Focus on Healthcare Payments

Past History and New Trends in the Use of Healthcare Payment Cards

Total U.S. healthcare costs were a staggering $2.25 trillion in 2007, and they are expected to double over the next decade. While it’s true that public funds, such as Medicare and Medicaid, and private insurers covered most of these costs, consumers directly paid for 12 percent ($269 billion) of the expenses — the majority of which were made using cash and checks. Traditional credit and debit cards were used to pay for a smaller, but still significant, portion of these expenses. The remaining out-of-pocket expenses, less than four percent, were paid for with cards tied to healthcare accounts.

The potential to use card-based payments in conjunction with healthcare spending accounts is ripe. In 2007, these cards captured approximately $8 billion in transaction volume, despite significantly higher expectations for growth. Depressed growth has been attributed to slow consumer adoption and complex payment structures within the healthcare industry. Despite these obstacles, there are new trends and developments that may lead to increased growth in the use of healthcare payment cards.

We expect to see a shift away from employer-provided healthcare to consumer-directed healthcare plans (CDHPs); debit and prepaid card applications that address limitations in paper-based environments; and Internal Revenue Service (IRS) regulations that address important impediments to the expansion of growth in healthcare cards.

Types of Healthcare Accounts

For those unfamiliar with this promising industry, a basic primer: There are three different types of healthcare accounts, which include flexible spending accounts (FSAs), health reimbursement accounts (HRAs), and health savings accounts (HSAs). Each account has its own unique history, defining characteristics and propensity to be used in conjunction with a card.

The FSA, which was introduced as a result of an IRS ruling in 1978, is the oldest of the three types of accounts. An FSA allows individuals to set aside money on a pre-tax basis for healthcare expenses not reimbursed by employer-sponsored health insurance programs. The accounts are funded by monthly payroll deductions.

HRAs are another type of healthcare account offered by employers. Like FSAs, HRAs can be offered regardless of health plan coverage, though many employers offer HRAs alongside high-deductible healthcare plans. Accounts are funded by the
employer rather than the employee, and these contributions are also non-taxable.

In 2003, the Medicare Prescription Drug, Improvement, and Modernization Act introduced the HSA. An HSA allows anyone covered by a high-deductible healthcare plan to make tax-deductible contributions to save for qualified medical and retiree health expenses. The account can be funded by the employee or the employer, but the employee owns the account and can transfer it when changing jobs. HSAs must be tied to a healthcare plan with a deductible of at least $1,000.

A Growing Consumer Responsibility

FSAs, HRAs and HSAs are expected to grow as more individuals enroll in consumer-directed healthcare plans, which shift more responsibility for healthcare decisions and payments from employers to employees.

Underlying the trend toward CDHPs has been the rapid growth in overall healthcare costs. As a result, many employers are faced with the growing cost of funding healthcare plans and are looking for more affordable alternatives. In 2007, a traditional employer-sponsored health plan cost the employer an average of $7,928 per employee. Employees enrolled in these programs paid an average premium
of $1,690.4 CDHPs, which can be significantly less costly to employers, represent an attractive alternative to many businesses. These plans are also seen as a way to extend healthcare coverage to a working population. For example, small businesses that are unable to offer their employees traditional health plans may turn to CDHPs as a cost-efficient health benefits program.

The U.S. Department of Health and Human Services has forecasted annual growth rates of 5 to 6 percent for out-of-pocket healthcare spending, reaching $414 billion in 2015. This trend will offer more opportunities for payment card applications.

Simplicity in Debit and Prepaid Cards

Debit and prepaid cards that directly access FSA and HRA accounts remove two hurdles that keep many people from enrolling in these accounts. The first is the “double payment” problem associated with FSAs. Traditionally, employees using an FSA make payments for authorized medical purchases with money from their own pocket first and then submit receipts for reimbursement from the FSA. In essence, the employee spends the money twice: first, when the money is taken from his or her paycheck to fund the FSA, and second, when making the healthcare purchase.

The second hurdle is the reimburse- ment process. There is a significant lag between the time the healthcare purchase is made and the reimburse- ment form is completed — and then it still must be mailed so the final reimbursement can be received. When the consumer uses an FSA or HRA debit or prepaid card, the purchase amount is deducted directly from the account, eliminating both the second payment and the whole reimbursement process.

Automatic Verification Prospects

The option to access healthcare accounts with a debit card for eligible purchases was introduced in a 2003 IRS ruling. Up until this point, paper-based reimbursement was the standard option, which essentially meant attaching sales receipts along with the reimbursement form to substantiate that the claim was for an eligible purpose. Although the ruling offered guidance for electronic substantiation, many purchases still ended up requiring additional cumber- some manual processes. However, the IRS issued a new ruling in 2006 that expanded and streamlined electronic substantiation, which is to take effect in 2009.

The original 2003 ruling included three methods of electronic claims substantiation: payment at a medical provider based on merchant code; recurring claims that have already been approved; and real- time adjudication for non-medical merchants (i.e., grocery stores and discount stores).

The 2006 IRS ruling addressed this by providing non-medical merchants with an alternative for substantiating claims through the use of an inventory informational approval system (IIAS).

This system allows merchants to identify whether the purchase is an eligible healthcare expense by appending their own inventory control information (i.e., stock keeping units). FSAs and HRAs directly benefit by circumventing the reimbursement process, while HSAs benefit indirectly. Although HSA purchases do not require third-party substantiation, receipts for healthcare-related purchases need to be submitted to receive tax benefits. The new IRS rule requires that these purchases be flagged on receipts at non-medical merchant locations, making record keeping easier for HSA users.

An Optimistic but Uncertain Future

There is a tremendous opportunity for using card applications in the area of out-of-pocket healthcare spending. Unfortunately, for such payment innovators, the expected growth in card-based healthcare payments has not been realized, forcing many early entrants to postpone or abandon their plans. Among other factors, it can be concluded that policymakers and payment providers have underestimated the complexities and the barriers to adoption.

The payment card industry has been built around a far simpler and more straightforward business model: the purchase of goods from retail merchants. In the retail merchant environment, price is readily established, and once a purchase is made, the transaction is generally completed. Payments for healthcare services are far more complex, with the price often not available at the point-of-sale and subject to different deductibles or co-payment structures. Transactions are often linked over time as part of an ongoing treatment, and payments are subject to complicated adjudication rules. These and other complicating factors create real challenges to innovators attempting to apply basic retail payment card technology to this far more complex industry.

However, market trends toward growth in CDHPs, increased simplicity for out-of-pocket spending with a card product, and IRS rulings expanding the use of healthcare cards may be reasons for renewed optimism for future growth. At the same time, there is reason to urge caution in interpreting the potential impact of these developments. Further research that includes consumer behavior and attitudes is clearly warranted.

Ann Kjos is an industry specialist in the Payment Cards Center of the Federal Reserve Bank of Philadelphia. This article was adapted from a Payment Cards Center Discussion Paper that she wrote titled, “New Prospects for Payment Card Application in Health Care?” The views expressed here are not necessarily those of this Reserve Bank or of the Federal Reserve System. For more information on the Payment Cards Center or to access a complete version of the original paper, please visit http://www.philadelphiafed.org/payment-cards-center.