Philadelphia Reflections

The Plight of the Latecomer to HSA

Medicare had been in existence for fifteen years when Health Savings Accounts were designed. Medicare was popular and apparently permanent. Accordingly, the HSA proposal was intended to phase out when the individual became a Medicare recipient. Since there might be an unspent surplus at that time, it was provided that the surplus be turned into an IRA, partly as a gesture of deference to Senator William Roth of Delaware, who was the originator of the tax-exempt fund idea.The consequence is that the HSA now bridges the transition, between health care and prolonged longevity. That's a feature now seen to be an enhancement.

However, experience with the program shows we overlooked something. The plans are attracting a following between the ages of 35 and 50, which is to say they turn unattractive to people 50 to 66, who ought to be in their highest years of earning. On interviewing them, the difficulty seems to be that diseases start increasing at about that age, and a depletion of the account gives it scant opportunity to recover before the program terminates. Compound interest is fine, but if you have used it up for disease A, it cannot compound enough to support disease B. By contrast, a subscriber at age 35 might well be in a position to pay for one bout of illness, followed by compound interest build-up. So the plan covered two or three more severe illnesses before age 66 is attained. The contribution limit of $3300 annually is just not enough to provide a comfortable margin. Furthermore, the purpose of the limit is not clear. If a subscriber contributes more, it would be his own money, not the governments. True, it would be tax exempt, but a very large proportion of the population are tax-exempt through their employer, anyway. People whose income is concentrated may be especially affected, such as those who sell a farm or business, or athletes. Finally, everything said about unexpected illness would be true of unexpected stock market fluctuations.

Proposal 3: The annual limit of deposits to HSA should be increased by a COLA based on medical costs, rather than the cost of living. Furthermore, the limit should be a lifetime limit rather than an annual one. At present, this would substitute a lifetime limit of $132,000 for an annual limit of $3300.

This proposal, while welcome, may still not be enough. The employee with recent experience with healthcare costs, has by the age of 50 come to realize that the personal cost of an HSA has three sources: the deposits which we have mentioned; plus the premium of his required Catastrophic insurance; plus the compound interest rate which his HSA manager is allowing to pass through to him. Additional deposits cost the manager nothing, but the insurance premium and the interest rate are passed through to him from vendors, and their cost is largely obscure to the customer. "Kickbacks" are particularly obscure.

First, the interest rate. The stock market has gone up 12% a year for a century. With transaction costs of perhaps 0.5%, the customer should also subtract 3% for inflation. That creates the remote possibility of paying 8.5% to the customer, and we have in this book generally assumed a net return of 6.5%, with a profit to the middle-men of 2.0%, assuming the middle-man accepts the risk of "black swan" volatility. This is generally about 50% every 28 years. However, the broker probably does not look at it that way. He notices the stock market has gone down in the past few months, may go down more in the next year, and might then take ten or fifteen years to recover to a profitable level. Furthermore, new HSA subscribers may well be young and improvident, have few assets to supply a cushion, and background of judging a consultant's value by the labor he applies, rather than the risks he takes. The customer wants 6.5%, the broker offers 1%. Each sincerely believes the other is cheating him.

Disintermediation, def. Eliminate the middle-man.

The Nut of It.

So, there are other places to look for the difference. The employer can afford to give up the difference, providing he gets a 40% tax deduction directly, borrows the money at 6%, and is making profits this year. The HSA manager can afford to make up the difference, providing he treats the HSA deposit as a pass-through rather than a paid service and makes it up by adding a surcharge to the insurance premium. The insurance company can make up the difference by lowering its prices and profits. It would take subpoena power and open books to know what was a fair proportion for each to contribute. However, the customer must receive a higher income rate, or the complicated interactions will not work. That's where we start. The HSA becomes feasible because transaction costs have been lowered by computers and near-zero interest rates. The customers cannot enter into the bargain if the finance industry refuses to share the windfalls along with the risks. The customer is going to get 6% or forget the whole thing.

Perhaps a simpler way to summarize the unfortunate confrontation is to recognize it is going to be difficult to support 6.5% retail interest rates in an environment of 1% bank rates, and historically low-interest rates, generally. That is particularly true in an environment of falling stock market prices. Unless it can be convincingly shown that someone in this circle is making outrageous profits, or unless someone is willing to put up the capital to buy this business at a discount, the following dangers must be faced and surmounted:

1. The medical customer will eventually resort to what he did in the 1930s. He will neglect his teeth, his gallstones, his varicose veins and hemorrhoids, his eyeglass refractions, and other optional, delayable, services. Consequently, the accident rooms of hospitals will be full of treatable but neglected cases.

2. The stockbrokers will recognize that the era of $250 commissions is over, and the retail customer is going to buy index funds over the Internet from wholesalers, and conduct his medical business dealings out of a bank safe deposit box. The history of discounts in closed-end investment funds is part of this conversation.

3. The insurance companies will surrender their surveillance role, and strip down to a re-insurance role. Something like the PSRO (Professional Standards Review Organization, see Senator Wallace Bennett of Utah) will take their place.

4. The hospitals can survive a long time on their present surplus assets, particularly buildings. In time, much of their role will be taken over by retirement villages. Doctors and pharmaceutical companies will be squeezed in ways unique to maintaining their function, more or less.

Which will we choose, if we are headed toward a 1930s depression? All of them. But assuming for the moment that things aren't so bad, let's start with #2. The stockbrokers are doomed, anyway. Almost all banks have some empty floor space, where a fee-only wealth advisor can function with his computer terminal. Alternatively, CPAs can absorb a new business model, in addition to filling out tax forms. One thing is not going to remain the same: the finance industry has a whole lot of disintermediation to do.

Originally published: Sunday, August 23, 2015; most-recently modified: Friday, June 07, 2019