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Also in this issue:

• Cover
• Voluntary strategy and the largets U.S. brokers
• The distributor of the future
• Don’t ruin your client’s HSA
• 2006 – A very good year for voluntary sales
• 2007 voluntary sales growth leaders
• Eastbridge has a new, improved website!
• Predictions by Eastbridge Consulting Group echoed in recent ERISA Industry Committee proposal
• Too many choices or too little advice—the dawning of the Age of Confusion
• Takeovers in the voluntary market
• Critical Illness—what’s taking so long?
• Can technology drive the bus?

• Too many group companies don’t “get” enrollment

Past Issues

• 2007
• 2006

Summer 2007 / No. 72

Don’t ruin your client’s HSA

By our guest contributor, Keith A. Prettyman

The advent of high deductible health plans (HDHP) and their tax deferred health savings accounts (HSA) has been both praised and reviled. Many insurance companies and insurance brokers have, (a) tried to capitalize on an opportunity; (b) tried to help clients establish pre-HDHP levels of coverage; or (c) both. They have done so with a variety of worksite products. The purpose of this article is to alert companies and brokers that their best efforts to be helpful may be putting their client’s HSAs at risk. In your attempt to help your clients fill the coverage gap, don’t make the cure worse than the disease.

Internal Revenue Code §223 establishes and regulates HSAs. In general, taxpayers are allowed a deduction equal to the amount paid in cash to an HSA (§223(a)). To be eligible for the deduction, the taxpayer must be an “eligible individual” under §223(c)(1). An eligible individual is a person covered by an HDHP but not covered at the same time by any health plan that is not an HDHP or that provides any benefit covered under the HDHP (§223 (c)(1)(B). Another section 223(c)(1)(B) allows the taxpayer covered under a HDHP to remain an “eligible individual” even though he or she has what is referred to as “permitted coverage” or “permitted insurance”. Thus, any insurance product offered to a client with an HSA must fall under either “permitted coverage” or “permitted insurance.”

§223(c)(1)(B)(ii) defines permitted coverage as, “coverage…for accidents, disability, dental care, vision care, or long term care.” §223(c)(3)(B) and (C) are the applicable definitions of permitted insurance as they apply to the types of coverage which might be sold to fill the HDHP gap. §223(c)(3)(B) provides that permitted insurance includes, “insurance for a specified disease or illness” and §223(c)(3)(C) includes, “insurance paying a fixed amount per day (or other period) of hospitalization” as permitted insurance. Finally, meriting consideration and discussion, is §223(c)(3)(C), which allows the HDHP to provide preventive care without a deductible (i.e., allows first-dollar payment for prevention).

All of this information has been available for analysis since the HSA law was passed as part of the Medicare Prescription Drug Improvement Act in 2003. However, even with several IRS notices, insurers and insureds were left to personal or independent third-party interpretation to determine the extent to which the law's various definitions allowed coverage in addition to the HDHP without disqualifying eligibility for an HSA. On January 26, 2007, the IRS released Private Letter Ruling (PLR) 123396-06 that provides clarification of the government’s view of the proper or allowable interrelationship of HDHPs, HSAs, and supplemental coverages. While the PLR cannot be relied on as the precedent for any other taxpayer, the general direction provided is very helpful.

Broadly speaking, there are four categories of products that could be used to fill the gap in coverage created by high deductibles: mini-meds, specified disease (cancer, critical illness, and heart/stroke), hospital indemnity, and accident policies. Given the law and the helpful direction of the PLR, what products can you safely provide your HSA-covered clients without disqualifying the tax-favored status of the HSA?

The PLR examines six policies and 38 riders. Six of the policies are specified disease policies covering first occurrence of cancer, heart attacks/heart disease/stroke or “disease specified in the policy.” Two of the policies are hospital indemnity and three are accident policies. None of the 11 policies is a mini-med. The reason is obvious (at least as it applies to traditional mini-meds). A mini-med is essentially a major medical policy with a lower maximum annual or lifetime benefit. As such, mini-meds not only do not fit within the definition of either permitted coverage or permitted insurance, but such policies would qualify as a health plan (which is not a HDHP and provides benefits which are covered under the HDHP). In other words, your client, if covered by a mini-med, is not an “eligible individual” under §223.

In general, the PLR finds the other three categories of products safe for your HSA-covered client to own. There are, however, both clarifications of some past concerns and some clear warnings about specific benefits within each generally safe product category. First the good news, which relates to specified disease. Prior to the PLR, questions informally hovered about what “specified disease or illness” meant in §223(c)(3)(B). Specifically, must the policy cover only one (i.e. “specified”) illness and what is the meaning of “disease” or “illness” and does that differ from a condition? As to the first, the PLR clearly allows as “specified disease or illness” multi-sickness policies. Further, the PLR eliminated the previous worry about whether something like “heart attack” or “stroke” was a condition resulting from a disease or illness rather than a specified disease or illness and was, thus, disqualified from consideration as permitted insurance.

With this, it is now safe for you to offer specified disease, hospital indemnity, and accident policies to your HSA-covered clients, right? Not so fast! There are limits and pitfalls in the various riders and optional benefits associated with these products. That is, depending on the total package being provided, the HSA-covered client may be disqualified as an eligible individual. While the specific application of §223 to the total package of benefits is beyond the scope of this article (and in any case, qualified counsel should be consulted), the following general guidelines are useful.

• Avoid specific provider benefits even if tied into hospital confinement (e.g.: private duty nursing or inpatient physician visits).
• If diagnostic or wellness benefits are to be provided (under the safe harbor for “preventive care”) be sure the services qualify under §1871 of the Social Security Act or IRS Notice 2004-23.
• Do not include outpatient benefits as part of a hospital indemnity policy’s specified diseases and illnesses.
• Avoid surgical benefits, except in connection with accidents or specified diseases or illnesses.

Keith A. Prettyman, J.D., CLU, ChFC is an attorney with Woods & Aitken, LLP. One of Keith's areas of practice emphasis is insurance law, especially worksite benefits. Prior to joining Woods & Aitken, Keith served as General Counsel and Vice President of Worksite Benefits at Assurity Life for over 28 years. He can be reached at (402) 437-8504 and at kprettyman@woodsaitken.com.