benefits, a separate rider will satisfy the requirement, and that is a clear delineation. However, for a self-insured employer, the issue becomes murky. Many self-insured employers have different claims administrators for medical and prescription drug benefits, but will still use a single plan number for both parts and will file only one Form 5500 for the single, composite ERISA plan. The question is whether this single ERISA plan will be considered one "plan" or two "plans" for purposes of the transition relief. Given the rationale for providing the transition relief, arguably it should be enough to qualify for the transition relief if a self-insured employer has separate administrative structures, such as separate claims administrators. Still, given the uncertainty surrounding this issue, a cautious employer that is currently offering HSAs and co-pay based prescription coverage may want to go farther and split the medical and prescription drug benefits into two separate ERISA plans, in order to shore up the applicability of the transition relief. On the other hand, an employer that is looking at offering HSAs for 2005 may want to wait and see if the June 2004 guidance clarifies the issue of a "separate plan," possibly obviating the need for this increase in the number of ERISA plans.

There are a number of HSA issues still on the table waiting to be addressed by Treasury and IRS in the promised June 2004 guidance. The most important issues are as follows –

• FSA and HRA Coordination – One of the important issues facing employers, which want to offer an HSA/HDHP design to their employees, is whether an employee can also elect to participate in a health flexible spending account ("health FSA") or a health reimbursement arrangement ("HRA"). Based on oral comments from IRS officials, it is clear that an employee with an HDHP could also be covered by a health FSA or an HRA, if the health FSA or HRA only covered expenses that were permitted coverage (i.e., dental and vision). There have also been positive indications that a health FSA or HRA can cover other expenses (including expenses covered by the HDHP) if coverage only begins after the minimum deductible is satisfied, or if the coverage is only for preventive care. In effect, the health FSA or HRA would meet the requirements to be a high deductible health plan. Many have wondered, however, if a carve-out strategy could be used for health FSAs and HRAs, so they could cover expenses before the minimum deductible is met that are not permitted coverage or preventive care. Like with prescription coverage, the idea was to have them cover expenses that are carved out from the HDHP. However, based on the prescription drug ruling above, it seems clear that an employer cannot carve-out a benefit from the HDHP and use that as the basis for providing the benefit through a health FSA or HRA.

• HSA Matching Contributions by Employers – Employer contributions to HSAs are subject to a nondiscrimination rule, which the statute says shall be "similar to" the rule applicable to Archer MSAs. If the employer makes contributions for any employee, the Archer MSA rule requires the employer to make available comparable annual contributions, which are the same amount or which are the same percentage of the annual HDHP deductible. These contributions must be made available to all employees covered by an HDHP at the same level of coverage (single or family), with adjustments for part-time and part-year employees. Some employers have inquired whether they could structure their contributions as matching contributions, similar to those allowed for 401(k) plans. The rationale is that the statute only requires the availability of comparable contributions, and by offering the match the employer would make available the same contribution to all. However, IRS personnel have indicated unofficially that the legislative history for Archer MSAs, which applies by cross reference, contemplates employees actually receiving comparable contributions, and not just that they be available. Based on this, it currently appears that matching contributions will not be permitted by the guidance to be released in June.

• Employer Restricted HSAs – Since the enactment of HSAs, some employers have wondered whether they could establish limits on the HSAs of their employees. For example, an employer who contributes to an HSA might want assurance that its contributions will be used only for medical expenses. One approach that has been suggested would be to have the employee agree contractually to certain restrictions in exchange for employer contributions. At the press event for the March guidance, a Treasury representative commented, on the one hand, that there is nothing in the statute that prohibits employers from restricting HSA accounts, while on the other hand noting that the HSA is an account that is nonforfeitable and that is owned by the individual (and that is subject to rollover to a different HSA custodian at any time). The summation was, therefore, that the idea presented some issues. In addition, however, based on the IRS’ comments concerning matching contributions, it appears that employers could not condition making an employer contribution on an employee’s agreeing to restrict the HSA without violating the nondiscrimination requirement.

• Other Miscellaneous Issues – Other issues that Treasury and IRS are considering addressing in the June 2004 guidance include the following –

• A model trust/custodian document for HSAs.
• Administrative procedures on how employers can establish HSAs for their employees.
• Application of the Section 125 regulations for HSAs that are a part of a cafeteria plan.
• Corrective procedures where employer contributions exceed the statutory contribution limits.
• Relationship between out-of-pocket expenses and lifetime maximums on benefits.
• Calculation of the statutory annual deductible in situations where expenses incurred in the last part of the year roll over and apply to the deductible in the next year.

The information contained in this article is not intended as legal advice or as an opinion on specific facts. For more information about these issues, please contact the author(s) of this article or your existing firm contact. The invitation to contact the author is not to be construed as a solicitation for legal work in any jurisdiction in which the author is not admitted to practice. There will be no charge for the initial contact. Any attorney/client relationship must be confirmed in writing. You may also contact us through our Web site at www.kilpatrickstockton.com