Philadelphia Reflections

The musings of a physician who has served the community for over six decades

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Letter: Dan Rostenkowski Chairman, Committee on Ways and Means Re: Using Health Insurance to Increase the Nation's Savings

Dan Rostenkowski, Chairman

Committee on Ways and Means

U.S. House of Representatives

Re; Using Health Insurance to Increase the Nation's Savings

Mr. Chairman,

These hearings were called to examine the nation's collective rate of private savings, reflecting concerns that superior economic performance by certain foreign countries may partly be caused by their greater savings rates. I am not qualified to judge such matters; this testimony accepts it would be useful for the nation to increase its collective investment pool. My proposal; is that this committee could cause a substantial increase in the investment pool through the enactment of some revenue-neutral tax law liberalizations, relating to health insurance.

For persons from birth to age 65, the organizational form of health insurance is almost entirely an outgrowth of the tax laws.


Employees are not required to pay income tax on money used to purchase their health insurance, so long as their employer buys it for them,

And the purchase of health insurance by any other method must be paid for with after-tax dollars,

And employers are permitted to reduce their own income tax by treating such in-kind employee remuneration as a business expense,

It would then seem silly for employees to purchase health insurance in any other way, and silly for employers to provide taxable cash remuneration rather tax-exempt benefits.

The remuneration system has responded massively to this set of tax incentives. The preponderant bulk of health insurance for persons under age 65 is in the form of employer-based group health plans. There are a number of advantages to this uniquely American system, primarily the provision of health insurance to persons who might not be wise enough to buy it out of discretionary income. There are also a number of disadvantages to the system, primarily the international competitive disadvantage it imposes on American industry to have employee personal expenses forcibly included in the cost of manufacture.

Existing Limitations of Law. But the main disadvantage of the system for the purpose of increasing the national savings rate is not inherent in the employer group health insurance system but is rather a product of some traditional rules and rulings which have become attached to it. Somehow the courts and regulatory bodies appear uncomfortable (without express Congressional sanction) with acknowledging that this tax abatement was an inducement to people to buy something they really should have been provident enough to buy without such added incentive. Instead, health care has been treated as preventative maintenance of an employer's necessary asset, his employee. Seemingly following some such reasoning, an employer is not permitted to refund or carry health benefits over from year to year. As a consequence, employer-based group health insurance buys only a current year's health expense in a collective way, sometimes referred to as "pay as you go". Looked at in another way, group health insurance takes a form analogous to "term" life insurance. It is, in short unfunded.

Other Advantages of prefunding. Since the subject of today's hearing is the search for ways to increase investment funding rather than to deliberate how people should best spend their investment proceeds, it may not be entirely germain to tout the considerably reduced cost of health insurance and health care which would result from the infusion of compound interest into the funding of health insurance. Or to tout the increased portability of such funded insurance for the employee as he moves between employers. Or to reflect upon how many fewer persons would lack health insurance coverage during the intervals when they are unemployed. However, since the law of unintended consequences applies to this proposal as it does to any other, the good consequences must be mentioned for balance.

Duration of Investment. For the purpose of visualizing the investment pool which could result from actually encouraging the prefunding of health insurance, consider briefly the shape of average lifetime health costs. A cartoon of the average cost would resemble a dumbbell, portraying heavy costs associated with birth and early childhood, heavy costs associated with the process of dying, but comparatively modest average health costs in the many years between birthing and death. From the employer's point of view, the cartoon is modified by the absorption of most death costs by Medicare after the termination of active employment, qualified in turn by whatever retirement health benefits may be provided. For the present, we can avoid such tangles to concentrate on the point that there are many years of low health care expenditure within the average employees' career, during which time compound interest could be building up to help pay for the rainy day. It is not excessive to project a trillion dollars eventually resting in such a funding pool. I leave economists to conjecture what such a pool would mean to American enterprise, banking, interest rates, inflation and balance of international payments.

Although the insurance industry does sometimes dismay me with lack of statesmanship, I have nothing but admiration for their ability to devise ingenious technical methods for selling their products and reducing their administrative costs. They can probably think of better ways to achieve funded health insurance than the one I am about to propose, but they have not yet done so, and therefore I venture to propose the IRA for Health.

The proposal to fund health insurance would be:

Either employers (treating it as a business expense) or individuals would be permitted to make tax-exempt contributions to individual IRAs, up to the amount of the annual premium for full first-dollar health insurance.

And, IRAs would be permitted to purchase, without tax, health insurance for the individual with copayment and deductible features at a lesser cost, retaining the difference as an investment fund.

And, when the investment fund grew to the point where its investment income equaled the premium of the health insurance, further withdrawals for specified purposes would be permitted without everyone understands the principles involved in the Individual Retirement Account, including tax deductibility of the contribution, tax sheltering of the investment growth until the time of withdrawal, and the 10% penalty for early withdrawal. To use the IRA to fund health insurance, the 10% penalty for early withdrawals is a severe impediment, and that rule mainly imposed at the behest of bankers, I understand must be appropriately modified. Furthermore, people are not interested in accumulating the money they cannot spend, and if their funds generate a profit, it must somehow be available to them. I would propose allowing any surpluses to be applied to long-term health insurance, and/or possibly a few other designated alternatives.

The original IRA was criticized as lacking incentive for truly increasing the saving rate. However, if a new form of medical IRA were to supplant the present system rate. However, if a new form of medical IRA were to supplant the present system of employer-based health insurance groups, there would be ample incentive to use it, and no greater loss of revenue by the Treasury. Although most persons are not sophisticated investors, I presume that banks, mutual funds, and insurance companies would compete to be so for them.

Changing from group policies to individually owned ones exposes the intergenerational subsidy which most of them contain: and transitional intergenerational subsidy which most of them contain, and transitional measures are required. Older employees are subsidized by younger ones in the present health insurance system with a level premium for all members of the group. Older participants can fairly asset their generation subsidized a predecessor generation, and feel entitled to be subsidized in turn. This unwritten covenant is unfair to everyone; the older generation badly needs to have its rights defined, while the system needs to know its obligation.

Much of the early investment income from a funded system would indeed have to be used to pay off this perceived obligation. It would admittedly be quite a while into the transition before health insurance premiums themselves could be lowered. That is irrelevant, of course, if the main focus is placed on increasing the size of the national investment pool.

Deductibles, not Copayments. The main source of investment capital within the proposed system comes from reducing the premium by substituting high-deductible insurance but maintaining a constant employer contribution. In my opinion, a 20% copayment creates more administrative costs than any savings from usage disincentive; it merely shifts 20% of the cost to the subscriber. On the other hand, high front-end deductibles a thousand dollars a year, for example, will reduce the premium of health insurance by nearly $500 a year. Deductibles get rid of costly small claim processing and restore a marketplace for fees, against which the costs of a more major illness can be compared, through the use of relative value scales. Most health insurance abuse takes place in small claims since large medical expenses are seldom discretionary.

Funded Deductibles. My vision is of an individual IRA for Health which rapidly accumulates enough surplus from the use of a deductible, so that the accumulation equals the deductible. After all, if a working person has a thousand dollars in his fund, and carriers a thousand-dollar deductible policy, he is fully covered; but he also faces an incentive not to invade his fund, because it is tax sheltered. Only if the money is locked away forever will the average person overlook a legal opportunity to conduct his affairs "off the books." The principle is, I believe, very widely understood.

Perpetual Insurance. If the employee escapes major health costs for fifteen years, which is the usual pattern for young people, he can find himself in the position where investment income from the fund is sufficient to pay the annual health insurance premium, without further employer contribution. Making allowances for a reinsurance plan for those who are not healthy or fortunate, the remarkable opportunity is remotely visible of persons with permanently funded health insurance, reaching the age of 65 with, then, no need for Medicare.

There is no need today to spin out the filaments of the dream because to do so would provoke not-picking. The main thrust is simple that the incentives to the average American would be quickly perceived and socially useful. And, remarkably, it is difficult to imagine an interest group, whether in the insurance industry, health industry, labor or management, whose interests would be genuinely injured by it.

Everyone would surely be better off if health insurance used investment income to reduce its costs (instead of living from hand to mouth with "pay as you go" financing), and no one has ever publicly disputed it. But there is nevertheless a good reason to be apprehensive about proposals to make such a switch which are careless about the period of transition. Perhaps just because its design was so poor, existing unfunded insurance is fragile. A heedless changeover has the potential to leave many people uninsured for protracted periods, destroying insurance carriers and hospitals in the process. Transitional difficulties consist of fixing an engine with the motor still running.

The transitional issues are pretty obvious. If offered a better or cheaper alternative, most subscribers are not sentimental and would abandon their present coverage if they could. The danger is that healthy (hence cheaper) clients could migrate more readily than sicker more expensive ones, thus forcing higher premiums for those whose poor health made them unwelcome in any company but the one which was stuck with them. The rising premium would soon induce progressively less healthy subscribers also to jump ship, and premiums would soon induce progressively less healthy subscribers also to jump ship, and premium might spiral upward until the carrier collapsed because eventually, no one would pay such prices unless he was already wearing a hospital gown. In this kind of cyclone, hospitals could imagine themselves faced with uninsured sick patients which public opinion would not let them turn away. Imagined Result: bankruptcies, a sacrifice of quality, and hastily contrived legislation which would probably make things worse. Small wonder the insurance industry is so timid and conservative.

Getting Rid of Costly Clients.

A socially acceptable transition must, therefore, include provisions to have the parade of migrants to funded insurance consciously include a representative balance of the whole community, or so to speak "minimize adverse risk avoidance". Some higher-risk individuals must also be encouraged to move to the funded system, while a balancing proportion of low risk younger people must remain on pay-as-you-go until sicker ones come along too. Luckily, each year on their 65th birthdays' certain number of oldest costliest individuals move on to Medicare where coverage is universal. These alumni annually reduce the number of "substandard risks" who must be protected. Actuaries could probably help us guess how many other substandard risks there are, plus the annual rate at which additional people get sick and enter the substandard risk category. Such estimates would help engineer a transition, but it's quite doubtful the cost and accuracy of individual risk assessment could ever permit an equitable quota system. It seems much more workable to let risks fall where they may and subsequently use reinsurance to pay for excess costs wherever they happen to surface. We thus get into the matter of risk pooling, which is the main subject of the third section of this book.

Liberalizing the Reserves of Pay-As-You-Go Policies.

The pilgrimage to funding must be relatively balanced in every company which is to survive, bearing in mind that every insurance company going out of business dumps its expensive risks o society. Companies will vary in their skill and luck in managing upheavals, so the first requirement is more slack in the system. State Insurance Commissioners must be made to understand how essential it would be to relax regulatory restraints on health insurance reserves. It is practically unimaginable that any company could handle major shifts in the severity of its risks, with only two months revenue in reserve. Indeed, it is questionable whether three months in reserve are adequate to protect against the simple premium cycle. Insurance premium tends to follow a six-year cycle, three up and three down. During prosperous years, the companies must be given every incentive to increase a transitional reserve, and during down years premiums must fall less or even rise to keep from depleting the reserve fund.

Along the same lines, a 1987 federal tax law creating special taxes on Blue Cross/Blue Shield reserves greater than three months revenue, should at the least be amended to provide an exception for a transitional reserve fund. To say so might possibly annoy the commercial insurers who encouraged the passage of that legislation, but my intent is to urge the same freedom for all health insurers to increase their tax-paying competitors do not play on a level field, payment into a tax-exempted "transitional reserve" should be a one-way street toward escrowed reinsurance purposes.

Expanding Reserves Into Fully-funded Insurance.

The net effect of increasing reserves is to make pay-as-you-go subscribers pay slightly higher premiums, which is after all why politically minded Insurance Commissioners have constrained the reserves. The pay-as-you-go subscriber would get something for his money in the form of reduced future premiums, but it would probably be politically more visible to give him his share of the transitional reserves as a "cash value", portable as he transfers his coverage. Carry that thinking all the way, and it leads to a transformation of pay as you go into funded insurance by simply allowing the reserves to grow enough to do the job. Therefore, as reserves grow they first satisfy the need to pool the reinsurance risk that some company is unfairly going to have too many sick subscribers, but eventually reserves get large enough to be used to reduce the cost of premiums. How do you draw the line between the two purposes? You do it through the political process, based on a political process, based on a political equity judgment of how much you think young good people should pay for old sick ones, and how much you think the old sick generation has had a free ride in the past and now ought to pay for it.

Taxing the Lucky Ones. Because rising premiums of pay as you go insurance will induce more young subscribers to jump ship, premiums of the other ship, the pre-funded alternatives, can be raised to break the speed of the cyclone. The mechanism would be the imposition of mandatory premium surcharges flowing into the reinsurance pool for their endangered competitors. Although this proposal will seem unwelcome to the funded companies, the actual implementation will only be necessary if they draw too much business too quickly. The general idea would be to try to avoid quota systems, utilizing instead the imposition of mandatory premium surcharge when business gets too good. The proposal is for a "cannibal tax" to fatten their own funded reserves, which in dire emergencies would be available to improve the nutrition of missionaries in the stew pot who are going to be eaten, but later. Since the goal is to replace unfunded insurance with the funded kind, loss of business by a pay=as=you-goer is not a bad thing, but depletion of his reserves by bad loss experience definitely would be a reason to petition the rescue fund. Self-insured company plans which are federally regulated under ERISA will need congressional action, while health insurance companies (which are state regulated) will require fifty different actions. There is considerable merit to following fifty different ideas to be tested in different states since some approaches will undoubtedly prove to be more successful than others which now seem equally plausible. As has been the case so often in the past, the income tax law is the easiest place to hang out a national incentive which requires state action to implement. Since funding of health insurance to be successful is almost certain to require tax-frees compounding of interest on permanent reserves, this by itself should be sufficient incentive to state legislatures.

If you think about it, the elder subscribers to our present form of health insurance are in a pretty shaky position. Each year's coverage is independent of every other year. No matter how many years they have been subscribers improved position to forecast the future of national health care expenditure, through re-adjustment to the existing forecasts of future economic growths. Such a revised health care expenditure forecast would be as imprecise as economic growth forecasts are known to be. But at least it would not coax policy development to react to an assumption of an infinitely rising straight line. If a straight line did in fact define the future of these matters, the only appropriate response would be hysteria.

Changing nature of health care at different economic levels. For a second point, the nature of medical care is materially different between low-income and high-income groups in this country, and health care for high-income groups is cheaper. Our ability to employ shorter lengths of stay for patients in an institutional setting is mostly a or more billing steps inevitably increases claims volume, the resultant cost to the intermediaries will relentlessly find its way back to the Medicare budget. It will likely provoke alarm about the apparent increase in the volume of services since claims volume is the most speedily available surrogate for service volume. It will, no doubt, induce many physicians to refer patients to hospital outpatient laboratories where the charges are clearly higher in absolute terms, and the net revenue effect on the federal government must reflect the tax-exempt status of one type of vendor and the taxable status of the other.

It is different for physicians to measure the increased overhead cost of extra claims efforts since one ordinarily does not hire a fraction of an employee. It is easier to look back over the last ten years and see a truly important upward pressure on the cost of doing medical business, which such organizations as "Medicare Economics" Magazine have documented clearly. Furthermore, new rules take time to move the system, and a better idea of the eventual impact of this rule on physicians can be gained by reviewing the remarkable jump in commercial laboratory charges in the time since they were required to bill Medicare directly, and hence incurred both administrative expenses and bad debt experience from which they had previously been shielding. While there were some reported abuses of the process of physicians subcontracting laboratory work, such could easily have been eliminated by fair handling and preparation charges, and in any event, the scope of abuse could not possibly have equaled the cost escalation provoked by the direct-billing rule. (Please refer to the recent report of the United States General Accounting Office report GAO/HRD-88-32.) The 1987 rule will have the same effect in time although some of it will be hidden in Medicare Part A as a result of physician referral to hospitals.

Increased Reconciliation Costs.

Although your subcommittee includes some members who are former accountants, even they will probably feel their eyes glaze over when the subject of open-balance and open-item billing is mentioned. However, that is the issue which the apparently simple December 1987 prohibition on direct billing has created. Since the doctor who does not welcome the assignment of benefits must bill the patient for office services and also bill Medicare for the office laboratory services, he must find a way to keep the payments separate. That is, instead of merely keeping a running balance of unpaid receivables, he must identify the items and check off each one individually as payment is, or is not, received. Any doctor who uses any sort of assignment process must employ more highly trained employees to cope with the complexity, and hire more of them. He must accept the likelihood of more error, hence lower income. His costs will rise, and inevitably costs to the program will follow.

Mr. Chairman, during the introduction to one of last year's hearings on this subject, you announced your wish to induce physicians to join the Medicare participation program by simplifying their overhead. In that spirit, it would be proper for the government to put itself to extra trouble and expense in order to make things easier for participating physicians. However, once that motivation is announced, it is of increased importance to avoid actions which might give the impression of attempting to coerce unwilling physicians by unnecessarily disrupting their affairs. I am sure you agree with this viewpoint, and urge you to reconsider the office laboratory billing prohibition.

Respectfully submitted,

George Ross Fisher, M.D>


Originally published: Tuesday, November 06, 2018; most-recently modified: Thursday, May 23, 2019