In 1996 the 104th Congress created a Medical Savings Account (MSA) demonstration project as part of the Kassebaum-Kennedy health insurance reform legislation. Tax-advantaged MSAs are personal savings accounts that must be combined with high-deductible health insurance. Account holders use MSA funds for small and routine health care expenditures, and their health insurance covers more costly medical events. [See Figure I.] The MSA legislation took effect January 1, 1997. ¹ In addition, as part of the 1997 Balanced Budget Agreement, Congress created a Medicare MSA demonstration project, but that legislation does not take effect until January 1999.

During the 1996 legislative debate, proponents argued that MSAs would be very popular, while opponents argued that MSAs would destroy the health insurance market. Both groups were wrong. MSA sales have been slower than predicted, and there appears to have been no negative impact on the health insurance market. Indeed, early indications are positive, as a number of previously uninsured people appear to have purchased MSAs. However, the government has done little analysis of the MSA project and has postponed a comprehensive study it was to have done.

Now that MSAs have been on the market for 18 months, what is known about them and the marketing effort that resulted from the legislation? Why have they been slow to catch on? How can they be improved? What needs to be done next? This study answers these and other questions about MSAs.

This analysis is not based on polls or scientific research. As the General Accounting Office (GAO) has discovered, it is extremely difficult to conduct surveys of the small numbers of people who have signed up for an MSA. Broad-based national survey techniques such as telephone interviews would not reach a large enough sample of MSA account holders to be significant, and insurance companies understandably are unwilling to allow researchers access to their customer databases in order to question account holders about their experience with MSAs.

Instead, this analysis is based on monitoring of the MSA market - the products and marketing efforts that have been used to date and frequent off-the-record discussions with the insurance executives most closely involved in the product.

The agreed-upon demonstration project is quite modest, but it is a start. The agreement permits: ²

• An annual tax-deductible contribution to the MSA - up to 65 percent of the policy's deductible in the case of individual coverage and 75 percent of the deductible for family coverage - when combined with a health insurance policy with an annual deductible of $1,500 to $2,250 for an individual and $3,000 to $4,500 for a family.

• Tax-free buildup of money in the MSA and tax-free distributions of MSA funds for medical expenses.

• Maximum out-of-pocket expenses (including the deductible) of no more than $3,000 under an individual policy and $5,500 under a family policy.

• Funds withdrawn and used for nonmedical expenses to be considered as income and subject to income taxes, plus a 15 percent penalty - unless such withdrawals are made after age 65 or the onset of a disability.

• At death, any remaining MSA balance to be includible in the decedent's gross estate, under rules similar to those applicable to Individual Retirement Account (IRA) funds.

• No "sunset" provision for MSAs; those who get them may keep them.

Unfortunately, the restrictions Congress imposed on MSAs not only limited the number of people who can buy them, but also made their purchase and maintenance very complex.

• Only employers with 50 or fewer employees, along with the self-employed, are permitted to obtain a tax-free MSA.

• The demonstration project is limited to four years and 750,000 policies. There is no limit on the number of dependents covered or the number of uninsured who may apply, but once the 750,000 cap has been reached, no more MSA applicants may be accepted.

• Small businesses that switch to an MSA plan may grow to 200 employees within the four-year demonstration project, but additional employees would force the company to drop its MSA program or put new employees in a different plan.