Philadelphia Reflections

Good Ol' Health Savings Accounts

In 1981 at what was then called the Executive Office Building of the Reagan White House, John McClaughry and I conceived the Medical Savings Account, later known as the Health Savings Account. John was at that time Senior Policy Advisor for Food and Agriculture, but he had read my book The Hospital That Ate Chicago, and it inspired him to think about a better way of financing health care. He asked me to come down to Washington to discuss the issue. We met and fleshed out the idea. Little did we then suspect how many delightful features would pour out of the simple little invention with only two moving parts.

It was patterned after the tax-deductible IRA (Individual Retirement Account) which Senator Bill Roth of Delaware was bringing out the following year. But with two major variations: our account contained the unique feature of a second tax exemption, given on condition the withdrawal was spent on health care. Otherwise, a regular IRA subscriber pays the usual income tax on withdrawals and gets only one tax deduction, the one he gets when he deposits money into the account. Bill Roth later produced his second kind, the Roth IRA, which allowed a tax-exempt withdrawal but took away the tax-exempt deposit. Only the Health Savings Account gives you both. In Canada, by the way, they do allow both deductions in their IRA, but in America only the HSA offers it.

Garlands of Unexpected Good Features. So the first part of a Health Savings Account is just that, a tax-exempt savings account, obtainable in the same way you get an IRA or a Roth IRA, although a few eligible outlets were slow to take ours up. And the second combined feature was to require a high-deductible, "catastrophic", stop-loss health insurance policy -- the higher the deductible, the cheaper the premium gets.

Further, the more you deposit in the account, the higher is the deductible you can afford, so you save money going either way and get extra benefit in your account for having a tailor-made insurance program. The industry term for this kind of insurance is "excess major medical", which the two of us wanted to avoid because of its implication it was somehow frivolous or unnecessary, when in fact it is central to the whole idea. Linked together, the two parts enhanced each other and produced results beyond the power of either, alone. The savings account was first envisioned to cover the deductible, but nowadays it also commonly attaches a special debit card to purchase relatively inexpensive outpatient and prescription costs. That led to further administrative savings to the subscriber if he shopped frugally for optimum proportions of deductible insurance. Right now, it's a little uncertain what the current Administration will permit in the way of catastrophic health insurance, so, unfortunately, it is just about impossible to give concrete examples of what the ultimate cost will prove to be. But we do know that in the old days, a $25,000 deductible was available for $100 a year. Nowadays, a $1000 premium is more likely. When we get to explaining first year and last year of life insurance, it will become clear that this premium can be appreciably reduced.

But while the savings account allowed someone to keep personal savings for himself, the insurance spreads the risk of an occasional heavy medical expense at what ought to be a bargain price for bare-bones insurance. You needn't spread any risk for small expenses because you control them yourself, but no one can afford some of those occasional whopper expenses. There's no reason why you couldn't set the deductible level yourself, weighing your own ability to withstand bigger risks. In practice, the actual savings were reported to approach 30% (compared with "First-dollar" health insurance), quite a pleasant surprise. But because of the younger age group of the early adopters, much of this saving was achieved in the out-patient area.

(Let's start using the present tense to talk about it, although right now it's hard to know what politics will permit.) So, hidden in this bland dual package are lower premiums, less administrative red tape, less moral hazard, but complete coverage. Right now, that's somewhat subject to change. It provides complete coverage in the sense that the insurance deductible can be covered by the savings account, but contains the option to be saved, invested or used for small outpatient expenses. Furthermore, the account carries over from year to year and employer to employer. So it eliminates job-lock, use-it-or-lose annoyances, and allows a healthy young person to save for his sickly old age. Curiously, many of the subscribers have elected to pay small expenses out of pocket, in order to make the tax deduction stretch farther.

In one deceptively simple feature, many of the drawbacks of conventional health insurance have been removed. The bank statement from the debit card can even do the bookkeeping. The first part of the two-part package, the savings account, creates portability between employers, opens up the possibility of compound interest on unused premiums, eliminates pre-existing conditions even as a concept, and creates a vehicle for transferring the value of being a "young invincible" forward into age ranges when the money really is likely to be needed for healthcare. Maybe some other features can be added later, but introducing an unfamiliar product is always greatly assisted by having it all appear so simple. The HSA only has two features, but they solve a dozen pre-existing problems.

To return to its history, nearly 15 million accounts have been opened, containing $24 billion. John McClaughry and I (neither of us received a penny for any part of this) were seeking a way to provide a tax exemption to match the one which employees of big business get when the employer buys insurance for them. That is, Henry Kaiser inspired us to do it. Although we got the general tax-free savings idea from Bill Roth, we did him one better by giving a deduction at both ends, provided only -- you must spend the money on healthcare to get the second tax relief. An additional novelty at that time was a high deductible, which permits a "share the risk" feature unique to all insurance, but invisibly limits it too expensive items. It wasn't the original idea, but it turns out you get spread-the-risk and limits to out-of-pocket patient costs in the same package. Who could have guessed?

Volume control versus Price Control in Helpless Patients.We did know a third automatic advantage, not fully exploited so far: it seems possible the hateful DRG system (with its codes restructured) could become a useful tool for dealing with a major flaw in the Medicare system. Professional peer review has become pretty good at controlling the volume of services, but prices still escape effective control. No amount of volume control can, alone, address the price issue. Controlling vital services for helpless people is a delicate matter.

Quite a few of those services match (or contain) identical items in the outpatient area. The outpatient area faces outside competition from other hospitals, drugstores or vendors. Instead of letting helpless inpatients generate unlimited prices for the outpatients, why not let competition in the outpatient area define standards of prices for inpatient captives? Outpatients and inpatients overlap in the ingredient components, considerably more than most people suppose. Inpatients may have higher overhead because of the need to supply their needs at all hours, but a standard extra markup around 10% ought to take care of that. No doubt some services are unique to the inpatient area, but a relative value scale is then easily constructed, thereby linking unique costs to other services which are exposed to competition. Ultimately, provable relationships to market prices might even discipline big payers demanding unwarranted discounts. This last is a deal breaker, provoking suspicions of abused power by a fiduciary. The government in the form of Medicaid is often the worst offender, so we need not imagine laws will prevent discounts so long as law enforcement remains crippled. Every business school teaches that discounts below cost are a path to bankruptcy, but business schools have apparently not had enough experience with governments to suggest an effective remedy.

Other than two variations (double tax deductions, and incentives if used for health care), a Roth IRA would be nearly the same as an HSA, with independently purchased Catastrophic backup. But the assured presence of low-cost, high-deductible insurance provides security for another needed feature: Using individual accounts with year-to-year rollover , we could introduce the notion of frugal young people pre-paying the healthcare costs of their own old age. For all we knew, there weren't any frugal young people, but we were certainly pleasantly surprised. And catastrophic insurance added the ability to share the opportunity of that feature -- subsidizing the poor at bearable prices. As we will shortly see, it also offers an incentive to save for retirement. Think of it: almost nobody can afford a million-dollar medical bill, but almost everybody welcomes low premiums. Catastrophic coverage offers the only chance I know, of approaching both goals at once. And it offers the fall-back, that if you are lucky and don't get sick, you can use it for your retirement.

As the only physician in the room, I also pointed out another pretty gruesome fact: either people end their lives have a lot of sicknesses, or they end up paying for a protracted old age. Only infrequently, do real people encounter both problems. It can happen of course; breaking a hip after long confinement in bed would be an example.

People end their lives with sickness, or else they must pay for protracted old age.

Still More Good Features. Including these self-canceling needs in a single package allowed some flexibility between them -- something badly needed for a century. We cannot go on passing a new regulation for every quirk of fate; a good program must allow some latitude. Extended longevity tends to be hereditary, and so separate policies (sickness care and long-term care) are more expensive individually than the two combined because the patient can out-guess an insurance company. Health Savings Accounts balance an incentive to save for one's own future health costs "at the front end" with reasonable cost limitations "at the time of later service", even though two time periods are decades apart. That's obviously superior to increasing the sickness subsidy at the back end, because, among other things, the patient will later have even more clues about his impending future. If cost reduction goes too far at either end, it amounts to an incentive to spend carelessly. Saving becomes fruitless.

A tax deduction is a tax deduction, but this one has two: An incentive to save, and a later option to spend the savings on either healthcare or retirement. That's nearly specific enough. Furthermore, it offers a choice between saving preferences -- you can have interest-bearing savings accounts, or you can invest in the stock market, or a mixture of both. The HSA automatically converts to a regular IRA (for retirement) at age 66 when Medicare appears; that should be optional for all health insurance, but isn't. The IRA up in Canada includes both front and back features, but in the United States the HSA is the only savings vehicle to have dual deductions, so it's more flexible. As the finances of Medicare become shaky, it may be time to provide additional alternatives. At least, we ought to consider extending age 66 to a lifetime coverage option.

This harnessing of two familiar approaches makes a deceptively simple package which ought to be considered in other environments, unconnected with medical care. In most public policy proposals, the deeper you dig, the more problems you turn up. In this one, we found the proposal already had hidden answers to most concerns we could discover. It's possible to fall in love with an idea that does that for you. It lets you sleep at night, secure in the knowledge you aren't mucking things up for people.

Another surprise. Overall, the Affordable Care Act has probably helped sales of HSAs, since all four "metal" plans of the ACA contain high deductibles, serving in a (rather over-priced) Catastrophic role. This may be a way of covering the bets in a confusing situation. The ACA is a needlessly expensive way to get high-deductible coverage because it pays for so many subsidies. Frankly, it baffles me why subsidies swamp the costs of Obamacare but are made unworkable for HSAs. Many of the details of the subsidies are obscure, including their constitutionality, so we have to set this aside for the moment.

One good motto is don't knock the competition, but we must comment on a few things. The Bronze plan is the cheapest, therefore the best choice for those who choose to go this way. But uncomplicated, plain, indemnity high-deductible, would be even cheaper if its status got clarified. The good part is, the current rapid spread of high deductibles suggests mandatory-coverage laws may, in time, slowly go away. At first, the ACA looked like a bundle of mandatory coverages, all made mandatory at once. But they may be learning a few basic lessons as they go. Mandatory benefits are an example of mixing fixed indemnity with service benefits, with the usual dangerous outcome. Like many dual-option systems, they create loopholes. The HSA seems to avoid this issue by effectively being two semi-independent plans, for two separate constituencies -- who are the same people at different ages. Once more, we didn't think of it, the features just emerged from the plan.

That's about as concise a summary of Health Savings Accounts as can be made without getting short of breath. But of course, there is more to it, particularly as it affects the poor. For example, there is an annual limit to deposits in the Health Savings Account of $3350 per person, and further deposits may not be added after age 65. They can be "rolled over" into regular HSAs when the individual gets Medicare coverage, and supposedly has no further financial needs. So plenty of people have health care, but can barely support their retirement. These plans are absolutely not exclusively attractive to rich people, but it must be admitted, poor people start with such small accounts that companies can't operate profitably unless the client sticks with them for a long time. If people possibly can, they should scrape together one $3300 maximum payment to get a running start.

The problems of poor people can nevertheless be eased, within the limits of the plan's design. Since people will be of different ages when they start an HSA, it might be better to set lifetime limits, or possibly five-year limits, to deposits, rather than yearly ones. Some occupations have great volatility in earnings, and sometimes a health problem is the cause of it. To reduce gaming the system, perhaps the individual should be permitted to choose between yearly and multi-year limits, but not use both simultaneously. As long as the self-employed are discriminated against in tax exemptions, that point could certainly be modified. There remains only one major flaw, which we propose should be fixed:

Proposal 6: Congress should permit the individual's HSA-associated Catastrophic health insurance premiums to be paid, tax-exempt, by Health Savings Accounts, until such time as elimination of the present tax exemption for employer-based insurance is accomplished by other means.

Subsidies for the Poor? Here's my position. If poor people could get subsidies for HSA to the same degree the Affordable Care Act subsidizes them, Health Savings Accounts should prove at least as popular with poor people as the Administration plan. Mixing the private sector with the public one is always difficult. Why not make subsidies independent of the health programs? There is no point in having the poor suffer because someone prefers a different health system. Quite often, a subsidy program is mixed with a public program, in order to make its passage more attractive; that's not necessary.

Proposal 7:That health care subsidies be assigned to patients who need them, rather than attached specifically to one or another health system that happens to serve them.

Let's just skip away from all those digressions, and return to the poor in other sections. If the concern is, health care is too expensive, why in the world wouldn't everyone favor the cheapest plan around? Part of the answer, politics aside, is that young people have comparatively little illness cost, while old folks have a lot. Since Medicare, therefore, skims off the most expensive healthcare segment of the population, the fairness of any health subsidy program is difficult to assess. Evening out the tax deduction for the catastrophic portion equalizes the unfair tax deduction for self-employed and unemployed people. Perhaps the equality issue should be re-examined after each major revision since many moving parts get jostled, every time.

The government is going to have trouble affording the existing subsidy, so it may not endure, particularly at 400% of the current poverty level. But if we can subsidize one plan, we can subsidize the other, instead. The government would then be seen, and given credit for, saving a great deal -- by inducing destitute people to use HSA as an alternative option, equally subsidized by an independent subsidy agency. As for single-payer, the government for fifty years borrowed to continue Medicare deficit financing and got it to 50% universal subsidy without much notice. That's like boiling the frog too gradually to be noticed until it is too late. But suddenly expanding the 50% subsidy to the whole country at once, would definitely be noticed. Extending such levels to the whole country should anyway be buttressed with accurate cost data. Administrative cost savings are just a smoke screen. Total costs are the real cost. Other people also point out Medicare was financed after we had won some wars, but now we seem to be losing wars.

Originally published: Wednesday, August 06, 2014; most-recently modified: Sunday, July 21, 2019