Flexible spending accounts let employees spend pre-tax dollarson out-of-pocket medical expenses: co-pays, eyeglasses, and otheritems not directly covered by health insurance. Beginning in 2003,plan participants could also spend FSA dollars on over-the-countermedications.

In January 2011, however, FSA rules began to shift, withprescriptions now required for over-the-counter medications boughtwith money from an FSA. The change, coupled with more to come in2013 and 2018, will substantially rearrange the landscape of FSAplans for employers, plan participants, and third-partyadministrators.

These benefits administrators worry that the new rules will makeFSAs less attractive to employees — and to employers as well.

FSA rules, then and now
There is no legal limit on the amount of pretax dollars employeescan put in FSAs. They can use that money to pay for qualifiedhealth care expenses, often using a debit card to access funds. Anymoney left in an FSA account at the end of the calendar year, orleft behind when an employee changes jobs or is laid off, revertsto the employer, which typically uses the cash to offset the costof employee benefits.

Employees must use all the money set aside in an FSA during theyear or lose the unused portion. As part of the 2010 health carereform legislation, FSA rules are changing. Beginning in January2011, employees must get a prescription from a doctor in order touse FSA funds to buy over-the-counter medication. Beginning in2013, FSA contributions will have a $2,500 cap.

Finally, in 2018, FSAs will be subject to the so-called Cadillacexcise tax, which will levy a 40 percent excise tax on health carebenefit values that are above a stated limit. These changes arepartly in response to suggestions that, in a rush to use up FSAmoney before the end of a calendar year, participants oftenpurchased many products that they didn't need, essentially wastinga tax benefit. The bigger reason, however, is to increase taxrevenue.

By making it harder to use pretax dollars on out-of-pockethealth care expenses, legislators hope that consumers will spendalready taxed dollars on the same expenses. According toprojections from the Congressional Joint Committee on Taxation, therule change regarding over-the-counter products will raise $5billion over the next ten years.

Limits hurt participants — and TPAS
None of those changes specifically kills FSAs, points out HilarieAitken, a partner at Flex-Plan Services in Bellevue,Wash.,  a TPA for FSAs and other employee benefitprograms. Even so, the changes make FSAs more difficult to use, andthat will hurt employees, employers and the TPAs that run them. FSAproponents take issue with the idea that an FSA is a wasteful taxbreak.

“Detractors say there's an incentive for people to overuse theirFSAs to buy stuff they don't need, and then get a tax break forthat,” says Scott Mardis, senior vice president for sales atAmeriflex, a TPA in Mt. Laurel, N. J. “But that doesn't happen toomany years in a row, because people adjust their spending levels tomatch reality.”

FSA opponents also point to seemingly limitless FSAcontributions — which will disappear in 2013 — as anotheropportunity for wasteful tax breaks. Mardis, however, points outthat even if consumers didn't put a practical cap on FSAcontributions, employers would. “Most employers do set a limit toFSA contributions, because they don't want employees to access thewhole amount and then quit,” Mardis says.

“In that case, the employer must make up the difference, andthey move to limit their liability. They already police themselvesand have a financial stake in doing so.” It's wasteful, however, toforce consumers to get prescriptions for FSA-fundedover-the-counter medications, Aitken says. “Doctors aren't wantingto give prescriptions for things like Claritin or Tylenol.

They don't want the liability of prescribing medications withouta clear need or for patients they haven't seen for a particularissue.” Nor do doctors typically get paid for writingover-the-counter drug prescriptions. Some consumers might take thetime to make a doctor's appointment to save a bit on coughsyrup.

Those who do, Mardis says, could clog the calendars of generalpractice physicians, who already are in short supply in the UnitedStates. Moreover, those additional appointments and ensuingprescriptions have the potential to drive up the utilization ofexpensive health care.

“Take away FSA over-the–counter benefits and someone will go tothe doctor and get a prescription, and that's penny wise but poundstupid,” Mardis says. “What was a $10 bottle of Advil, discounteddown to $8, is now a doctor's visit plus a prescription.”Ultimately, Aiken thinks, fewer people will get prescriptions forover-the-counter medications.

“There always will be people who are willing to take the time toget the tax savings, particularly if they take a particularover-the-counter drug on a regular basis,” she says. “But mostpeople won't bother getting the prescription. They'll just buyover-the-counter products out of after-tax dollars.” That's alreadyhappening in at least one pharmacy.

“There is definitely a difference in the number of people usingFSA accounts for over-the-counter purchases, and I think a drop inthe number of over-the-counter purchases overall. I feel it in mylittle store. I can only imagine what it's like in big stores,”says Dennis Galluzzo, a pharmacist at Family Medical Pharmacy inBuffalo, N.Y. Customers who do ask their physicians for aprescription for over-the-counter medication aren't gettingenthusiastic responses, Galluzzo adds. “Some doctors are irate.They don't want to be bothered with it,” he says.

A dying benefit?
Aitken thinks the new requirement that consumers get a prescriptionin order to use FSAs to buy over-the-counter medication will reduceFSA participation — not just because getting a prescription is ahassle, but also because using a debit card to buy over-the-countermedications was probably the easiest way to use an FSA.

“Over-the-counter medication purchases are user friendly andeasy, and they really served as a gateway to FSAs,” Aitken says. Anemployee who begins using a debit card — a familiar process — tobuy an antihistamine is more likely to tackle the more complexpaperwork necessary to be reimbursed for larger items than issomeone who encounters potentially confusing, time-consumingpaperwork on a first exposure to FSAs.

When fewer people want to participate in FSA programs, employerslose a valuable tool. Many employers are fighting the rising costof health care insurance by implementing programs with higherco-pays and deductibles. An FSA, which lets workers pay thoseco-pays and deductibles with pre-tax dollars, is a logical benefitto put in place next to a high-deductible health insuranceprogram—but only if employees are willing to use it.

“From an employer's perspective, an FSA fits into the largerscope of consumer-driven health care,” Mardis says. “If you'retrying to implement a $2,000 deductible and you don't put an FSA inplace, that money will come out of employees' pockets, money theymay not have right now. An FSA could save them $1,200 a year intaxes, which significantly decreases the pain factor of that $2,000deducible.”

Employers also save on payroll taxes for each employee whoparticipates in an FSA. “Reduce those numbers and you reduce theemployer's tax savings,” Mardis says. “The new cap gives employersone more reason to say 'forget it, it's not worth it.' The taxsavings aren't as great and employees aren't as happy.” Given therelatively small size of the tax savings legislators hope willfollow, Mardis says, “this takes away a benefit for very littlereturn.”

Employers might have even less reason to offer FSAs beginning in2018, when the Cadillac excise tax goes into effect. The new lawwill impose a 40 percent excise tax on any amount in excess of astated limit on the value of health care benefits. “The 40 percentis assessed to the insurer, which in this case is the employer,”Aitken says. Money in FSAs counts as part of the overall value ofeach employee's health care coverage. If a plan's value is over thecap, Aitken says, “an FSA might be a place to trim.”

Taken together, the rule change — and the rule changes that willfollow in 2013 and 2018 — might not bode well for TPAs. Theseadministrators typically handle claims, accounting and compliancein return for a monthly per-participant fee. Fewer participantswould mean less income immediately; a dwindling participant basecould also mean that fewer employers offer FSAs in the future.Aitken asked the 54 people her firm employs if they thought therule changes would lessen FSA participation.

“The consensus is that it could, and maybe would, deterparticipation,” she says. “A lot of people who aren't comfortabledealing with tax benefits will be less likely to use it, and itdoesn't promote new users.” Mardis agrees, saying that he thinksoverall FSA participation will go down. “This causes additionalconfusion and fewer people participating in an FSA program,” hesays. Some statistics, however, seem to suggest that the 2011 and2013 rule changes, at least, may not have a huge effect on FSAparticipation rates.

These numbers suggest that FSA participants, as a group, spendrelatively little FSA money on over-the-counter medications, andmuch more on prescription drugs and medical treatments. Moreover,most FSA participants are already contributing amounts that areless than the upcoming FSA contribution limit of $2,500. By andlarge, this data seems to indicate, FSA participants are alreadyworking within the bounds of the first two FSA rule changes.

More will be revealed, of course, as time goes on. In themeanwhile, Aitken says, “It's important that participants andemployers understand how these provisions are going to affect them.We need to keep on educating participants and reaching out toelected officials. As an industry we need to work on behalf ofpeople who rely on FSA accounts to afford their health care.”