BANKS AND BANKING;

BANKS;

You asked for background on medical savings accounts (“MSAs”), relevant federal law (including provisions in the recently adopted Medicare reform legislation) and the state legislation passed last year.

SUMMARY

An MSA is a tax-exempt personal savings account in which the account holder can save money for future medical expenses. The MSA must be used in combination with a high deductible health insurance policy. A 1996 federal law authorized a demonstration program that gave federal tax breaks for MSAs that meet certain requirements. The recently adopted Medicare reform legislation makes this program permanent for Medicare, eliminates a cap on the number of beneficiaries who can participate in the program, and creates Health Savings Accounts (“HSAs”), a similar tax-favored account for medical expenses.

Connecticut has adopted laws to accommodate MSAs. Most recently, it adopted legislation this past session to remove a limit on deductibles for policies issued in conjunction with MSAs. As a result, MSAs established in conjunction with high deductible health insurance policies issued in Connecticut may now qualify for favored tax status under the federal Internal Revenue Code. The state Insurance Department provides a list of companies that provide high deductible health insurance policies on-line at its Website, www. ct. gov/cid.

FEDERAL LAW

The tax provisions of the 1996 federal Health Insurance Portability and Accountability Act (“HIPAA”)(P. L. 104-191) authorized a four-year MSA demonstration program beginning on January 1, 1997 for the private sector. The program allowed up to 750,000 high-deductible health insurance policies to be sold to self-employed people and individuals employed by small businesses (employers with 50 or fewer employees). Persons with such policies could establish tax-exempt trusts that they could use to save for future medical expenses. The MSAs authorized by HIPAA became known as Archer MSAs. The covered individual sets up an Archer MSA in a U. S. financial company, such as a bank. The federal legislation has been amended several times before this year, extending the Archer MSA demonstration deadline to December 31, 2003. Without additional federal legislation, no new Archer MSAs can be sold after December 31, 2003.

The Balanced Budget Act of 1997 (P. L. 105-33) authorized a limited Medicare MSA demonstration program. The program permitted qualified Medicare beneficiaries and other Medicaid beneficiaries to enroll in high-deductible health insurance policies and contribute to MSA plans through December 31, 2003, or until the program enrolled 390,000 individuals. The MSAs authorized by the Balanced Budget Act of 1997 are called Medicare plus Choice MSAs. A Medicare plus Choice MSA is an Archer MSA designated by Medicare as the sole means of paying the policyholder’s qualified medical expenses. Medicare, rather than the beneficiary, deposits the money into the account. Under Medicare plus Choice, the beneficiary chooses which high-deductible policy he wants to use, but the Medicare program must pre-approve the policy.

The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (P. L. 108-173) makes the Medicare plus Choice MSA program permanent and eliminates the enrollee cap. While Medicare plus Choice MSAs can be sold after December 31, 2003, no new non-Medicare-related Archer MSAs can be sold after December 31, 2003 without additional federal legislation. The demonstration program for HIPAA-authorized Archer MSAs currently ends on December 31, 2003. However, individuals who established an Archer MSA prior to December 31, 2003 can continue to use their account.

Although no new non-Medicare-related Archer MSAs may be sold after December 31, 2003, the Medicare Improvement law establishes a new kind of medical savings account called Health Savings Accounts (“HSAs”). Effective January 1, 2004, employers of all sizes can offer tax-favored HSAs to their employees. HSAs are funded by employee contributions through pre-tax payroll deductions or employer contributions. Similar to MSAs, eligible employees must be covered by a qualifying high deductible health insurance policy to contribute to an HSA.

STATE LAW

PA 03-78 exempts high-deductible health plans used to establish federally qualified MSAs from the $ 50 maximum home health care deductible required in certain health insurance policies. The act applies to individual and group policies that pay (1) basic hospital expenses, (2) basic medical-surgical expenses, (3) major medical expenses, (4) accident-only expenses, (5) hospital or medical expenses, (6) limited benefit expenses, and (7) hospital and medical expenses covered by HMOs. With the passage of this act, high deductible insurance policies issued in conjunction with MSAs may now qualify as an MSA high deductible health plan under provisions of the federal Internal Revenue Code.

Previously, because of the state mandated deductible limit on home health care, the Connecticut Insurance Department informed carriers that the related MSAs may not qualify for favored tax status under federal law. The Department advised those carriers that offer high deductible plans to take particular care when advertising the plans to avoid any deception or tendency to mislead or deceive (Bulletin HC-52). To ensure disclosure, all policies issued as MSA high deductible health plans on or after March 19, 1997 must contain the following statement on the face of the policy: “This product is intended to be federally tax qualified. Approval by the Insurance Department does not guarantee tax qualification. Please seek the counsel of a tax advisor. ”

MEDICAL SAVINGS ACCOUNTS (“MSA”)

Contributions to MSAs may be claimed as a deduction when filing federal income taxes. Since the Connecticut income tax is based on the federal Adjusted Gross Income, MSA contributions are allowed as a deduction for state income tax purposes as well. Interest on the assets in an MSA and distributions from the MSA used for medical expenses are tax-free. The contributions to an MSA remain in the account year to year until the participant uses the funds. In addition, the MSA assets are portable so that they stay with individuals if they change employers or leave the workforce. Either an employer or an employee can make contributions to the MSA, but not both.

Tax-qualified MSAs are only available to (1) employers with 50 or fewer employees, (2) the self-employed, and (3) the uninsured. MSAs cover single individuals and families. For 2003, the annual deductibles allowed for coverage under a high deductible health insurance policy issued for use with an MSA are $ 1,700 minimum and $ 2,500 maximum for singles and $ 3,350 minimum and $ 5,050 maximum for families. The maximum annual out-of-pocket expense is $ 3,350 for singles and $ 6,150 for families. The maximum amount a person can contribute to an MSA is a percentage of the maximum plan deductible allowed by law: 65% for singles and 75% for families.

Further information about MSAs is available from the Internal Revenue Service’s Website, www. irs. gov, in Publication 969.

HEALTH SAVINGS ACCOUNTS (“HSA”)

Like MSAs, contributions to HSAs may be claimed as a deduction when filing federal income taxes. Since the Connecticut income tax is based on the federal Adjusted Gross Income, HSA contributions are allowed as a deduction for state income tax purposes as well. Interest on the assets in an HSA and distributions from the HSA used for medical expenses are tax-free. The contributions to an HSA remain in the account year to year until the participant uses the funds. In addition, the HSA assets are portable so that they stay with individuals if they change employers or leave the workforce. Unlike MSAs, however, an employee and his employer can both make contributions into an HSA.

HSAs are available to employees of all size employers. HSAs cover single individuals and families. For 2004, the minimum deductibles for a high deductible health insurance plan issued for use with an HSA is $ 1,000 for singles and $ 2,000 for families. The maximum annual out-of-pocket expense is $ 5,000 for singles and $ 10,000 for families. Individuals can save up to $ 2,600 per year in an HSA. Families can save up to $ 5,150 per year. Individuals who are age 55 or older may also make additional catch-up contributions.

We anticipate that the IRS will develop publications on HSAs in the future.

JB/KM: ts