Philadelphia Reflections

Lifetime Health Savings Accounts:How Much is Enough?

The Duchess of Windsor was reported to say, a woman can never be too rich or too thin. Perhaps, but with insurance you state -- in advance -- how much insurance you can buy, best not expect more. In healthcare, it's my hunch something drastic would have to change before the American public voted an assessment for more than $3300 per person, for every working year from age 26 to age 65. In fact, if it went much higher, many people would probably look for a way to escape the burden. Perhaps we could supplement 3% per year, the historical rate of inflation for the past century. That's fair because although it would reach $10,000 at age 65 instead of $3300, everything else would have readjusted to give it the same financial impact. Similarly, asking people 26-65 to pay for all ages is more palatable if it's arranged as your own childhood and retirement to be supported.

Excluded: Past debts and Custodial Care. In any event, any payments for past debts, for health or otherwise are not envisioned in the following plan. The term "fixed income" reminds our debt and equity obey different rules, and the premise is the income supplement of this calculation will be based on equity, common stock. Furthermore, we know the National Debt, but how much of it once paid for health services, is fuzzy. When I started this analysis, I really never dreamed all of the current healthcare costs might be covered by investment income from common stocks, and it's going to take some experience to be sure even that is reasonable. It allows us to take a stance: if it won't pay current costs, at least it will pay for some of them. If it more than pays for them, annual deposits should be reduced, never confiscated. To avoid circumvention by changing definitions, it might be well to state custodial care costs are not included, either, because they are treated as retirement income.

Medicare. Making it easier to explain, let's begin at the far end of the process, the day after death, looking backward. This proposal didn't initially include a Medicare proposal, but the accumulation of its unpaid debt has become so alarming, considering Medicare within Health Savings Accounts could fast become a national priority having no other solution. In addition, most factual health data come from Medicare, so the reader gets accustomed to hearing about it. So, while the Medicare situation is fraught with political obstacles, we might have to risk them. While debt overhang from earlier years continues to grow, Health Savings Accounts cannot be confidently promised to rescue Medicare by itself. But perhaps at least the Savings Account discussion could put a stop to going deeper into debt. Even a stopgap would have to get started pretty soon, but there is also a chance an improving economy might partially reduce the indebtedness.

Medicare-HSA Overlaps. At present, Catastrophic coverage is required for Health Savings Accounts, but its premiums are not tax-exempt. To extend HSA for the life expectancy, therefore, requires an additional average of 18 years of after-tax premiums. We have split lifetime HSA into two parts at age 65 and assume a single-premium ($80,000) exchange for Medicare, possibly traded for partial forgiveness of premiums and rebate of payroll taxes. It is important not to count the $80,000 twice if it assumed to be self-financed. One quarter from payroll taxes, one quarter from premiums, and a half from the $80,000 which used to be from the taxpayers. If pre-payment begins at an early age, Medicare costs might be quite modest after growth from income. Even when we show all the costs, including double payments, using an HSA at conservative rates like 4% will reduce the Medicare cost by 75%. Better performance depends heavily on approaching 12.7% by passive but hard-boiled investing. To pay down the existing debt back to 1965 is not contemplated by this proposal. At present, it grows by 50% of annual costs by addition; and an unknown amount by compounding. The amount of debt service is probably going to depend on the national ability to pay it down, regardless of its written terms. The same is likely to be true of subsidies for the poor. Ultimately, both of these decisions are political, limited by the ability to pay. Because of the long time periods, comparatively modest interest rates could convert this impending disaster into a manageable cost, but it should not be contemplated until net investment returns approach 12.7 %. The outcome of these intersections is that the terms and benefits become largely a matter of political choice. That has been true for a long time, yet no effective corrections have been made. It is perhaps unbecoming of a citizen to say so, but the political system needs some steps taken to increase its sense of urgency.

Disintermediation of Investment Returns. By this reasoning, the rescue of Medicare depends on the political choice to do it, and the avoidance of a collision with the financial industry. Without a solution to the Medicare problem, a solution to paying for healthcare at younger ages becomes quite feasible, but it would be useless. Conversely, solving Medicare would be possible if the problems of younger people were ignored, but that is equally unlikely. To solve healthcare financing for all ages depends on introducing some new feature, and the easiest solution to imagine is to raise effective net interest rates. Interest rates are unusually low at present, and the Federal Reserve probably feels it would be dangerous to raise them. However, that's the easy part, because interest rates are certain to rise, eventually. What's much harder to envision is to flow the improved rates and the transaction-cost efficiencies through the financial system without wrecking it. What's hard to imagine is not hard to seem feasible, however. It is to take investments averaging 12.7%, flowing 10% past the intermediaries to the investor; and keeping it up for a century. Disintermediation, so to speak.

Rationalizing Fragmented Payments The transition to a solvent system could be greatly eased by the present premiums and payroll deductions, which are largely age-distributed, and can, therefore, be forgiven in a graduated manner for late-comers to the program. Most redistribution of high-cost cases should be handled through the catastrophic insurance, which is well suited for invisible and tax-free redistribution. Because of hospital internal cost-shifting, inpatients are overpriced, rapidly heading toward underpricing. This distortion of prices is achieved by squeezing inpatient prices with the DRG to shift costs and overpricing to hospital outpatients. In the long run, distorting prices has the effect of raising them. This will more immediately affect the relative costs of Catastrophic and Health Savings Accounts and should be more carefully monitored, with an eye toward re-achieving equilibrium.

Dual Reimbursement Systems are Better Than One At present costs, statisticians estimate average lifetime healthcare costs at about $325,000 in the year 2000 dollars; we could discuss the weaknesses of that estimate, but it's the best that can be produced. Women experience about 10% higher lifetime health costs than men. Roughly speaking, how much the average individual somehow has to accumulate, eventually has to equal how much he spends by the time of death. At this point, we must work around one of the advantages of having separate individual accounts. On the one hand, individual accounts create an incentive to spend wisely, but it is also true that pooled insurance accounts make cost-sharing easier, almost invisible, and (for some) tax-free. Therefore, linking Health Savings Accounts with Catastrophic insurance provides a way to pool heavy outlier expenses, while the incentive for careful money management resides in the outpatient costs most commonly employed (together with a special bank debit card) to pay outpatient costs. Such expenses are much more suitable for bargain-hunting anyway because dreadfully sick people in a hospital are in no position to bargain or resist.

Internal Borrowing. Furthermore, there is a significant difference between mismatches of aggregate revenue-to-expenses of an entire age group, and outliers within the same age cohort, the latter much likelier to be due to chance. To put it another way, somebody has to pay these debts, and the plan has been designed to break even as an entirety. Surely we must have a plan about who should pay them when enough revenue is not yet present in a new account. Surely some groups are always in surplus, other groups are always in arrears; the two should be matched, at low or zero interest rates. Borrowing between sick outliers and lucky good people within the same age cohort should pay modest interest rates, and borrowing between different cohorts for things characteristic of the age (pregnancy, for example) should pay none. Unfortunately, some people may abuse such opportunities, and interest must then be charged. Until the frequency of such things can be established, this function of loan banking should be part of the function of the oversight body. When it's limits become clearer, it might be delegated to a bank, or even privatized. While it is unnecessary to predict the last dime to be spent on the last day of life, incentives should be identified by the managing organization, separating structural cash shortages from abusive ones. Much of this sort of thing is eliminated by encouraging people to over-deposit in their accounts, possibly paying some medical bills with after-tax money in order to build them up. Such incentives must be contrived if they do not appear spontaneously. User groups can be very helpful in such situations. People over 65 (that is, those on Medicare) spend at least half of that $ 325,000-lifetime cash turnover, but just what should be counted as their own debt, can be a matter of argument (see below.)

Proposal 10: Current law permits an individual to deposit $3300 per year in a Health Savings Account, starting at age 25, and ending when Medicare coverage appears. Probably that amount is more than most young people can afford, so it would help if the rules were relaxed to roll-over that entitlement to later years, spreading the entire $132,000 over the forty-year time period at the discretion of the subscriber.

Bifurcated Health Savings Accounts. When Health Savings Accounts were first devised, it never seemed likely that Medicare might be supplanted. However, Medicare has grown both highly popular and severely under-funded, probably running at a large loss. The rules should be modified to permit someone who has health insurance through an employer to develop a Health Savings Account which the funds but does not spend while he is of working age. The funds would then build up, enabling him to buy out Medicare on his 65th birthday or thereabout, with a single-premium exchange at present prices, (exchanging about $100,000 funded by the forgiveness of Medicare premiums and some portion of payroll deductions from the past). He would have to purchase Catastrophic coverage at special rates. If this approach proved popular, it might supply extra funds for loaning to HSA subscribers in the outlier category. While there is no thought of phasing out Medicare against the subscribers' will, Congress would certainly be relieved to have subscribers drop out of a program which must be 50% subsidized.

Proposal 11: The present closing age for HSA enrollments at the onset of Medicare should be extended a few years older. And single-premium buy-outs of Medicare coverage, including the possible return of payroll deductions where indicated, should be permitted as an option.

Proposal 12: Congress should create and fund a permanent Health Savings Account Agency. It should have members representing subscribers and providers of these instruments, with the power to hold hearings and make recommendations about technical changes. It should meet jointly with the Senate Finance Committee and the Health Subcommittee of Ways and Means periodically. It should be involved with the appropriate Executive Branch department, to review current activity, detect changing trends, and recommend changes in regulations and laws related to the subject. On a temporary basis, it should oversee inter-cohort and outlier loans, leading to recommendations concerning the size and scope of this activity.

Single-Premium Medicare, age 65 Hypothetically, if anyone could live to his 65th birthday without spending any of the accounts, a prudent investor would have accumulated $132,000 in pure deposits on his 65th birthday. He only needs $80,000 to fund Medicare as a single-payment at age 65, however, so he can even afford to get sick a little. If he starts later than age 25, he has already paid for Medicare somewhat, with payroll taxes. That could be considered payment toward reduction of the Medicare debt.

If someone makes a single deposit of $80,000 on his/her 65th birthday, there will accumulate $190,000 in the account over the next 18 years, the present life expectancy if he spends nothing for health and invests at 5%; and $190,000 is what the average person costs Medicare in a lifetime. Since the average person spends $190,000 during 18 years on Medicare, enough money will accumulate in Medicare to pay its expenses, and after some shifting-around, this should make Medicare solvent, in the sense that at least the debt isn't getting bigger because of him. Furthermore, index funds should be returning 10-12% over the long haul, so there should be some firm discussions with the intermediaries about some degree of dis-intermediation. Please don't do the arithmetic and discover that only $40,000 is needed. That seems plausible, but that's wrong because the costs remain the same , and previously the government has been borrowing half the money from foreigners. In effect, the subscribers have been paying the government in fifty-cent dollars, while claiming the program is entirely self-funded. There has been an exchange of one form of revenue for another, so the required revenue actually does demand $80,000 for a single deposit stripped of payroll deductions and perhaps premiums. An end would be put to further borrowing, but the previous debt remains to be paid. I have no way of knowing how much that amounts to, but it is lots. All government bonds are general obligations, mixed together, while access to Medicare reports back to 1965 is not easily available. What we can more confidently predict is the limit young working people can afford for the sole purpose of paying off the Medicare debts of the earlier generation. If there are other proposals for paying off this foreign debt, they have not been widely voiced. And the debt is still rapidly growing.

Escrow the Single Premium A young subscriber would have to set aside an average of $850 per year (from age 25 to 64) to achieve $247,000 on his 65th birthday, assuming a 5% compound investment income and relatively little sickness. This might seem like an adequate average, but occasional individuals with chronic illnesses would easily exceed it in health expenditures. Assuming a 10% return, he would have to contribute $550 yearly. It is not easy to estimate the size and frequency of expensive occurrences in the future, so someone must be designated to watch this balance and institute mid-course adjustments. As an example, simple heart transplants costing $200,000 are already being discussed. To some unknown extent, the cap on out-of-pocket expenses would have to be adjusted to pass these cost over-runs indirectly through the Catastrophic insurance. Insurance does greatly facilitate sharing of outlier expenses, but usually requires a time lag whenever new ones appear.

It does not require much political experience to know taxpayers greatly resent paying debts that benefitted earlier generations. They complain, but complaining does not pay off the debts of the past. To double required deposits in order to pay off past debts, as well as using forgiveness of payroll deductions and premiums, would require an additional $120,000 per year escrow, for each year's debt accumulation. At present, roughly $ 5300 per beneficiary, per year, is being borrowed, and there are roughly twice as many current beneficiaries as people in the tax-paying group, but for only 18 years, as compared with 40 years as a prospective beneficiary. So that comes to liquidating roughly $1300 a year of debt to balance the two populations or $2600 a year to gain a year. That's for whatever the debt happens to be, which surely someone can calculate. To accomplish it, one would have to project an average of ??% income return. That's definitely the outer limit of what is possible, and it probably over-reaches a little. Therefore, to be safe, one would have to assume some other sources of income, a change in the demographic patterns, or an adjustment with the creditor. Assuming inflation will increase expenses equally with inflation seems a possibility. And it also seems about as likely that medical expenses will go down, as that they go up. You would have to be pretty lucky for all these factors to fall in line over an 80-year lifetime.

Medicare: Optional, Mandatory, or Third Rail? It is this calculation, however rough, which has made me change my mind. It was my original supposition that multi-year premium investment would only apply up to age 65, and that would be followed by Medicare. In other words, it should only be implemented as a less expensive substitute for the Affordable Care Act. It seemed to me the average politician would be very reluctant to agitate retirees by proposing a plan to eliminate Medicare. They would feel threatened, the opposing party would fan the flames of their fears, and the result would be a high likelihood of undermining the whole idea for any age group, for many years. Better to take the safer route of avoiding Medicare, and confining the proposal to working people, where its economics are overwhelmingly favorable.

But when the calculations show how close this proposal under optimistic projections would come to failure, and when nothing remotely close to it has been proposed by anyone, the opportunity runs the risk of passing us by. So, I changed my mind. The moment of opportunity is too fleeting, and the consequences of missing it entirely are too close, to worry about the political disadvantages of doing the right thing. The transition to a pre-funded lifetime system will take a long time to get mature, and the political obstacle course preceding it is a daunting one. However, there is another way of saying all this, which is perhaps more persuasive that Medicare must be changed. It begins to look as though the unfunded and accumulated debts of Medicare are such a drag on our system of government, that very little can be accomplished by anyone, until this central problem is addressed. In that sense, our problem is not the uninsured or the illegal immigrants, or an expensive insurance system. Our problem has become Medicare underfunding, and our second problem is that everyone loves Medicare.

The "simplified" goal is therefore for everyone to accumulate $80,000 in savings by the 65th birthday, remembering that savings get a lot harder when earned income stops and definitely remembering that people approaching retirement are not likely to part readily with $80,000. With the current law, you would have to start maximum annual depositing in an HSA of $3300 by your 52nd birthday, to reach $80,000 by age 65, and you would still need 10% internal compounding to make it. With a 5% return, you would have to start at age 48. But notice how easily $200 a year would also get you there, starting at age 25 (see below) but it immediately gets questionable to assume $700 a year deposit for a 25 yr-old receiving 5% returns. We are definitely reaching a point where the ideas proposed in this book will no longer bail us out of our Medicare debt. Because -- the most optimistic of these projections are achieved by assuming there will be no contributions at all from people aged 25-65, for their own healthcare, babies, contraceptives and whatever. Many frugal people might skin by with looser rules; But the universal goals of the past are just that, the goals of the past. If we are going to cover lifetime health costs instead of just Medicare, many more will need $80,000 to do it and have something left to share with the less fortunate. But to repeat, that still compares very favorably with the $325,000 which is often cited as a lifetime cost. Unfortunately, that just isn't enough, the Chinese will have to wait for repayment. This book was not written to propose a change in Medicare, but in writing it I do not see how we get out of our healthcare mess without addressing Medicare. If politicians can be persuaded of that, at least we will no longer need to invent reasons for urgency.

Starting with the Medicare example. Notice that forty years of maximum contributions would amount to far more than the necessary $40-80,000 by age 65. We haven't forgotten that the individual is at risk for other illnesses in the meantime, so in effect what we need is an individual escrow fund for lifetime funding intended (at first) only to replace Medicare coverage. (We are examining lifetime coverage, piece by piece, trying to accommodate an extended transition period.) Depending on a lot of factors, that goal could cost as little as $100 a year deposited for forty years at high-interest rates, or as much as the full $1000 per year with low rates. It all depends on what income you receive on the deposits in the interval. In a moment, we will show that 10% return is not impossible, but it is also true that a contribution of $1000 per year would not seem tragic, compared with the present cost of health insurance (now averaging over $6000 a year). I have unrelated doubts about the current $325,000 estimate of average lifetime health costs, but that is what is commonly stated. For the moment, consider these numbers as providing a ballpark worksheet for multi-year funding, using an example familiar to everyone, but not necessarily easy to understand after one quick reading.

The Cost of Pre-funding Medicare. Rates of 10% compound income return would reduce the required contribution to $100 per year from age 25 to 65, but if the income were only 2% would require $700 contributed per year, and at 5% would require $300 per year. Remember, we are here only talking of funding Medicare, as a tangible national example, Obviously, a higher return would provide affordability to many more people than lesser returns. Let's take the issues separately, but don't take these preliminary numbers too literally. They are mainly intended to alert the reader to the enormous power of compound interest. Let's go forward with some equally amazing investment discoveries which are more recent, and vindicated less by logic than empirical results.

Originally published: Thursday, November 13, 2014; most-recently modified: Sunday, July 21, 2019