Health coverage is largely regulated by state and territorial law, so, if the laws aren’t in sync with the Health Savings Account (HAS) concept, they must be changed to allow HSAs to function as Congress intended.

Prodded by insurers who want to offer HSAs, lawmakers are scrambling to remove barriers, and they’re doing it under a deadline: The Treasury Department, which regulates HSAs on the federal level, has given the states until January 1, 2006, to complete the work.

“There are really only a few stragglers,” said J.P. Wieske, director of state affairs for the Council for Affordable Health Insurance (CAHI). But which state laws still pose roadblocks? Even the experts disagree.

Take the issue of mandated benefits, for example. Any HR manager knows that a mandated benefit is a service or treatment that a government—typically, their state—has required health plans to cover. In some states, lawmakers have decreed that some of those mandates may not be subject to deductibles—in other words, the plan must pay the first dollar for those mandates and it can’t come out of the employee’s pocket.

But as those familiar with HSAs know, many of the services and treatments received by employees with HSAs are subject to deductibles. That’s because an HSA works in tandem with a high-deductible health plan (HDHP). To set up an HSA, an employer buys each employee an HDHP to cover all health expenses over $1,000 for individual employees and $2,000 for families.

Those dollar amounts are minimums that are adjusted annually for inflation. But Larry Akey, spokesman for America’s Health Insurance Plans (AHIP), says the deductibles for most HSAs are slightly over those amounts.

For health expenses under that dollar limit, the employer puts money into a fund for employees to spend as they see fit. That fund is the HSA. The money in it is not subject to income taxes, and it is portable when employees change jobs. Because money in the HSA is by its nature subject to a deductible, that means that any state-mandated benefits that may not be subject to deductibles are off-limits to HSA holders.

Example: In New Jersey, state law forbids the application of a deductible to the mandated benefit for tests that measure the level of lead in children’s blood, and any necessary medical treatment. New Jersey lawmakers acted to change that law to make that benefit compatible with, and available to, HSA holders.

Similar issues have arisen elsewhere. In Texas, it is hearing screening for newborns. In Indiana, treatment of diabetes. In Rhode Island, early intervention services for children with developmental disabilities. CAHI lists several jurisdictions that still have to change at least one of their mandated-benefit laws (Arizona, California, Colorado, Indiana, Minnesota, Rhode Island, Texas and the District of Columbia). The National Council on State Legislatures (NCSL) lists only 14 states that have acted so far this year. AHIP, on the other hand, maintains that New York and New Jersey are the only stragglers.

What’s an employer to make of all this? Dan Perrin, president of the HSA Coalition, a group that was instrumental in securing passage of the federal legislation that created HSAs, tries to make sense of what appears to be a situation in which no one really knows which states or territories have changed their laws to beat the January. 1 deadline.

“Mandates are in the eye of the beholder,” Perrin said. “It can be a matter of interpretation. I think that only New York and New Jersey will miss the boat. To the extent that there may be [unamended] mandates in other states, I think they’ll change their laws prior to the January 1 deadline. Employers, bankers and doctors all support HSAs, and that’s a difficult coalition to overcome.”

Richard Cauchi, health program director for the NCSL, agrees. “In general terms, there is a matter of degree regarding which changes are absolutely required to even allow sales of HSAs [a smaller number, perhaps none] and which states and territories could benefit by broadening how sales are treated by banking law or state income taxes.”

The consequence for a state or a territory that doesn’t meet the January 1 deadline is a serious one for would-be sellers of HSAs, Wieske said. “If a mandate isn’t changed, the plan won’t meet the definition of an HDHP, and the funds in the HSA won’t get favorable federal tax treatment. Insurers can still sell them, but, without the federal tax break, they won’t be attractive to consumers. The tax break is the one aspect of HSAs that employees understand best.”

What to do about this conflicting information? “Your insurance broker will know,” counsels Lisa Horn, manager of health care policy for the Society for Human Resource Management (SHRM). “The insurance industry certainly wants to offer them, so insurance professionals will know their status in a given jurisdiction.”

In addition to the problems with state-mandated benefits, there’s another set of roadblocks in some state tax laws. When it passed the federal law that made HSAs possible, Congress exempted the money in HSAs from federal income tax. Some states, however, define income differently than the IRS does, so, in some states, the funds in an HSA may be subject to state income tax—again, unless state lawmakers change the laws.

“Eighty-six percent of the states, and the District of Columbia, have changed their tax laws,” Perrin said. “Minnesota and Rhode Island were the most recent to do so. Only seven states don’t allow a state tax deduction for HSA contributions: Alabama, California, Maine, Massachusetts, New Jersey, Pennsylvania and Wisconsin.” According to the NCSL, however, tax bills were still pending in California, Hawaii, Illinois, Maine, Maryland, Massachusetts, Michigan, Minnesota, Oregon and Washington.

In states where the funds in HSAs are still subject to state income tax, that obstacle doesn’t bar insurers from selling the plans, Akey says, because the funds still receive favorable tax treatment on the federal level. And, he adds, insurers are doing a good job at educating consumers on the state law tax issues and glitches.

“The big impact is on the federal level,” Wieske stated. “The average federal income tax rate is 30 percent. The average rate on the state level is 7 or 8 percent.”

There are even more potential headaches to be considered before forging ahead with HSAs:

Can HSAs be coupled with HMOs? Akey says that AHIP has identified five states that bar insurers from coupling HSAs with high-deductible HMOs: California, Illinois, Missouri, New Jersey and New York. A count by the publication Inside Consumer-Directed Care lists Illinois, Maine and Missouri. To the extent that these impediments exist, they won’t stop the insurance industry from offering HSAs in those states; they’ll only limit the kind of plan with which the HSA may be paired.

Can state or territorial employee plans offer them? In many states, state employee unions have opposed HSAs for their members. “In general, we believe that HSAs only benefit people who don’t need health care,” said Jodi Sakol, associate director of public affairs with the American Federation of State, County, and Municipal Employees. “They’re not a good deal because of the high deductible. They represent an erosion of the employer-based health system.” Florida recently enacted a law enabling the state to offer HSAs to its employees. A number of other states are considering similar proposals.

Can states require insurers to offer them? So far there’s been little progress in resolving this question. Maine considered a bill this year, but it died. A proposal in Maryland was withdrawn, and a Nevada proposal died.

A survey released by Watson Wyatt Worldwide earlier this year, showed that most U.S. workers had neither heard of HSAs nor understand how they work. And only 8 percent of employers now offer them. But another 18 percent said they wanted to offer them -- it’s an idea that is beginning to interest employers and as the cost of health care continues to gain urgency, interest will continue to grow.

“It’s too soon to say whether HSAs will be a contributing cure to the health care cost crisis,” observed SHRM’s Horn. “But employers in every state and territory would like to have the opportunity to offer them.”