Does Supplemental Coverage Disqualify You from Funding Your Health Savings Account?

This column is an excerpt (Question 15) from a book to be published later this year to help guide account owners, employers, benefits managers, and administrators understand Health Savings Account compliance issues. The format consists of a common question, an explanation in easy-to-understand English (often with an appropriate example), and a citation from government documents to support the answer. The book is designed to inform. It is not a legal document, and the contents should not be construed as legal advice.

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Question: My employer offers a voluntary supplemental insurance product that pays us $500 per day for up to the first five days of a hospitalization. This coverage looks like a good way to reimburse a portion of my deductible responsibility if I’m hospitalized. Can I purchase this coverage and remain HSA-eligible?

?Answer: Yes. See Question 14. You can buy certain supplemental insurance coverage and remain HSA-eligible. These policies are not medical plans. They do not reimburse your medical claims. Rather, they compensate you for a financial loss by paying a fixed amount that you can then use to replace or supplement your income.

The three most common forms are:

?Hospital. You experience a temporary loss of income during a hospital stay. These plans pay you a fixed amount – either per admission or per day up to a certain number of inpatient days – when you’re admitted to the hospital. You can use these funds to pay your out-of-pocket medical expenses or other personal bills.

?Accident. You experience a temporary or permanent loss of income because of an accident. This type of policy specifies covered events and the amount of money that you receive if you experience a covered loss. Covered accidents may include medical emergencies, burns, broken bones, ruptured disks, loss of a limb, loss of eyesight or hearing, paralysis, and accidental death. You can use the funds to pay your out-of-pocket medical expenses associated with the accident or for other purposes.

?Critical illness. You experience a temporary or permanent loss of income because of a critical illness. Like accident coverage, these plans specify covered events and the corresponding payment. They typically cover cancer, heart attack and other cardiac-related events, COPD, and other diseases. They compensate you, not medical providers, and you decide whether to use the funds to pay your medical expenses associated with the illness or other personal expenses.

?Some insurers now offer plans that effectively roll these three supplemental plans into a single policy that lists hundreds of hospital, accident, and critical-illness events and the amount paid for each.

Some employers offer one or more of these plans. Many don’t. Insurers that underwrite supplemental plans typically require that a certain percentage of employees enroll before they activate the coverage. Otherwise, if only a small percentage of employees sign up, the issuing company fears adverse selection – the phenomenon that occurs when only employees who are certain or highly likely to experience a loss elect coverage. In that case, the issuing company becomes merely a payer of known future claims, not a true insurer protecting enrollees against unforeseen events.

?Tips

?If your employer offers a voluntary supplemental plan, consider carefully whether the coverage makes financial sense for you. If your medical plan has a $3,000 deductible, a hospital policy that pays $1,000 would cover a substantial portion of your deductible if you receive inpatient care. That’s enticing, particularly when you’re a new Health Savings Account owner and haven’t accumulated an adequate balance.

On the other hand, according to the Centers for Disease Control and Prevention, only 7% of Americans stay overnight in a hospital each year. So, you may receive diagnostic services and treatments that satisfy your deductible outside a hospital and not receive any inpatient care. In that case, your hospital coverage wouldn’t pay a benefit, and you’d be responsible for all out-of-pocket expenses without any supplemental insurance payment.

Another limitation to hospital insurance is that a growing number of patients who have an overnight stay in the hospital aren’t really admitted. It’s a technical distinction, but an important one (especially for Medicare enrollees, as the coverage – and thus patient’s financial responsibility – is quite different). When you spend the night in the hospital, you may be an admitted patient or on observation status. You won’t know the difference unless you ask. You and your hospital roommate may share the same room, television, bathroom, and nurse, yet one of you is admitted and the other is under observation. If you’re in the hospital with observation status, you’re not formally admitted, and your hospital insurance plan may not pay a benefit.

You should approach supplemental insurance the way you analyze other forms of coverage – by asking the right questions:

• What is my potential financial loss if I experience an event and don’t have supplemental coverage?
• What is the likelihood that I’ll experience this loss?
• What’s the price of the coverage?

You should ask these questions whenever you’re offered an opportunity to purchase a voluntary supplemental policy. The higher the potential loss and risk of that loss, the more motivated you are to purchase coverage. You probably associate high financial loss with the loss of your home or a serious motor vehicle accident. For those situations, most people buy homeowners or auto insurance.

?Example: Your kids are active and play sports. You usually make at least two trips annually to your local hospital’s emergency department for stitches, concussion evaluation, or possible bone fractures. If the premium is $600 annually and your average emergency department visit is $825, purchasing accident insurance is probably prudent.

On the other hand, you probably don’t expect a high financial loss or probability of loss when considering an option to purchase an extended warranty on a toaster or leaf blower. Although you and your children may have the same smartphones and the cost of loss or damage would be the same regardless of whose smartphone was involved, you probably assign different likelihoods to this loss.

You must make the same assessment when you have the option to purchase supplemental coverage. Does cancer run in your family? Have you not been hospitalized since you had your tonsils removed 40 years ago? Are you expecting to deliver a baby this year? Are your kids active enough that only one visit per child to the emergency department is considered a successful year?

Finally, make sure you understand the full range of benefits. Some policies pay a cash benefit for proactive healthy steps – like an annual physical, regular dental cleanings, and routine mammograms. In these cases, the reimbursement offsets a portion of the premium, which may change the buy/don’t buy calculation.

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IRS Notice 2004-2:

?Q-6. What other kinds of health coverage may an individual maintain without losing eligibility for an HSA?

A-6. An individual does not fail to be eligible for an HSA merely because, in addition to an HDHP, the individual has coverage for any benefit provided by “permitted insurance.” Permitted insurance is insurance under which substantially all of the coverage provided relates to liabilities incurred under workers' compensation laws, tort liabilities, liabilities relating to ownership or use of property (e.g., automobile insurance), insurance for a specified disease or illness, and insurance that pays a fixed amount per day (or other period) of hospitalization.

?In addition to permitted insurance, an individual does not fail to be eligible for an HSA merely because, in addition to an HDHP, the individual has coverage (whether provided through insurance or otherwise) for accidents, disability, dental care, vision care, or long-term care. If a plan that is intended to be an HDHP is one in which substantially all of the coverage of the plan is through permitted insurance or other coverage as described in this answer, it is not an HDHP.

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The content of this column is informational only. It is not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.

HSA Question of the Week is published every week, alternating every other Wednesday with HSA Wednesday Wisdom and every other Monday with HSA Monday Mythbuster.