- CARES act provisions empower HSA accounts, but may negatively impact the custodians.
- OTC drugs and other previously ineligible items now qualify as HSA eligible.
- Increased spending of HSA funds affects custodial revenues in the short term.
- Commuter benefits segment is expected to face challenges during the COVID-19 crisis.
The Coronavirus Aid, Relief and Economic Security Act, commonly known as the CARES Act, was passed by Congress in order to aid Americans with emergency relief in response to the economic impact caused by COVID-19.
The CARES act includes several provisions that have a major impact on individuals with health savings accounts (HSAs), flexible spending accounts (FSAs), and health reimbursement arrangements (HRAs). I believe these provisions empower HSA accounts and are great for account holders. However, it can have a negative short-term impact on the custodians.
Impact on HSA
The CARES Act repeals the prescription requirement for over-the-counter (OTC) drug and medicine reimbursement. OTC drugs include those you can buy off the drugstore, grocery store, or convenience store shelf as well as those dispensed by a physician without a prescription. Due to this, individuals can use tax-free HSA dollars for things like Tylenol, Advil, cough syrup and more. On average, U.S. households spend about $442 annually on OTC products.
The CARES Act adds menstrual care products such as tampons, pads, liners, cups and sponges as qualified medical expenses for HSA reimbursement. A survey was commissioned by INTIMINA and conducted by OnePoll during late 2019. Results revealed the average woman surveyed spends $13.25 a month on menstrual products.
These provisions in the CARES act empower HSA accounts and will encourage individuals to utilize their balance to stock up on the items. Since these items are part of a household annual spend anyway, it only makes sense to use HSA funds (or claim reimbursement) to make these purchases tax free.
I am excited to see empowerment of HSA's during this crisis. It obviously highlights the strength of the platform. However, my concern lies in the fact that, in the short term, this would drain HSA savings and reduce custodial assets for HealthEquity (NASDAQ:HQY) and other HSA custodians.
Together, these add up to an average of $600 a year, about 17% of an individual HSA contribution limit for 2020. However, most HSA account holders don't max the contribution.
Employee Benefit Research Institute survey reveals that the average balance was $2,803 in 2018.
With 5.3 million HSA members and $11.5 Billion in HSA assets, the average HealthEquity account has $2,817 in savings (source).
Provisions under the CARES act in the short term are likely to cause a reduction in savings and, in turn, the custodial assets for HealthEquity. While spending HSA funds would result in an increase in interchange revenue, it is the case only if the spending occurs through the HealthEquity debit card. An out of pocket expense, followed by requests to reimburse qualified expenses, would result in loss of custodial assets and no interchange revenue for HealthEquity.
Acquisition of WageWorks has caused a shift in HealthEquity's revenue mix. The company is less dependent on custodial revenue than previously. Since the acquisition was completed after the first half of 2019, and due to the fact that, during Q4, 23% of HQY's revenue came from yield on custodial cash, down from 48% in Q2, I expect 2020 revenue mix dependency on custodial cash to be lower.
Source: Author's calculations
Federal Reserve's response to the pandemic by lowering interest rates will also weigh down HealthEquity's custodial revenues.
Contribution Limits Rising
Contribution limits have progressively increased over the years, but with the intention to encourage tax free savings. If there is a motivation to encourage spending, I believe the limits should increase further. IRS documentation provides insight that 2021 contribution limits are expected to be $3,600 for individuals and $7,200 for families.
Spending vs Saving
Despite 57% of HealthEquity account holders contributing more than $2,000 annually into their HSA, the average balance remains low. This is indicative of high spending of HSA funds.
In my opinion, long-term account holders recognize the more tax-savvy aspects of an HSA account and are maximizing their savings. Devenir research points to organic growth in HSA savings as the account ages.
Savings growth is desired, since custodial revenue could be boosted from investments. But only about 5% of active HealthEquity HSA accounts have investments. The number is quite small, but is up from 3.7% in 2018 (prior to WageWorks acquisition).
Source: Company 10K
As outlined above, CARES provisions are likely to foil hopes to see higher % of investment accounts in 2020, but it is early to tell.
The CARES Act temporarily allows High-Deductible Health Plans (HDHPs) with an HSA to cover any telehealth or remote care expenses, even if the participant hasn't reached his/her deductible. Current trend in HSA spending is mostly on doctor/hospital visits.
I see the telemedicine provision within the CARES act as a favorable move overall since the average cost of a virtual visit is $40 to $50, while in-person care can cost as much as $176 per visit. If this provision is extended to a longer term, it would help control the spending of HSA funds.
An important challenge faced by HealthEquity (and other HSA custodians) is the lack of awareness of the benefits of an HSA account. Many individuals confuse HSAs as FSAs and tend to spend all their funds for the fear of it being use-it-or-lose-it. This perhaps is one reason for increased spending of HSA funds, for the fear of losing the balance at the end of the year.
Moreover, it requires someone to be more tax-savvy than most people are to realize the benefits of the account, especially with rising healthcare costs.
I believe the CARES act provisions are likely to bring more attention to the concept of HSA and may encourage more people to utilize it.
HealthEquity largely depends on partnership with employers to provide its retirement accounts to employees. COVID-19 has caused a massive surge in unemployment. This is likely to negatively impact the opening of new HSA accounts, as bulk openings occur during new employee onboarding.
However, it is important to note that several companies hired aggressively during the crisis to fulfill the growing demand. Hence, it may not be a situation of negative YoY growth in accounts.
Lockdowns and stay-at-home orders and the work-from-home concept are likely to reduce contributions into the commuter benefits program, a division that HealthEquity acquired from WageWorks. Commuter accounts are primarily meant for frequent transactions and contribute to the interchange revenue segment. I anticipate a short-term decline in this due to limited work-related commute.
I believe the market may have priced in the lower interest rates and the unemployment situation, thus leaving HQY's stock significantly lower than its February highs. I believe the growth story for HealthEquity and HSAs in general looks strong; CARES act empowers the program in the long term, despite creating short-term challenges for custodians.
This article was written by
Analyst’s Disclosure: I am/we are long HQY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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