How Would a Health Freedom Account Change the Market?

A powerful member of Congress proposes a new type of health account that would change some entrenched programs. Does it make sense? Does it have a chance?

U.S. Rep. Chip Roy (R-TX), a member of the powerful House Rules Committee that determines which bills reach the full House for a vote, introduced legislation in the last Congress that would change the way the federal government offer tax benefits to Americans who purchase medical coverage from private insurers. The bill, titled the Healthcare Freedom Act, replaces Health Savings Accounts with Health Freedom Accounts, allows tens of millions of additional Americans to pay their qualified out-of-pocket medical expenses tax-free, and shifts the tax benefit from employers to all Americans.

It's an interesting bill. Its provisions, and the potential implication, are worth reviewing.

The Employer Exclusion

A key feature of Roy's plan is to replace the employer exclusion. The terms refers to the tax treatment of medical coverage dating back to World War II. When wages were frozen and companies needed to hire from a scarce workforce during the early 1940s (remember, a lot of potential workers were fighting a war on two fronts), they offered medical insurance to encourage new workers to enter the workforce and retain their employees. The Internal Revenue Service confirmed a decade later that the employer contribution to medical premiums was tax-free (excluded from income) to the employee.

The employer exclusion is the foundation of today's employer-sponsored coverage that enrolls some 170 million Americans (most of the rest of the population is covered by Medicare, Medicaid, and other government programs, by coverage in the nongroup market, or not insured). But the employer exclusion isn't without controversy:

1. Traditional employees receive a rich tax break that others who purchase insurance on their own don't receive.
2. The employer contribution to premium isn't charity offered by the company to workers, but rather part of employees' compensation. In effect, the employer controls this money earned by employees, and workers can access this portion of their compensation only by paying the company to purchase medical coverage.

The Roy Solution

Under Roy's plan, the employer exclusion would end five years after the bill is enacted. In its place, every American - traditional employee, gig worker, business owner, the unemployed) - would receive a tax credit to purchase coverage. This program would be revenue-neutral, as it would redistribute the $350 billion-plus that the employer exclusion represents in tax savings in the form of a tax credit equal to the value of the exclusion.

This approach would allow each employee to choose the plan that fit her needs and budget, rather than select from a limited menu (as few as one product, rarely more than three) of coverage options that a company offers. Each worker could balance her preferences for premiums (the fixed amount paid, regardless of utilization) with out-of-pocket responsibility upon receiving care. These two concepts are inversely proportional: In general, the lower the premium, the higher the out-of-pocket responsibility, and vice versa.

Opposition

The employer exclusion is indefensible from an economic perspective. The employer contribution to premium isn't an altruistic act of charity or an added bonus beyond compensation (as supporters of the Affordable Care Act believe). Rather, this money represents a portion of each employee's compensation. The employer controls this money earned by employees, and workers can access this money only by paying an additional fee.

Example: An employer pays 75% of the premium of a family medical plan priced at $24,000. The company retains its share ($18,000) unless the employee forks over an additional $6,000 of wages to unlock the benefit. Only then does the employee receive the additional $18,000 of compensation. If the worker receives coverage through his spouse and thus waives coverage through his employer, his company keeps the $18,000 that he earned.

This arrangement has powerful allies, including:

• business groups, who appreciate the tax treatment of their premium payments and are concerned that ending the employer exclusion would threaten their opportunity to attract and retain talent with rich medical coverage.
• medical insurers, who achieve efficiencies when they sell their plans through businesses (in effect, wholesaling their products to employees) rather than at retail (selling to consumers one-on-one).
• benefits advisors, through the National Association of Benefits and Insurance Professionals, their trade group, because they too benefit from the scale of group sales.
• Politicians who value the market-stabilizing effect of employer-sponsored coverage and who support the Affordable Care Act's mandate that applicable large employers (51 or more employees) offer coverage or pay fines.

The argument that the employer exclusion is part of the foundation of group coverage that insures 170 million or so Americans is compelling, economic theory aside. It's unlikely that the employer exclusion in its current form will be replaced by anything other than a government monopoly over the design, delivery, and financing of medical care (the so-called Medicare for All or single-payer proposals that don't generate much political support today).

Decoupling

Some people in the Health Savings Account industry propose the idea of allowing all (or at least more) Americans to enjoy the benefits of these accounts regardless of whether they're covered on an HSA-qualified plan. The idea is simple: The average deductible in 2022 was $1,763 among employees whose group plan included a deductible, according to the Kaiser Family Foundation. Nearly half of workers at small companies (50 or fewer employees) faced deductibles of $2,000 or more, and one-third of all employees were covered on plans that met or exceeded that threshold.

Yet many of those plans aren't HSA-qualified because they cover some non-preventive services below the deductible (e.g., primary-care visits or generic prescriptions covered in full after a copay). These people face high out-of-pocket costs but don't receive the benefit of paying these expenses at a 25% to 35% average discount that owners of Health Savings Accounts enjoy.

The issue with decoupling is the cost to the federal treasury. The Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) score each piece of proposed legislation to determine its effect on federal tax receipts and expenditures. Given these scorers' assumptions in previous analyses of health account, this provision would likely result in a very high (and unrealistic) level of tax expenditure. (Note: Tax expenditure is the term for the amount of money that the federal government would otherwise collect in taxes.)

Other Provisions

The Healthcare Freedom Act would increase contributions to Health Savings Accounts to $12,000 for individual income-tax filers and $24,000 for joint filers. These figures are far higher than the current $3,850 for self-only coverage and $7,750 for a family plan. The new provision also bases the contribution on the account owner's tax-filing status (individual or joint) rather than whether the medical plan covers one person or multiple family members. The catch-up contribution for owners age 55 and older, frozen at $1,000 annually under current law, would increase to $5,000.

This provision is problematic on several levels. First, only a small percentage (in the 3% to 6% range in multiple industry surveys) of Health Savings Account owners today contribute to the current statutory maximum. Allowing much higher contributions invites further criticism that these accounts are a tax shelter for the wealthy. Second, the CBO and JCT likely would make wildly exaggerated assumptions about the percentage of account owners who would suddenly find $12,000 or $24,000 to contribute to their account. The resulting calculation of tax expenditures would doom this provision.

The bill also defines costs associated with direct-primary care, healthcare sharing ministries, and medical cost-sharing organizations as qualified expenses. This provision has long been on the wish list of relevant stakeholders. Direct-primary care is an arrangement in which a patient pays a fixed fee to an independent primary-care doctor who then provides routine services at no additional cost to the patient. It's a terrific arrangement for both doctors (who can practice medicine without insurers' requirements, receive a steady income, and minimize administrative expenses) and patients (who enjoy budget certainty, can access their physician through a variety of media, and receive referrals to specialty care based on price/value or professional relationships rather than the doctor's affiliation with a medical-delivery system). But this arrangement disqualifies a patient from opening and funding a Health Savings Account. And the monthly or annual fee is not a qualified expense. The proposed bill addresses the latter concern, but not the eligibility issue.

Healthcare sharing ministries and medical cost-sharing ministries aren't insurance and aren't regulated by any level of government. They are agreements among members to chip in each month to cover the expenses of members who receive care.

Example: A sharing ministry enrolls 1,000 family members. Members submit monthly claims totaling $1,000,000. Each family is assessed $1,000. If claims the following month total only $500,000, each family contributes $500.

Because these arrangements aren't insurance, no one covered by one can open or fund a Health Savings Account. And since the assessments aren't for services received by a qualified family member, someone who previously funded a Health Savings Account couldn't reimburse the assessment tax-free from her account. The Roy bill doesn't address either issue.

The Bottom Line

The proposed legislation offers a fresh perspective on an alternative to the employer exclusion that would spread the benefit (the cumulative tax expenditure) across all Americans who purchase qualifying coverage. It's an idea worth considering. But it will run into huge opposition by people whose business models and political futures are tied to the employer exclusion. We are unlikely to see any movement to eliminate or reduce the exclusion in its current form.

The idea of increasing contribution limits is dead on arrival unless it's part of a broader reform (such as allowing people who don't benefit from the employer exclusion to enjoy a comparable tax break by purchasing coverage with tax-free funds from a Health Savings Account).

There are separate legislative proposals to redefine direct-primary care so that it's not disqualifying and allow fees to be reimbursed tax-free from an account. This proposal has merit. But treating the healthcare-sharing programs as insurance doesn't generate much support beyond the several million Americans covered by these arrangements and the organizations that administer them. Don't expect any independent legislation supporting them to pass.

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