Philadelphia Reflections

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


Health Reform: Changing the Insurance Model
At 18% of GDP, health care is too big to be revised in one step. We advise collecting interest on the revenue, using modified Health Savings Accounts. After that, the obvious next steps would trigger as much reform as we could handle in a decade.

HEALTH SAVINGS ACCOUNT: New Visions for Prosperity
If you read it fast, this is a one-page, five-minute, summary of Health Savings Accounts.

Second Edition, Greater Savings.
The book, Health Savings Account: Planning for Prosperity is here revised, making N-HSA a completed intermediate step. Whether to go faster to Retired Life is left undecided until it becomes clearer what reception earlier steps receive. There is a difficult transition ahead of any of these proposals. On the other hand, transition must be accomplished, so Congress may prefer more speculation about destination.

Handbook for Health Savings Accounts
New volume 2015-07-07 23:31:01 description

Consolidated Health Reform Volume
To unjumble topics

SECTION THREE: Classical Health Savings Accounts: Many Surprises

One of the originators of Health Savings Accounts describes their advantages over existing health insurance. Improvements are suggested for the regular HSA. More dramatic cost improvement emerges from a lifetime HSA version, substituting whole-life approaches for pay-as-you-go. Most of this requires legislation, but could reduce health costs dramatically.

The section describes some of the nuts and bolts of Health Savings Accounts, and sketches in some more elaborate variations which might be possible. Recall we have estimated the Health Savings Accounts would earn an average 6.5% compound interest income during the long lifecycle between healthy youth and sickly elderly. But the variability of prices and terms among Catastrophic Health policies currently limits specific examples of what might be possible. And the instability of regulations explains most of the remaining uncertainties.

Classical Health Savings Accounts (C-HSA)

Some Unintended Opportunities

The present state of healthcare legislation is, to put it delicately, immature. Both Health Savings Accounts and the Affordable Care Act are the law of the land, but the Obama Administration defiantly slipped in some regulations, and quietly slipped in others, which have no precise authorization in the law. Everything may claim to be mandatory, but until enforcement begins, neither enforcement nor appeal to the Supreme Court about constitutionality seems completely feasible. When no one has been injured, no one has "standing" in the eyes of the courts.

Funding the Deductible. For example, every one of the governmental "metal" plans has at least a $1250 front-end deductible, going up to $6300 for full coverage. Meanwhile, non-government health insurance is rapidly replacing copay with high deductibles, too. (Co-pay is the main cause of supplemental insurance, a doubling of administrative burden.) Unless a person is eligible for subsidy, this mandatory large deductible makes the insurance hard to use unless the individual has saved up some cash for his deductible, somewhere else. So why not provide a tax incentive to have the deductible in escrow? At the moment, Health Savings Accounts are the only feasible approach to this goal, but that does not exactly mean they have been authorized to do so, since double coverage is more or less frowned upon. The deductible means nothing until you get sick, so Obamacare gave itself a few years to figure this out, but the public is apparently in jeopardy if it tries to invent a work around. It begins to look as though the voters may not give the originators of this plan enough time in office to see this as a problem they must address. So, if this is going to be everybody's problem, why not see if the Health Savings Account can offer to do it. By doing so, the individual apparently must drop his existing insurance, so go figure.

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By accident or by design, All Obamacare policy choices have high deductibles. {bottom quote}
The Bronze Plan is Cheapest

People who have no illnesses, naturally have little present concern with ambiguities in health insurance. But health inurance will matter as soon as illness appears. Therefore, the present state of limbo will increasingly be of concern to more people. Seemingly, there is a race between the three branches of government to start an action. Either a compromise must be reached between the Executive and Legislative branches, or else the Courts will be forced to intervene by some injured person. Curiously, the only Justice to express displeasure with the present Constitution is Ruth Ginsburg, whose two cancers make her likely to be the next Justice to retire.

A piggy-bank for Millennials. Whatever someone may think of Obamacare, the front-end deductibles provide a pretty substantial incentive to maintain at least $1250 per person cash reserve somewhere, and an HSA would be just a wonderful place to keep it. If that is somehow blocked, an IRA would be almost as satisfactory. If Congress addresses the matter, an IRA could later add a feature to roll over the deductible from such IRAs to HSAs. If the individual avoids spending what is in the HSA, it eventually will revert to an IRA on attaining Medicare eligibility, anyway. Calculating a 10% investment return, age 25, and assuming no medical expenses, it might then have grown to $51,000 taxable, or somewhat less if lower interest rates are assumed. For someone who stays healthy, its minimum distribution as an IRA at age 65 would start paying a taxable retirement income of over $775 a year. That's pretty good for an investment of $1250. Obviously, everybody older than 25 gets less, but in no case does anyone get less than the $1250 he/she put in, just to cover a possible deductible. The issue of the high investment return is taken up in Section Four. As will then be seen, there are two issues: whether such a return can be safe and consistent; and whether hidden fees will undermine the return.

It's true you can't spend the same money twice. If the fund is depleted by spending for a deductible, it must be promptly and fully replaced to keep the fund growing. However, Aetna studied and GAO confirmed, that only 50% of enrollees in employer-sponsored HRAs withdrew any of their funds (which might have been used for outpatient as well as high-deductible purposes). Apparently these clients were more anxious to preserve the tax shelter, than to protect their health, which is a slant I hadn't considered. This was true, even though the employers' efforts to enhance the compound income were not particularly strenuous. In a sense, it is a flattering sidelight on the frugality of many Americans. But the power of compound interest lies in re-investing the profits, so reasonably prompt restoration of the enhanced principal would not materially reduce the final outcome, just so long as internal profits remained untouched. It would be fairly simple to impose this requirement, creating a distinction between "balance" and "available balance", but doing things for people's own good, is always a questionable adventure.

We mentioned earlier, Roger G. Ibbotson, Professor of Finance at Yale School of Management has published a book with Rex A. Sinquefield called Stocks, Bonds, Bills and Inflation. It's a book of data, displaying the return of each major investment class since 1926, the first year enough data was available. A diversified portfolio of small stocks would have returned 12.5% from 1926 to 2014, about ninety years. A portfolio of large American companies would have returned 10.2% through a period including two major stock market crashes, a dozen small crashes, one or two World Wars hot and cold, and half a dozen smaller wars involving the USA. And even including one nuclear war, except it wasn't dropped on us. The total combined American stock market experience, large, medium and small, is not displayed by Ibbotson, but can be estimated as roughly yielding about 11% total return. Past experience is not a guarantee of future performance, but it's the best predictor anyone can use. The supply of small-cap stocks is probably a limiting factor. As we will see, your money earns 11%, but that isn't necessarily how much its owner will earn. But inflation throughout the period remained close to 3%. In this sense, the income net of inflation was never higher than 9%, so we have to presume 9% sets a theoretical limit to what can be achieved by passive investment, even after heroic efforts to reduce middle-man costs. Most of our estimates are based on 6.5%, and most investment managers produce less than that. Nevertheless, very substantial program gains are possible in every tenth of a percentage point which can be further squeezed out. The next candidate for streamlining cost is the Catastrophic insurance premium.

Catastrophic insurance has not been popular for many decades, so presumably there is room for competition to reduce premiums, marketing costs, profit margins, and other conventional competitive tools. The reimbursement to hospitals has suffered from favoritism directed toward some of its client corporation groups, who indirectly force Catastrophic to absorb some of their costs. And finally, there is likely to be overlapping provision for the same costs in a year-to-year system, which might be wrung out by five-year, ten-year or even lifetime policies. One can see potential economies on every side, but they will not come easily. In the long run, a perfect system might generate the revenue equivalent of 10.5% as a top limit instead of 9%. As everybody came up to speed, the potential is there for easily managing what might now be borderline achievable results. In fifteen years, that is. In the meantime, we will have to be satisfied with less ambitious projections for our present approach of term insurance.

So, in the meantime, we take things in a different direction, based on the whole-life insurance model. But one point may not be so clear: the Savings Account part of HSA is already lifetime, in the sense of rolling over and accumulating after-tax income for the rest of life. So for that matter, Catastrophic high-deductible insurance would be an easy next step, requiring only some adjustment of the present unfortunate tendency to assume an equivalence between "mandatory" and "exclusively mandatory". Money is money, and the courts will have to decide what sort of entirely fungible money is satisfactory for meeting minimum, maximum or any other coverage requirements. Since the "metals" plans all have high deductibles, but also have unduly high premiums, it seems likely the idea was to force insurance premiums to cover the subsidies for the uninsured. Such confusions of language and intent are ordinarily corrected by technical amendments. At age 66, right as it now is, every HSA turns into an IRA for retirement purposes. But up until age 65 it can be used for medical expenses, getting a second tax deduction. We are close enough so that changes to enable a whole-life approach are imaginable, but not yet feasible.

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 to 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. 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 if for your retirement.

As the only physician in the room, I also pointed out another pretty gruesome fact: either people end their lives having a lot of sickness, 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 a long confinement in bed would be an example.

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People end their lives with sickness, or else they must pay for protracted old age. {bottom quote}
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 confused 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, 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.

Commentary: Agency for Mid-Course Corrections

Among the many things we don't know about the future, is the average longevity eighty years from now. The whole-life insurance industry prospered when they sold policies assuming American longevity of 47 years in year 1900, and it turns out to be 83 today, still growing fast. If longevity should get shorter, as it recently has in Russia, life insurance would go out of business. Since we can't rely on projections, we have to rely on early observations, and make mid-course corrections.

President Lyndon Johnson both underestimated how much Medicare would cost, and how politically successful it would be. He was in no position to multiply 50 million Americans times $11,600 per year per person, times 22 years per person. That simple sentence tells you all you need to know about current Medicare costs, but who knew? Nor could he know how fast longevity would grow, or how fast the cost would rise. But we can monitor the trend, extrapolate, and revise the extrapolation. Medicare was a medical success, which had to be paid for; and President Johnson's successors might have found that out a little sooner, and changed course. If we must find fault, failure to readjust early, would be my candidate.

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So, who is counting? {bottom quote}
Quis custodiet custodies?

For reasons obvious or not, the nation would be well served to create a monitoring agency for the guidance of future Congresses in charge of the type of Health Savings Accounts we already do have, and maybe some related issues. When we start envisioning lifetime coverage , it becomes even more vital to have a permanent agency to sort out what is happening. This is particularly important when the Branches of the Federal Government are divided between the two parties. Informally, the subcommittees of the Appropriations Committees have assumed much of the burden of overseeing agencies. They are the only Congressional Committees to review every program every year. However, the Agencies have grown to be the largest bureaucracies in the government, and tend to become jealous of their independence, as the Appropriation Committees grow too burdened to bother with them. It begins to look as though we need more Congressmen if we want Congress to maintain a closer control of the agencies. Each Congressman now represents a million constituents, and simply cannot do all we would like him to do. As much as anything, we need a core group who worry about issues in advance, and have the prestige and access to make their views be heard. Rather than design a blueprint, let's review some issues that such a body might explore.

Proposal 8: Health Savings Account Age Limits Should be Extended, from the Cradle to the Grave. A few extra years might be a minor improvement in special cases. The real benefit would be to create a continuous account, which could grow over long periods of apparent inactivity.

Proposal 9: Instead of annual contribution limits, the limit for HSA should extend over several years, or even be a lifetime limit. When deposits must be skipped for health or occupational reasons, there should be an opportunity to catch up. Athletes and similar occupations tend to concentrate earning power in a few years.

Since the HSA is increasingly accustomed to augmented retirement income, thought should be given to extending the idea to amounts of money which could encourage that use. Furthermore, there are special circumstances, like a partial Medicare buyout, in which a limit to deposits forces a choice between two desirable uses for the same money. If the individual has the money for more than one purpose, it seems wrong to force a choice. For example, it's considerably safer to over-deposit more than you believe you will need, planning to return the excess. As a practical matter, the usual danger is overoptimistic revenue projection. Someone who sells his business at age 63 might have enough cash, but still encounter trouble with the $3300 per year limit because he once needed the income to run the business. It seems pointless to squeeze through such a narrow window, and much better if the window were at least enlarged to permit lump-sum deposits up to a $132,000 lifetime limit. With that sort of cushion, plus a stretch of reasonably good health at the right time of life, it would become considerably safer to take risks. At age 65, a lifetime of health costs is already in the past, but the curve of health expenses starts to bend upward at age 50, at a time when college expenses for children may be persisting, and the house isn't quite paid for. It seems a pity to cripple a good idea with pointless contribution limits that almost stretch far enough, but leave people fearful. If Congress develops a serious interest in lifetime insurance, the yearly contribution limit should be revisited. The optional side use for retirement should be examined in parallel, including its potential for being gamed.

Revisited by whom? Someone should be empowered to travel, and talk to people in the field. Maybe hold hearings, maybe just interview. A simplified goal is therefore to accumulate $80,000 in savings by the 65th birthday, intending to make a single-premium buy-out. That clarifies costs, but is it practical on a large scale?Remember that savings get a lot harder when earned income stops. With current law, you would have to wake up and start maximum annual depositing of $3300 by your 50th birthday, to reach $80,000 by age 65, and you would need generous internal compounding to make it. But notice how easily $100-200 a year would also get you there, starting at age 25 (see below), even justifying somewhat less optimistic investment income returns until age 65.

Many more frugal people might skin by with looser rules; It even could rather easily be subsidized for poor people and hardship cases. If you are going to cover lifetime health costs instead of just Medicare, many more will need $80,000 to do so, and have something left to share with the less fortunate. But to repeat once again, that still compares favorably with the $325,000 often cited as a lifetime cost. That's all we care to promise in public, but secretly we know it may not be enough. The plain fact is, if longevity or inflation get out of hand, someone must have the authority to raise the contribution limits, and to do that, there should be some research by a trusted house actuary.

Proposal 10: Instead of the present annual limit of contributions to Health Savings Accounts of $3300 per year, Congress should permit a lifetime limit of $132,000, with annual deposit limits adjustable to bring accounts at their present age, up to what they would have been if $3300 annually had been deposited since age 25.

Proposal 11: Congress should reserve decisions to itself for changing the lifetime contribution level, and review final appeals from contract terms which seem to threaten imminent major adjustment to the general public lifestyle.

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, .

It is this calculation, however rough, which has made me change my mind. It was my original supposition that multi-year premium investments would only apply up to age 65, and that would be followed by Medicare. In other words, HSA 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 then fan the flames of their fears, and the result would have a high likelihood of undermining the whole idea for any age group, for many years. Better, I thought, 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 cautious revenue projections could come to failure, and when nothing else remotely close to it has been proposed by anyone, the opportunity runs the risk of passing us by. So, I have 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 disadvantage 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. At least we should allow it as a demonstration option, where some fears will prove unwarranted, while others can be corrected.

So we make the guess of the average life expectancy where things will eventually flatten out, will then be about 91. (Be careful, most census figures are for life expectancy-at-birth.) But many people would have to be lucky in all details: a favorable investment climate for the right ten-year periods, plus a favorable health situation which avoids expensive illnesses just at the age when they begin to threaten. Some life-saving scientific advances would be a big help, too. Using a lower goal of $80,000 and an interest rate of 7% is considerably easier to conjure, but the barrier which might be reached first is the $3300 yearly contribution limit. Some unfortunate individuals might be forced to pay all medical expenses out of pocket in order to make the investment fund stretch, even before the average becomes affected. The individual who came up short might still remain considerably ahead of where he would be without an HSA, but we are using a precise match of revenue and expense, to simplify the examples.

Someone who sells his house or business at age 63 might have the cash, but still have trouble because of the $3300 per year deposit limit. It seems pointless to squeeze through a narrow window, and much better if the window were enlarged to permit lump-sum deposits up to a $132,000 lifetime limit, adjusted for inflation and compound income returns. With that sort of cushion, plus a stretch of reasonably good health at the right time of life, it would become considerably safer to take the risks. At age 65, a lifetime of health costs is nearly in the past, but the curve of health expenses starts to curve up at age 50, at a time when college expenses for children may be persisting, and the house isn't quite paid for. It seems a pity to cripple a good idea with pointless contribution limits that almost stretch far enough, but leave people fearful. If Congress develops a serious interest in lifetime insurance, the yearly contribution limit should be revisited.

The simplified goal is therefore to accumulate $80,000 in savings by the 65th birthday, remembering that savings get a lot harder when earned income stops. With current law, you would have to start maximum annual depositing of $3300 by your 50th birthday, to reach $80,000 by age 65, and you would still need generous internal compounding to make it. But notice how easily $100-200 a year would also get you there, starting at age 25 (see below) and less optimistic investment income returns until age 65. Many more frugal people might skin by with looser rules; poor people and hardship cases could more easily be subsidized. If you 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 once again, that still compares very favorably with the full $325,000 which is often cited as a lifetime cost. We have already imposed an extra $80,000 internal savings requirement in order to include Medicare; here is the place it would be a hardship. That's about as far as concentrated thought will carry you. It leads to the conclusion that it might be better to modularize Medicare and let the public pick and choose what it wants to buy its way out of.

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 investment 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 well-understood national example, Obviously, a higher return would provide affordability to many more people than lesser returns. When $100 competes for the investment income from 10%, it's much easier than $300 competing for 5% income. Let's take the issues separately, but don't take preliminary numbers too literally. They are primarily intended to alert the reader to the enormous power of compound interest, and the big difference made by relatively small changes in it. Let's go forward with some equally amazing investment discoveries which are more recent, and vindicated less by logic than empirical results.

A transition from term insurance to pre-payment of Medicare is greatly eased by forgiving the premiums and payroll deductions, which are roughly age-distributed, and can therefore be forgiven in a graduated manner for late-comers to the program. Most cost-redistribution of high-cost outlier cases should be handled through the catastrophic insurance, which is well suited for invisible and tax-free redistribution. Because of hospital cost-shifting, inpatients are temporarily overpriced, but are quickly becoming underpriced as a result of hospitals gaming the DRG to shift costs to outpatients. This will in time affect the relative costs of Catastrophic and Health Savings Accounts, and must be carefully monitored for mid-course adjustments. This changing horizon of cost shifting reinforces the need to create a special agency to keep track of it. And to report its findings to Congress, who can consider the broader political implications, once they know the facts.

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 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 have extensive access to 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 about the size and scope of inter-subscriber loan activity. At first, it might conduct the loan activity itself, with an eye toward eventually overseeing a commercial vendor.

Cost Sharing with Frugality.At present costs, statisticians estimate future healthcare costs of about $325,000 (in year 2000 dollars) for the average lifetime. We could discuss the weaknesses of that estimate, but even though it's breathtaking, it's the best guess available. Women experience about 10% higher lifetime health costs than men. Roughly speaking, how much the average individual somehow has to accumulate, eventually must equal what he spends by the time of death. The dying individual himself has little interest in what is left unpaid at his death, so Society must do it for him, in order to survive as a Society. At this point, we unfortunately must also work around one of the great advantages of having separate accounts.

On the one hand, individual accounts do create an incentive to spend wisely, but it is also true that pooled insurance accounts make cost-sharing easier, almost invisible, and tax-free. Cost sharing induces reckless spending of other people's money however, while individual accounts induce frugality with your own money. Therefore, linking Health Savings Accounts with Catastrophic insurance provides a way to pool heavy outlier expenses, while the incentive for careful money management remains 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 argue or resist.

But a cautionary reminder: linking individual accounts to frugality through outpatients, as well as linking heedless spending to insurance through inpatients -- induces hospital administration to game the system we have here imagined. There's no doubt a system can be gamed by shifting medical care to the outpatient area, but we must expect the DRG to be attacked, in order to reverse such incentives, which run in the hundreds of billions of dollars. A well-informed monitoring system simply must be created and funded, if we ever expect the decision to hospitalize patients to rest on whether the patient needs to lie down, instead of on what kind of payment system we happen to fancy. At the same time, the present DRG coding system must be considerably improved to withstand being subverted. These are not tasks which congressmen typically enjoy, but they must be done within the legislative branch if we expect it to function.

Standard Deviation within and between age cohorts.Furthermore, there is an important distinction between a mismatch of revenue to expenses caused by chance within one age group, and a revenue mismatch between two age cohorts. To put it another way, somebody has to pay off these debts, and we must have a plan about who should pay them when revenue is not present in the account. Borrowing between subscribers within the same age cohort should pay modest interest rates to forestall gaming, but borrowing between different cohorts for things characteristic of their age level (pregnancy, for example) should pay no interest if at all feasible. Unfortunately, people sometimes abuse such opportunities, and interest must then be charged. Until the frequency of such things becomes better established, this function of loan banking policy should be part of the function of the oversight body, rather than the executive agency, which tends to want to retain the function. When its limits become clearer, it might be delegated to a bank, or even privatized, but the policy must be monitored by specialists who understand what is happening "on the ground". While it is unnecessary to predict the last dime to be spent on the last day of life, incentives should be understood by the managing organization, separating routine cash shortages from likely abusive ones. And looking at all such activity as potentially having been caused by payment design. Much of this sort of thing can be minimized by encouraging people to over-deposit in their accounts, possibly paying some medical bills with after-tax money in order to build the fund 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 careless overspending, can be a matter of argument.

Proposal 13: Current law permits an individual to deposit $3300 per year in a Health Savings Account, starting at age 25, and ending when Medicare coverage begins. Probably that amount is more than many young people can afford, so it would help if the rules were relaxed to roll-over leftover entitlements to later years, spreading the entire $132,000 over the forty-year time period at the discretion of the subscriber.

Finally, an observation. The classical Health Savings Account will save a big chunk of money, but who gets it will depend heavily on the health of individual subscribers, because it is term insurance, year to year. Two concepts loom over it: (1) The nation may want to distribute the good and bad luck more evenly, and (2) It would be much easier to cut down an over-funded project than to supplement an under-funded one. If we we can think of some ways to improve the product, we should start with as generous a benefit package as we can easily devise. Therefore, the rest of this book is devoted to making the returns more generous, and the outcome more predictable, sooner.

Fun With Numbers

The principles of compound interest are thought to have been a product of Aristotle's mind. The principles of passive investing are more recent, mainly attributed to John Bogle of Vanguard, although Burton Malkiel of Princeton has a strong claim. In the present section, we propose to merge the two methodologies, compound interest with passive investing, trying to give the reader some idea why the combination could supply Health Savings Accounts with seriously augmented revenue. Because there is so much political flux, it cannot be an actual plan until the politically-controlled numbers have some finality to them.

The proposal to accumulate funds, however, shifts responsibility to the customer to spend wisely, even resorting to employing some of the individual's taxable money to pay small medical costs, thus preserving the tax shelter. (Or to use escrow accounts, or over-deposit in some other way, such as reducing final goals.) HSA doesn't directly reduce health costs, it eliminates some unnecessary ones but provides lots of extra money to pay for essential ones. At the outset we want to state, schemes of this sort have a history of working effectively up to a certain level, and then begin to interfere with themselves as eager money rushes in. There's no sign of that so far, but it might appear. Therefore, we advise modest hedged experiments rather than attempts to pay for all of healthcare, reducing health costs perhaps by only a quarter or a half, since those smaller levels would still amount to large returns. Balancing the risks with investments outside the HSA -- is just another prudent way of hedging the bet.

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Money earning seven percent will double in ten years. {bottom quote}
The rough rule of thumb is, money earning seven percent will double in ten years; money at ten percent will double in seven years. Seven in ten, or ten in seven. You can use simple maxims to verify the attached ideas. An early realization is that compound interest accelerates with time, and is highly sensitive to small interest rate changes. An improved rate of interest generated by (Twenty-First Century) passive investing gets multiplied by (Twentieth-Century) extended life expectancy. This idea might not have worked, a generation ago. And it will not work in the future if future catastrophes shorten life expectancy, or interest rates rattle around. As happenstance, interest rates today rest near the "zero boundaries", but interest risk is not totally eliminated. Interest rates have a way of bouncing, and irrational exuberance is part of our system.

In fact, we have a tragic example in the nation's pension funds. A few decades ago, pension managers were tempted to invest in stocks rather than bonds, and then the stock market crashed, stranding pensioners with low rates of return, rather than the high ones they had hoped for. I want readers to understand I am well aware of the cyclicity of markets, and make these suggestions, regardless. As long as we include a thirty-year "Black swan" contingency by limiting coverage to a quarter or a third, it should be reasonably safe, but savings would still be enormous. There are other, more traditional ways of protecting endowments from stock crashes. With people of every age to consider, the long transition period alone would almost automatically buffer out black swans.

Having issued a warning to be a conservative investor, let's now introduce some notes of reassurance. Younger people are always likely to be healthier. Those who save their money while young therefore need not use all of it for healthcare -- for several decades. Compound interest works to magnify savings, the longer its horizon the better. We'll describe passive investing later, but it too should increase the average rate of return. These investments after some successes increase the incentives to save. If no one buys Health Savings Accounts, the incentives were apparently not large enough. If everyone rushes to buy, perhaps the incentives were unwisely too attractive. Right now, the financial industry is observing a rush to passive investing; nearly fifty percent of mutual fund investors are switching to "index funds" in spite of capital gains taxes on selling other holdings. Since the marvel of compound interest has been accepted for thousands of years, a mixture of compound interest and passive investing isn't an especially radical idea.

What's radical is the idea that all those highly-paid advisors can't do better than random coin-flippers. What's radical is to discover that the main ingredient of poor performance is high middle-man fees. Low fees won't assure high returns, but high fees will assuredly lead to low returns. If that new idea gets replaced in turn, it will be replaced by something better, and everyone should switch to it. But if compound interest is here to stay, this proposal is safer than it sounds. The investment income rate or continued employment of your agent is what isn't guaranteed, which is why business relationships (between customers and managers of HSAs ought to remain portable and transparent by law. Your manager might move, or you might decide to move away, from him.

Start by looking at what happens if you jump your interest rate curve from 5% to 12%, or if you lengthen life expectancy from age 65 to age 93. That's what the graph is intended to show, and we stretch the limits to see what stress will do. Jumping to the highest rate (12%)the interest rate gets the balance to a couple of million dollars pretty quickly and lengthening the time period further enhances that gain. The combination of the two easily escalates the investment far above twenty million. The combination of extra time and extra interest rate thus holds the promise of quite easily paying for a lengthening lifetime of medical care, regardless of inflation. In fact, it gets the calculation to giddy amounts so quickly it creates suspicion.

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Average lifetime health costs: $350,000 per lifetime {bottom quote}
The actuaries at Michigan Blue Cross, verified by the Medicare agency, estimate average lifetime health costs to be around $350,000 per lifetime. That's just an educated guess, of course, but increasing interest rates and life expectancy will very easily surpass that minimum estimate. How do we go about it, and how far dare we go? Remember, our whole currency is based on the notion of the Federal Reserve "targeting" inflation at 2%, but in spite of spending trillions of dollars, they seem unable even to achieve more than 1.6%. We had better not count completely on schemes which require the Federal Reserve to target interest rates, because sometimes, they can't.

One person who does have practical control of the interest rate an investor receives is his own broker. The broker shares the income, but usually takes the first cut of it, himself. Covering a full century, Roger Ibbotson has published the returns on various investments, and they don't vary a great deal. Common stock produces a return of between 10% and 12.7% in spite of wars and depressions; if you stand back a few feet, the graph is pretty close to a straight line. You wouldn't guess it was that high, would you? If you don't analyze carefully, a number of brokerages offer Health Savings Accounts which produce no interest at all -- to the investor -- for the first ten years. Indeed, the income of 2% also amounts to nothing at all during a 2% inflation. In ten years, 2% approaches a haircut of nearly 20%, explained by the small size of the accounts, and by the fact that customers who know better will generally just politely look for another vendor. Since the number of accounts has quickly grown to be more than fifteen million, it might be time for some sort of consumer protection. The prospective future size of these accounts should command greater market power, quite soon. After all, passive investment should mainly involve the purchase of blocks of index funds, all with fees of less than a tenth of a percent . Much of this haircutting is explained by the uncertainties of introducing the Affordable Care Act during a recession and taking six years just to get to the point of a Supreme Court Test, to see if its regulations are legal and workable. It can be used to provide high-deductible coverage, but it's expensive.

That's the Theory. The rest of this section is devoted to rearranging healthcare payments in ways which could -- regardless of rough predictions -- easily outdistance guesses about future health costs. When the mind-boggling effects are verified, skeptics are invited to cut them in half, or three quarters, and yet achieve a worthwhile result. The purpose here is not to construct a formula, but to demonstrate the power of an idea. Like all such proposals, this one has the power to turn us into children, playing with matches. By the way, borrowing money to pay bills will conversely only make the burden worse, as we experience with the current "Pay as you go" method. By reversing the borrowing approach we double the improvement from investment, in the sense we stop doing it one way and also start doing the other. In the days when health insurance started, there was no other way possible. The reversal of this system has only recently become plausible, because life expectancy has recently increased so much, and passive investing has put that innovation within most people's reach. The environment has indeed changed, but don't take matters further than the new situation warrants.

Average life expectancy is now 83 years, was 47 in the year 1900; it would not be surprising if life expectancy reached 93 in another 93 years. The main uncertainty lies in our individual future attainment of average life expectancy, which we don't know, but probably could guess with a 10% error. When the future is thus so uncertain, we can display several examples at different levels, in order to keep reminding the reader that precision is neither possible nor necessary, in order to reach many safe conclusions about the average future. Except for one unusual thing: this particular trick is likely to get even better in the future. Even so, it is best to do only conservative things with a radical idea.

Reduced to essentials for this purpose, today's average newborn is going to have 9.3 opportunities to double his money at seven percent return and would have 13.3 doublings at ten percent. Notice the double-bump: as the interest rate increases, it doubles more often, as well as enjoying a higher rate. If you care, that's essentially why compound interest grows so unexpectedly fast. This widening will account for some very surprising results, and it largely creeps up on us, unawares. Because we don't know the precise longevity ahead, and we don't know the interest rate achievable, there is a widening variance between any two estimates. So wide, in fact, it is pointless to achieve precision. Whatever it is, it will be a lot.

{William Bingham class=}
One Dollar: Lifetime Compound Interest

Start with a newborn, and give him a dollar. At age 93, he should end up with between $200 (@7%) and $10,000 (@10%), entirely dependent on the interest rate. That's a big swing. What it suggests is we should work very hard to raise that interest rate, even just a little bit, no matter how we intend to use the money when we are 93, to pay off accumulated lifetime healthcare debts. Don't let anyone tell you it doesn't matter whether interest rates are 7% or 12.7%, because it matters a lot. And by the way, don't kid yourself that a credit card charge doesn't matter if it is 12% or 6%. Call it greed if that pleases you; these "small" differences are profoundly important.

If that lesson has been absorbed, here's another:

In the last fifty or so years, American life expectancy has increased by thirty years. That's enough extra time for three extra doublings at seven percent, right? So, 2,4,8. Whatever amount of money the average person would have had when he died in 1900, is now expected to be eight times as much when he now dies thirty years later in life. And even if he loses half of it in some stock market crash, he will still retain four times as much as he formerly would have had at the earlier death date. The reason increased longevity might rescue us from our own improvidence is the doubling rate starts soaring upward at about the time it gets extended by improved longevity. In particular, look at the family of curves. Its yield turns sharply upward for interest rates between 5% and 10%, and every extra tenth of a percent boosts it appreciably.

Now, hear this. In the past century, inflation has averaged 3%, and small-capitalization common stock averaged 12.7%, give or take 3%, or one standard deviation (One standard deviation includes 2/3 of all the variation in a year.) Some people advocate continuing with 3% inflation, many do not. The bottom line: many things have changed, in health, in longevity, and in stock market transaction costs. Those things may have seemed to change very little, but with the simple multipliers we have pointed out, conclusions become appreciably magnified. Meanwhile, the Federal Reserve Chairman says she is targeting an annual inflation rate of 2% of the money in circulation; the actual increase in the past century was 3%. If you do nothing at 3%, your money will be all gone in thirty-three years. If you stay in cash at 2%, it will take fifty years to be all gone.

But if you work at things just a little, you can take advantage of the progressive widening of two curves: three percent for inflation stays pretty flat, but seven percent for investment income starts to soar. Up to 7%, there is a reasonable choice between stocks and bonds; but if you need more than 7% you must invest in stocks. Future inflation and future stock returns may remain at 3 and 7, forever, or they may get tinkered with. But the 3% and 7% curves are getting further apart with every year of increasing longevity. Some people will get lucky or take inordinate risks, and for them, the 10% investment curve might widen from a 3% inflation curve, a whole lot faster. But every single tenth of a percent net improvement will cast a long shadow.

But never, ever forget the reverse: a 7% investment rate will grow vastly faster than 4% will, but if people allow this windfall to be taxed or swindled, the proposal you are reading will fall far short of its promise. Our economy operates between a relatively flat 3% and a sharply rising 4-5%. In other words, it wouldn't have to rise much above 3% inflation rate to be starting to spiral out of control. Our Federal Reserve is well aware of this, the public less so. A sudden international economic tidal wave could easily push inflation out of control, in our country just as much as Greece or Portugal. On the other hand, as developing nations grow more prosperous, our Federal Reserve will control a progressively smaller proportion of international currency. Therefore, we would be able to do less to stem a crisis that we have done in the past.

To summarize, on the revenue side of the ledger, we note the arithmetic that a single deposit of about $55 in a Health Savings Account in 1923 might have grown to about $350,000 by today, in the year 2015, because the stock market did achieve more than 10% return. There is considerable attractiveness to the alternative of extending HSA limits down to the age of birth, and up to the date of death. It's really up to Congress to do it. If the past century's market had grown at merely 6.5% instead of 10%, the $55 would now only be $18,000, so we would already be past the tipping point on rates. In plain language, by using a 10% example, $55 could have reached the sum now presently thought by statisticians -- to be the total health expenditure for a lifetime. By achieving a 6.5% return, however, the same investment would have fallen short of enough money for the purpose. Like the municipalities that gambled on their pension fund returns, that sort of trap must be avoided. Things are not entirely hopeless, because 6.5% would remain adequate if our hypothetical newborn had started with $100, still within a conceivable range for subsidies. But the point to be made provides only a razor-thin margin between buying a Rolls Royce, and buying a motorbike. If you get it right on interest rates and longevity, the cost of the purchase is relatively insignificant. That's the central point of the first two graphs. For some people, it would inevitably lead to investing nothing at all, for personal reasons. Some of the poor will have to be subsidized, some of the timid will have to be prodded. This is more of a research problem than you would guess: a round-about approach is to eliminate the diseases which cost so much, choosing between different paths of research to do it, or rationing to do it. Right now we have a choice; if we delay, the only remaining choice would be rationing.

Commentary.This discussion is, again, mainly to show the reader the enormous power and complexity of compound interest, which most people under-appreciate, as well as the additional power added by extending life expectancy by thirty years this century, and the surprising boost of passive investment income toward 10% by financial transaction technology. Many conclusions can be drawn, including possibly the conclusion that this proposal leaves too narrow a margin of safety to pay for everything. The conclusion I prefer to reach is that this structure is almost good enough, but requires some additional innovation to be safe enough. That line of reasoning will be pursued in a later chapter.

Revenue growing at 10% will rapidly grow faster than expenses at 3%. As experience has shown, it is next to impossible to switch health care to the public sector and still expect investment returns at private sector levels. Repayment of overseas debt does not affect actual domestic health expenditures, but it indirectly affects the value of the dollar, greatly. Without all its recognized weaknesses, a fairly safe description of present data would be that enormous savings in the healthcare system are possible, but only to the degree, we contain next century's medical cost inflation closer to 2% than to 10%. The simplest way to retain revenue at 10% growth, on the other hand, is by anchoring the price to leading healthcare costs within the private sector. The hardest way to do it would be to try to achieve private sector profits, inside the public sector. This chapter describes a middle way. It's better than alternatives, perhaps, but not miraculous.

Cost, One of Two Basic Numbers. Blue Cross of Michigan and two federal agencies put their own data through a formula which created a hypothetical average subscriber's cost for a lifetime at today's prices. The agencies produced a lifetime cost estimate of around $300,000. That's not what we actually spent because so much of medical care has changed, but at such a steady rate that it justifies the assumption, it will continue into the next century. So, although the calculation comes closer to approximating the next century (than what was seen in the last century) it really provides no miraculous method to anticipate future changes in diseases or longevity, either. Inflation and investment returns are assumed to be level, and longevity is assumed to level off. So be warned. This Classical HSA proposal, particularly with merely an annual horizon, proposes a method to pay for a lot of otherwise unfunded medical care. The proposal to pay for all of it began to arise when its full revenue potential began to emerge, rather than the other way around. If a more ambitious Lifetime HSA proposal ever works in full, it has a better chance, but must expect decades of transition before it can. Perhaps that's just as well, considering the recent examples we have of being in too big a hurry. Rather surprisingly, the remaining problem appears merely a matter of 10-15% of revenue, but all such projection is fraught with uncertainty.

Revenue, The Other Problem. The foregoing describes where we got our number for future lifetime medical costs; someone else did it. Our other number is $150,750, which is our figure for average lifetime deposit in an HSA. It's the current limit ($3350 per year of working life) which the Congress applied to deposits in Health Savings Accounts. No doubt, the number was envisioned as the absolute limit of what the average person could afford, and as such seems entirely plausible. You'd have to be rich to afford more than that, and if you weren't rich, you would certainly struggle to afford so much. To summarize the process, the number amounts to a guess at what we can afford. If it turns out we can't afford it, this proposal must be supplemented, and the easiest expedient is to raise the contribution limits. Other alternatives are pretty drastic: to jettison one or two major expenses, like the repayment of our foreign debts for past deficits in healthcare entitlements, or the privatization of Medicare. Not privatizing Medicare sounds fine to most folks, but they probably haven't projected its coming deficits. It would leave us considerably short of paying for lifetime health costs for quite a long transition period, but it might be more politically palatable, like Greece leaving the Euro, than paying more. Almost anything seems better than sacrificing medical care quality, which to me is an unthinkable alternative, just when we were coming within sight of eliminating the diseases which require so much of it.

Escrow Accounts and Over-Depositing. The main unpredictable feature of these future projections is you can't predict when you will get sick and deplete the account. Money withdrawn early is much more damaging than money withdrawn late in the cycle. Catastrophic insurance will somewhat protect against this risk, but the safest approach is to use segregated, somewhat untouchable, escrow accounts for future heavy expenses. That, combined with deliberate over-depositing, is the safest approach. If Obamacare would settle down, it might serve that function, as well, but the political situation is pretty unsettled until a large-group design is made final, and that seems to mean November 2016 at the earliest.

Expanding the Money in a Health Savings Account

Let's see how short and succinct we can make it. Our task is to take the maximum amount of savings we could possibly ask the public to accumulate, invest it more or less on autopilot, and see if it can generate enough money to pay for what we assume will be health costs a century from now. Some would say that's a fool's errand, but let's see what we can do.

We start with an assumption the average person can save $3350 per year from age 21 to age 66; that's $150,750, total, the most anyone can invest in an HSA. The actuaries at Michigan Blue Cross, verified by Medicare, estimate average lifetime healthcare costs to be $350,000. Some people state you can stop talking, right there, because that's too much money. Please be patient, we will address indigency later. For simplicity, we wish to reduce the question to whether we could turn $150,750 into $350,000 in forty-five years with compound interest at reasonable rates. The answer is yes. We can't predict whether those future predictions of costs are accurate, but if accurate, they can be achieved. We assume two things:

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Long Term Strategies {bottom quote}

Indigents. We assume there will be no more indigents than at present. Can the government afford to subsidize them in this model? The answer is Yes, but its present commitment is in another direction, so it isn't entirely likely, very soon.

Outliving Your Income. We assume some people will use up their savings. If the average life expectancy, which is now 83, holds its present course, we assume this model can cope with it, even if the average life expectancy grows to be 93 in the next century. The arithmetic is quite favorable, but unfortunately, we don't know what new costs will be added in the meantime. Assuming there are some, we aren't counting them, so predictions about the future all contain this flaw.

We assume some other things, mentioned as we go along, essentially coming to the conclusion the model will produce a result which falls between the top and bottom curves in the graph. Please note the narrow range of variation in the early years and the widening upward range in later years. In particular, notice how a 3% (inflation) rate tends to stay flat well past any reasonable life expectancy, while more likely, investment income returns start to rise at age 60, and even sooner as the rate approaches 9% net of inflation. That seems to be a "sweet spot" the economy has discovered for itself in two hundred years of exploration.

We assume the equity stock market will follow the paths it followed since the Industrial Revolution. That is, it will produce an average of 12% gross return, with 3% of that eaten up by inflation, or 9% net of inflation. We then estimate our present conservative projections at producing at least 6.5% after costs, out of the remaining 9%. Dismissing inflation, we assume the stock market will operate between a 2% real return, and 9.5% real after inflation, leaving a 3.5% "cushion" for contingencies. When the Industrial Revolution ends, these basics may also change. We have a decade or so to try to get the investor's returns up closer to 8% safe level. And meanwhile, we must try to remain prepared for a bleak and bad depression, a "black swan", on average every 28 years, but individually unpredictable. In the meantime, we aspire eventually to pay for 100% of healthcare expenses, but promise to pay only a quarter of that. And finally, we assume medical care will change so much during the next century, that our calculations will need to be totally revised, long before then, with a so-called mid-course correction. With the understanding, that anything which pushes outside of the accompanying graph will have an obvious explanation, we assume future managers will make appropriate adjustments.

Single Premium Investment/Look carefully at the graph. It makes an unfamiliar assumption. It assumes a newborn baby started a Health Savings Account at birth, deposited $500 in it, and didn't touch the account again until he died. It is our assumption the average person could do that, perhaps with a stretch, and our further assumption that the government could do the same for indigent babies. There are times when neither the government nor many middle-class people could manage the necessary expenditures, but we set the value of $500 at birth as an extreme limit of what we think they both could do, on average most of the time. It's a number which is easily changed if the economy varies from our projection.

Let's dramatize the point we're making on a totally different scale, by temporarily appointing Warren Buffett as its role model. According to a story in the Wall Street Journal by columnist Morgan Housel, this is the way the best investor in history made his money. At the age of eighty-four, his personal wealth was $73 billion. Of that, he made $70 billion after the age of sixty. Some might retort, the trick is to make the first $3 billion by the age of sixty, but a more civil underlying moral is that compound interest really starts to work toward the end of life.

Just take another look at that graph; the particular power of compound interest works as efficiently with $500 as with $3 billion. It starts earlier with higher interest rates, in this case, age 40 at 12%, compared with age 85 at 5%, Mr. Buffett's numbers. Obviously, it pays to start early and to get higher interest rates if you can do it safely. And conversely, it's a bad idea to spend or squander your savings while you are young. Our preferred method is to raise the interest rate by reducing the attrition of middle-men, in the approach mentioned earlier. You might not reach 12%, but you have a fair chance of reaching 9% if you allow yourself fifteen years to work on it. In the meantime, be satisfied with less than 100% coverage by this method.

More seriously, why else did we pick this way to depict the future? Because at age 66, when Medicare takes over, all of the plausible curves have reached a point where they could match Medicare's expenditures, indefinitely. If Medicare went broke, or was otherwise unacceptable for some reason, liquifying the account would produce a sum matching Medicare's present rate of expenditure. And finally, the numbers become so astronomical at the far end, it seems entirely reasonable to transfer part of the account to a grandchild's account. That trick alone should greatly reduce the problem, and add 21 years for compound interest to do it. As we will see in a coming section, paying childhood health expenses in advance solves some otherwise difficult issues.

Black Swans and Portfolio Content.

A standard deviation is the amount of deviation which is seen in two thirds of cases, and usually refers to the minor dips and bumps seen in a year. The standard deviation of the stock market in a year is about 2% -- and can be ignored for this discussion. A much larger set of crashes occurs about once every thirty years, and is characterized by a crash of 30 to 50 percent. No one can afford to ignore something like that.

Protecting the investor against black swans is one of the few legitimate reasons for an investment return of less than 12%. Let's first look at how most big endowments handle the issue. A museum or university typically depends heavily on its endowment to keep it going. If it spent the full 12% of potential average endowment income in the good years, it might be unable to keep its door open during a black swan. It could set aside 30-50% of its endowment as a reserve for such contingencies, but income between recessions might go up to 15% and they would have missed it. A more conventional response has been to adjust the investment portfolio, so it maintains an annual investment return from a portfolio which is 60% stock, and 40% bonds. In the long run, that typically starts with a stock return of 12% and reduces it by a third to 8%, while investing the remaining third in bonds yielding 5%. Unfortunately, the long term experience is that inflation will nevertheless reduce all yields by 3%. So by prudent management of the endowment, a stockmarket yield of 12% is reduced to a spending rule of 5% (after inflation) representing what can safely be spent. Ouch! .

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30% Dips, lasting several years, Every 28 years, on average. {bottom quote}
Black Swans

Now, just a moment. We are talking about a Health Savings Account, not a university or an art museum. We aren't paying a big staff during hard times, we are investing for the far future, except for the fact the far future holds a different sort of terror for some, than for others. The young person may think he needs to pay his rent more than his drugstore bill. But he has so many years ahead of him, that may prove to be a very bad bargain, since depleting his account by a few hundred dollars may cost him thousands of dollars after he retires. If he can possibly borrow from his family, or reduce his college expenses right now, he should try to do it. A table should be prepared by his financial advisor at the HSA to convince him what is in his true best interests. It's a decision he should agonize over, not act on impulsively.

The converse is obviously true of a seventy year-old, choosing between a new car and botox injections. Either one might be fine, but growing a fund he will never live to spend, is not so smart. And there are hundreds of situations between the two extremes. Here's one possible alternative, which straddles the issues:

Although the majority of situations vary from one extreme to the other in response to how old the person may be, financial managers often prefer solutions which tend toward one-size fits all because it creates a bigger pool, and maybe better returns. But it definitely wouldn't be wrong to get better returns for a little more risk. Especially for younger people when better returns cast a long shadow. Perhaps the portfolio should have a larger common stock content for clients up to age 50 than 60/40, perhaps 80/20 or even 90/10. The age of 50 is selected because health problems tend to increase after age 50. Or the ratio might be adjusted for the increased obstetrical costs of age 25-35, particularly for females. Actuaries should be consulted for more complicated issues. Since we definitely frown on kick-backs and other manipulations, perhaps fees should reflect the value of actuarial advice of this sort.

Longevity, a Moving Target

In the last fifty or so years, American life expectancy has increased by thirty years, enough extra time for three extra doublings at seven percent. So, 2,4,8. Whatever money the average person would have had when he died in 1900, is now expected to be eight times as great, since he dies thirty years later in life. And even if he should lose half of it in some stock market crash, he will still retain four times as much as he formerly would have, at the earlier death date.

The lucky reason increased longevity might rescue us is the doubling rate started soaring upward at about the time it got extended by improved longevity in 1900 (when life expectancy was 47). In particular, look below at the whole family of curves. Its yield turns increasingly upward for interest rates between 5% and 10%, and every extra tenth of a percent boosts it appreciably more. Let's take a small example. Why don't we invest everything in "small" capitalization companies? Because there aren't enough of them to support such a large diversion to a frozen account. We are therefore forced to concentrate in large capitalization corporations, yielding only 11%. A few tenths of a percent extra yield might be squeezed out of this curiosity. Life expectancy is slowly but steadily lengthening. And so on. It's useful for the nation to realize that having everybody live longer is a good thing, just as long as too many extra people don't get sick with something expensive.

In the past century, inflation has averaged 3% per year, and small-capitalization common stock averaged 12.7%. That results in an after-tax growth of 9.7%. Some people consider 3% inflation to be good for the economy, many do not. The bottom line: many things have changed, in health, in longevity, and in stock market transaction costs. Those things may have seemed to have deviated very little, but with the simple multipliers we have pointed out, that upturn in income at the end of life becomes steadily magnified. If you do nothing at 3%, your money will be all gone in thirty-three years. That is if you leave your savings in cash. While it is true there are risks with all choices, the option of being a deer in the headlights is a poor one. There's a small but critical margin, and everyone must collectively struggle for very small improvements in it.

If you work at things just a little, you take advantage of the progressive widening of two curves, also shown on the graph: three percent (for inflation) remains pretty flat, but seven percent (for investment income) starts to soar much earlier. Up to 7%, there is a reasonable choice between stocks and bonds; but if you need more than 7% you must invest in stocks. Future inflation and future stock returns may remain at 3 and 7, forever, or they may get tinkered with. But the 3% and 7% curves right now are getting further apart with every year of increasing longevity. Some people will get lucky or take inordinate risks, and for them, the 10% (large-company stocks) investment curve might widen from a 3% inflation curve a whole lot faster. But except for desperate gamblers, every single tenth of a percent net improvement, will cast a long shadow. That means blue-chip common stocks are best, except during a black swan crash where all bets are off, but bonds are probably least bad.

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Save it, or Spend it. You can't do both. {bottom quote}

But never forget the reverse: a 7% investment rate will certainly grow much faster than 4% will, but if people allow this windfall to be taxed, gambled or swindled, the proposal you are reading will fall short of its promise. We are offering a way to minimize taxes, the other two risks are your own problem. Our economy operates between a relatively flat 3% and a sharply rising 4-5%. In other words, it wouldn't have to rise much above 3% inflation rate to be starting to spiral out of control. Our Federal Reserve is well aware of this, but the public isn't. A sudden international economic tidal wave could easily push inflation out of control, in our country just as much as Greece or Portugal if they leave the Euro. Another issue: As developing, nations grow more prosperous, our Federal Reserve controls a progressively smaller proportion of international currency. Therefore, we could do less to stem a crisis that we have done in the past.

To summarize, on the revenue side of the ledger, we note the arithmetic that a single deposit of about $55 in a Health Savings Account in 1923 might have grown to about $350,000 by today, in the year 2015, because the stock market did achieve more than 10% return. It might be more realistic to say $250 at birth rather than $55. but the principle is sound. You can't do it twice, but it ought to work, once. There is therefore considerable attractiveness to the expedient of extending HSA limits down to the age of birth, and up to the date of death. It's really up to Congress to do it.

If the past century's market had grown at merely 6.5% instead of 10%, the $55 would now only be $18,000, so we would already be past the tipping point on rates. You do have to leave some extra room. In plain language, by using a 10% example, $55 could have reached the sum now presently thought by statisticians -- to be the total health expenditure for a lifetime. But by accepting a 6.5% return, the same investment would have fallen well short of enough money for the purpose. Unlike the municipalities that gambled on their pension fund returns, that sort of trap must be anticipated to be avoided. Things are not entirely hopeless, because 6.5% would remain adequate if our hypothetical newborn had started with $100, still within a conceivable range for subsidies for the poor. But the point to be made provides only a razor-thin margin between buying a Rolls Royce, and buying a motorbike. If you get it right on interest rates and longevity, the cost of the purchase is relatively insignificant. That's the central point of the first two graphs. For some people, it would inevitably lead to investing nothing at all, for personality reasons. Some of the poor will have to be subsidized, some of the timid will have to be prodded.

This is more of a research problem than you would guess: a round-about approach is to eliminate first the diseases which cost so much, choosing between research to do it, or rationing to do it. Right now we have a choice; if we delay, the only remaining choice would be rationing.

Commentary.This discussion is, again, mainly to show the reader the enormous power and complexity of compound interest, which most people under-appreciate, as well as the additional power added through extending life expectancy by thirty years this century, and the surprising boost of passive investment income toward 10% by financial transaction technology. Many conclusions can be drawn, including possibly the conclusion that this proposal leaves too narrow a margin of safety to pay for everything. The conclusion I prefer to reach is that this structure is almost good enough, but requires some additional innovation to be safe enough. That line of reasoning will be pursued in a later chapter.

Revenue growing at 7% will relentlessly grow faster than expenses at 3%. As experience has shown, it is next to impossible to switch health care to the public sector and still expect investment returns at private sector levels. Repayment of overseas debt does not affect actual domestic health expenditures, but it indirectly affects the value of the dollar, greatly. With all its recognized weaknesses, a fairly safe description of present data would be that enormous savings in the healthcare system are possible, but only to the degree, we contain next century's medical cost inflation closer to 2% than to 10%. The simplest way to retain revenue at 7% growth is by anchoring the price leaders within the private sector. The hardest way to do it would be to try to achieve private sector profits, inside the public sector. This chapter describes a middle way. Better than alternatives, perhaps, but nothing miraculous. .

What HSA Does for Poor Folks: A Proposal

When I give talks about Health Savings Accounts, there often seems to be some person in the front row who doesn't seem to be listening. But he's usually the first to raise his hand with a question, which goes more or less like this: "Well, what does this do for poor people?" So here's my usual answer.

Poor people are all poor, but they are poor in different ways. For preliminary discussion, let's divide them into three classes.

On Their Way Up. Most Americans came here at the bottom, and worked their way up. Poverty may once have been their condition, but it wasn't their ambition to stay there. Everyone, particularly the newcomers, can see that cheaper means more people can afford something they once couldn't afford. It's the job of Health Savings Accounts to make healthcare cheaper, but if you subsidize more than half of the population, and then set a threshold of 400% of poverty, you tend to hold people in place. You tend to make subsidies hard to surrender, which increases the number of subsidized people, and ultimately makes subsidies too expensive to continue. It may be well-intended, but it makes things worse. The Latin expression Primum non nocere is the medical profession's motto, meaning "The least you can do for somebody, is not make their problem worse." On the other hand, by making healthcare cheaper, more people can afford it, so you've done a lot of good.

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Like Tolstoy's Unhappy Families, Poor people are Poor in Different Ways. {bottom quote}

Stuck at the Bottom. It's true a dismaying number of people are permanently unemployable. Not just unemployed, but unemployable. The Mayor of my little suburb tells me 8% of the school budget is devoted to "Special education", which mostly means mental defects of one kind or another. In spite of special education, a large proportion of mentally retarded kids will never be able to support themselves. And despite movies about Nobel prize winners with Lou Gehrig's disease, a lot of other people born with neurological conditions will never be self-supporting, either. My profession is working hard to reduce the number of permanently disabled, and quite often it is fiercely expensive to treat them, but we keep doing it. For the most part, these disabilities are easy to recognize, and with few exceptions it is society's obligation to subsidize them indefinitely. But it is not the role of Health Savings Accounts to define, identify or treat these people. In fact, it would injure our performance to take on a non-financial role. Give us the money and we will expand it and then pass it along. We will even contribute toward its cost, but much prefer to have government pay its own bills, and not disguise their taxes as part of our operating budget. Who made it government's duty? Our elected representatives in Congress did, and we try to follow their rules.

Temporary, Borderline and Political. For a while, I acted as a referee on Disability Determination. Let me tell you, it's often pretty hard to tell who is malingering, from who is eligible among a host of different assistance agencies, and who has long since recovered from a disabling condition. It's therefore expensive to administer Disability Determination, and physically exhausting if you take it seriously. It isn't the proper job for a Health Savings Account, which would do it very poorly, dragging down the performance of what else we would really like to do perfectly. Which is to reduce the effective cost of healthcare, by adding an unexploited source of revenue in the financial field.

HSA Proposal for the Poor. The proposal, therefore, is we should start with what is least controversial in almost everybody's mind, which is catastrophic health insurance. This type of insurance comes closest to what everyone would agree we owe all our citizens. No money is expended on the basis of income or social circumstances, it is decided individually at the hospital door, usually by accident room physicians. Its volume of component services would be controlled by an improved DRG, and its retail price should be determined by outpatient costs determined in turn by the marketplace, or by a relative value scale when no comparable outpatient service exists. It may be advisable to reconstitute the PSRO (Professional Standards Review Organization).

It may be desirable to dispense this catastrophic insurance through an HSA, although it is not essential. If it is the only benefit provided, it still would be useful to provide an accordion mechanism for additional services for those who rise from poverty, who are reimbursed through special programs in a variety of ways, or who find ways to supplement the cost themselves. Ultimately, it should provide a vehicle for integration, temporarily or permanently, into the private sector.

Investment Advice for Non-Investors

The cost of retirement living is probably already larger than the average lifetime cost of healthcare, or about $350,000. That's almost the same as saying nobody but a millionaire has a chance. But longevity is constantly lengthening, and healthcare will probably get cheaper eventually. So right now, retirement at $35,000 a year for 20 years is twice as expensive as healthcare, retirement at age 60 for 40 more years would cost four times as much as healthcare. Somewhere along the line, someone will suggest we make healthcare a minor component of retirement costs and roll the two together to save administrative costs. By that time, I expect healthcare to be largely an experience of retired people, anyway. With half the nation retired, the architects will have to design housing for that expectation. But the greatest challenge will be to find something for those people to do with their time. It might as well be -- it almost has to be -- something remunerative. Even assuming unlimited wealth, it's pretty hard to imagine people going on four ocean cruises a year, year after year. Or playing eighteen holes of golf, six days a week. I've known a few people who did things like that, but it's hard to imagine a whole nation doing it. And out of that synthesis will come some way to pay for retirement, including healthcare.

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Buy and Hold. Don't pay high fees. 6% Returns or Know the Reason. {bottom quote}

The alternative is to have no money. Alternatives to watching television aren't attractive, and in fact they aren't much different from going to jail, except it is reported it costs more to be in Leavenworth than to go to Harvard. It's sixty or more years into the future, so it isn't my problem to re-design a civilization to fit its coming demography. All I can do is mention that having a regular check come in, won't be enough to occupy the time of half the country, so they better get started, developing something else. Meanwhile, here's how to arrange getting that check

For most of the past decade, saving for a rainy day has been in an interest-rate environment which made the usual saving process almost useless. Let's compare today with a generation ago. When my mother died at the age of 103, she had been living for decades on her savings account at the bank, with certificates of deposit and interest rates which were quite generous. She had a few stocks, but interest on fixed-income sources was the main thing, not just for her but for all the elderly folks in her generation. Well, for nearly a decade things have been entirely different for investors.The government has been trying to fight a recession with zero interest rates, and the Federal Reserve has accumulated trillions of dollars worth of bonds it will some day try to sell. Much of this has been financed artificially in ways most of us could not possibly understand, but we do understand two things:

1. A lot, if not most, of this maneuvering has been at the expense of old folks. They were taught to depend on fixed income, but interest rates right now are smaller than the rate of inflation, while the price of bonds has been driven high by the government owning trillions of them. They threaten to crash if things go back to normal, so somebody wants them to remain low. The Chairman of the Federal Reserve wants to be calm and reassuring, but essentially admits she isn't certain what to do.

2. When the Federal Reserve starts to raise interest rates back to normal, it will sell bonds, perhaps trillions of them. The bond market may not plummet immediately, but only if the Federal Reserve makes selling mistakes. Cash may be king in this situation, but only if investors don't freeze, like deer in the headlights..

So, It's a little hard to imagine buying bonds, living on bank accounts, or doing most of the other things we watched our parents do with great success. That would include Health Savings Accounts, wouldn't it? No, it wouldn't. The HSA is a good place to buy common stocks, and the best of all places to park your spare cash. You can invest in anything you please with HSA, with or without coupons, because a tax-free account doesn't care about tax consequences. If your HSA has any limitations to what you can do, it must be caused by your broker or your advisor, not because the HSA program gets in the way. Overfunding the HSA account is always a good alternative, although mostly a passive investment in a low-cost index fund of the entire American market will work out better. Let's put it this way: if you start investing when you are fairly young, you will probably come out well enough. If you start investing when you are nearing retirement age, you had better be lucky, because you won't have time to ride it out.

1. The first weapon you will have is compound interest. It has great power, because its secret is its effective interest rate rises at the far end. A small amount early in life is better than a big amount near the end, but any time is better than never. The tax exempt feature is a treasure. Thirty years extra longevity this century extend it longer, and longevity continues to increase. But remember this: the net income must be larger than the rate of inflation. If you don't know the rate of inflation, just guess it is 3% a year.

2. The second weapon is passive investing. Don't try to beat the market, just try to equal the market, and you will eventually get where you are going. But don't pay high fees. Lots of brokers have great track records until you subtract their fees. In fact, it is probably impossible to have a great record unless you charge low fees. Instead, buy an index fund of the entire U.S. Stock market, and act like you forgot you have it. And don't establish a Health Savings Account with the first agent you happen to meet. I once overheard my mother advising my daughter, "Don't marry the first man who asks you."

Eligible Health Expenses

Back when Health Savings Accounts were started, just about anything you could buy in a drugstore was a healthcare expense. However, if you go into a drugstore today, especially a chain drugstore, you can buy ice cream cones, cosmetics, shaving equipment and so many other things, you have a little trouble finding the pharmacist. Therefore, a debit card receipt from a purchase of a drugstore item will cover many more things than the Health Savings Account originally contemplated.

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Eligible-item Debit Cards {bottom quote}

Evidently, a number of people exploited this loophole, and it isn't surprising the regulators responded with regulations. The drugstores could have responded by making debit cards only apply to eligible items, but many didn't. So now you need a prescription from a doctor for the item, and you are subject to a 20% fine if you use the accounts for a non-eligible service. Some congressman could devise a system which would serve the purpose without the red tape, and Congress might get rid of this nuisance on behalf of the (now) 14 million subscribers to HSA, and the already beleaguered clerks in the drugstores. Next thing you know, the medical supply stores will start selling ice cream cones, followed by more regulations to prevent such evasions. That's of course the problem with depending on the stores to give up the illicit sales, in preference to giving up the red tape.

Several websites have started broadcasting lists of eligible items, hoping you will buy such items from them over the Internet, and eventually competition will sort this out. Meanwhile, we have to advise you to check the websites before you shop.

Almost Good Enough

That's the good side of C-HSA. What continued to bother me was it was close to providing lifetime healthcare financing, but without much latitude. Perhaps it would be better to settle for half, or a quarter, which would certainly have plenty of latitude for revenue shortfalls. Better still, perhaps a way could be found to phase it in, but stop when it runs low on money. Because it contained so many little pleasant surprises, however, I decided to press onward to see if others could be found.

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Whole-life insurance is more profitable than term insurance, but it requires more capital. {bottom quote}

What emerged were these new ideas:

1. Multi-year policies. To go from a term-insurance model to a whole-life model, using the life insurance approach. This would take advantage of the uptick of the yield curve in compound interest discovered by Aristotle long ago, inflecting at about the forty year mark. And advances in science would provide some extra years of longevity, to take advantage of it.

2. Escrowed Sub-Accounts. Instead of one big balance, it became apparent that some funds were intended for long-term use, and were therefore entitled to different interest rates ( checking account, savings account, investment account), which the account manager would wish to have locked for a given time or purpose (66th birthday, ten-year certain, $10,000 minimum, etc.).

3. No age limitations. Further longevity could be introduced by making HSA a lifetime compounding experience, cradle to grave, but how to fund it remains an issue concentrated on the life alternatives facing those, age 21-66.

4. Birth and death insurance, catastrophic, disability, etc. Exploring the idea of HSA from birth, I came to realize the extra cost of the first year of life was a serious impediment to all pre-funded health schemes, since one can scarcely expect a newborn child to finance a debt of 3% of lifetime costs, in advance. To make matters worse, the same is even true of the 8% of lifetime costs up to age 21. Thinking that one over, I came to see why nobody had ever devised a really adequate scheme for lifetime coverage. Seen in that light, it became clear the consequences justified solutions which might upset ancient viewpoints about a vital and sensitive subject. Whether recent turmoil (about same-sex marriage, unmarried mothers and the like,) would soften resistance or harden it, was just a guess. The result of this thinking was birth-and-death insurance, covering only the first and last years of life. Furthermore, it became easier to contemplate the issue of perpetuities, or inheritance from grandparent to grandchild. The laws already sanction inheritance to 21 years after the birth of the last living descendant, generally adequate for the purposes in mind here. All such special-needs insurance tends to reduce the remaining liability of general-purpose insurance, and typically is not workable unless the two insurers coordinate with each other and keep adequate records of their compacts.

5. Passive Investing and Dis-intermediation.The whole concept of "passive" index investing was borrowed from John Bogle of Vanguard and Burton Malkiel of Princeton. Recent difficulties in the fixed-income market make stocks seem just as safe as bonds to more people, and generally they provide more yield. The historical asset tables of Roger Ibottson of Yale inspired further confidence in the approach. Having absorbed this lesson, the concept of replacing an advisor with a safe deposit box emerged, although custodial accounts are not expensive. This maneuver could shift the "black swan" risk from the agent to the investor, assuming the agent has not shifted it, already. Ownership of common stock may not be entirely perpetual, but partial ownership of an index fund containing a trillion dollars worth of common stocks, certainly does seem perpetual enough for ordinary purposes.

6. Zero-balance protection devices. The potential that someone might figure out a way to game this system had to be considered, in view of the staggering magnitude of this proposed funding system if it caught on. The brake which suggested itself was to force the balances to return to zero at least once in a time period, and possibly many times oftener, if necessary. Offhand, I do not see how this system could be gamed, so the power to impose zero balances at a trigger level of balance, is a credible threat if it impends.

7. Total-market Index funds as a currency standard. One throw-away idea emerges from this analysis. The world economy went off the gold standard some years ago, and since then has adjusted its currency by inflation targeting. In the recent credit crash, however, the Federal Reserve has been unable to reach the 2% goal for some time, for unknown reasons. If the reason for this remains unclear, or if the reason is unsatisfactory, it seems to me the total market index of the nation's common stock would be a superior proxy for re-basing the currency on the national economy. If other nations copied this standard, their central banks could agree on a system of leveraging it between currencies, but the essential fact would remain that each nation's currency was a proxy related to its national economy, ultimately based on the marketplace. That might even restore matters to where they stood before 1913, when the Federal Reserve was created. This certainly would be superior to what some people accuse the Federal Reserve of plotting (expunging our considerable debt to the Chinese by inflating our currency.) As people say, this matter is above my pay grade, but it certainly would have the advantage of stabilizing the medical system, and ultimately the retirement system. The need for protection against bit-coins might be kept in mind. If it prevented entitlements from off-the-books accounting, I would consider index funds as a currency standard, a considerable advance.

The addition of some or all of the above seven or eight features would provide more than enough extra money to fund the entire medical system until such time as it was forced, by scientific advances, to become a retirement fund with a small medical component. We have the rough estimate of $350,000 average lifetime medical cost, but no way at all of judging the average retirement cost, so this concept will have to terminate in fifty years or so, or when the data catches up with the theory. After all, the limit of desirable retirement income is not infinite for everybody, but it is obvious it is infinite for some people.

This synopsis of the additional concepts for Health Savings Accounts concentrates on paying for healthcare with a cash cushion in reserve, so it does not dwell on technicalities, favorable or unfavorable. It does however skip over one theoretical issue of some importance: where does this money come from? Linked to that is the wry observation that it proposes to reduce medical costs by spending gambling money from the stock market. Since people who would say that, show no reluctance to hurt my feelings, let me make a forceful reply.

The designers of the Medicare program in 1965 faced a huge transition problem, too, and nevertheless, plunged ahead in spite of badly underestimated future costs. So, although revenue surfaced in the HSA proposal had been there all along, it was never gathered and put to use -- wasted, let us quietly say. I do not blame Wilbur Cohen or Bill Kissick for making concessions to get it started. There is little else they could do from 1965 to 1975 except adopt a "pay as you go" strategy. But sometime after 1975 that was no longer the case, and the new opportunity was neglected in a befuddled realization that costs were going to escalate rapidly, although hidden from sight. A great many free-loaders were added during the transition, and there was little to do except wait for them to die. So, yes, things were allowed to get worse than they needed to get, but as a nation we happened to be even luckier than we deserved to be, as scientists eliminated dozens of diseases we might have had to pay for. Until the end of that race between costs and revenues had come into sight, it was not possible to guess which one would win.

So now it is our turn to make proposals. We must face similar daunting problems of transition by a partially paid-up constituency, headed into a fully-expanded set of benefits for at least thirty years. Plus a huge and undeclared national debt from borrowing to pay for previous mistakes. I have tried to be generous in my assessment of the 1965 achievement, which was considerable. Let us see whether the opposition party can bring itself to respond generously and without intransigence, however vigorously they may subject the issue to adversary process. It doesn't mean to be a punishment, it means to be a rescue.

Simplified Math

Let's do some simplified math. The ancient Greeks, possibly Aristotle, discovered that money at 7% interest will double in ten years. By remembering this simple accident, you can follow the math of Health Savings Account in your head, without writing anything down. If you remember that life expectancy is now 84 years, you have eight, going on nine, opportunities to double your money. Go ahead and do it: 2, 4, 8, 16, 32, 64, 128, 256, 512, 1024. At the rate things are going, a dollar at birth becomes 512 dollars at age 90, and it isn't unreasonable to hope for a thousand-fold increase in the future.

The current expectation is an average of $350,000 in lifetime healthcare costs per person. A gift to the newborn of $350 will almost pay for it. If he sets this aside for a lifetime, forgets he has it, or just doesn't spend it, it will cover his costs. Medicare is about half of the lifetime cost, so $175 at birth would pay for a buy-out. The individual is already paying a quarter of Medicare as payroll deduction, and another quarter as premiums. So, it would cost something like $87.50 at birth to pay for the rest. Whether it's a gift of his family or a government subsidy, that is manageable. It's close, but it's manageable.

How do we get 7% interest? We assume an index fund of the total stock market will produce 11% per year, because that's what it produced for the past century, in spite of wars and recessions. We assume 3% inflation, for the same reason, leaving 8% net return. Because every 28 years on average we have a "black swan" stockmarket crash of 30-50%, you have to ride it out. Therefore, the conventional advice is to invest 60% in stocks and 40% in bonds, reducing your net return to 5%. But unlike a college or a museum, we have no payroll to meet, so we only use 60/40 after the age of 50, when major illness costs begin. That brings us up to 6.5% overall, after the HSA gets past its early transition costs. Since index fund investing is now readily available for less than a tenth of a percent management cost, we ignore the present fees of ten times that, which are customary. If you are forced to it, just put the certificate in your bank lockbox and have it opened when you die.

How much you actually invest at birth, or whether some other payment method is employed, are political decisions. The point to be made right now, is that passive investing of this sort is close to being feasible. It is close, but a cure for cancer or diabetes might make it a sure thing. The points to be made are two:

1. Adopting this approach with the Classical Health Savings Account, may or may not pay for the whole health system for everybody, but it would pay for a mighty big chunk of it.

2. The rest of this book, attempts to find a few other improvements which really would pay for the whole system with some confidence. There's no way to prove it was successful except to conduct some pilot programs. I would expect that dozens if not hundreds of other people would try to find other refinements.

(Second Edition)Exit Strategy, Health Savings Account Death Balances

A subscriber with both Medicare coverage and an HSA may die with a balance left in his HSA account. That's what we would like to see, since it suggests ample provision for two universal needs. But what is the most useful re-direction of the surplus? Having died he can no longer use it, and his will may or may not indicate his wishes. True, he originally deposited the money in the account, but escaped income tax, so the government retains some sort of ownership right to the principal and its income.

If the government follows my suggestion, it will have established a first and last-year of life re-insurance program. In that case, a thing likely to result to a surplus at grandpa's death would be to use it to reduce the cost of health insurance for the grandchild. As they say, possession is nine-tenths of the law. Here, it seems a valuable thing to encourage, since it reduces the reluctance to fund the health expenses of a vaguely-related or even unrelated grandchild. Society not only has an incentive to soften the burden of maintaining the population, it probably also has the incentive to diminish its frictions. The less it costs, the more it eases the friction of odd-ball relationships, making it less likely for divorces, gender-changes and unrelated hostilities to end up in court. It thus suggests a welcome candidate for a default use of the money. Everyone who considers these matters deeply should remember, the traditional judge of such matters once was the family unit.

Having considered such a contingency, the next question arises whether all surplus in the HSA of someone who dies should be treated the same way-- that is, adding it to a first and last year-of-life pool. It would thus assist a basic function of everyone, and leave the burden of proof on those who feel a particular family situation has a higher claim on the money than society as a whole. A somewhat different approach might be to recognize newly-deposited money in an HSA is mostly original fully-taxed money, but over time a growing proportion of it comes from investment interest on the tax deduction. That is, the funds of younger people are mostly their own, but toward the end of life the government tax exemption has a growing claim to ownership. It would not seem unreasonable to switch the ownership presumption at the age of retirement, or some other surrogate for advancing age and changing responsibilities. These things change with time; consider how many orphanages there were a century ago, and how few there are, today.

HRSA preferable to 401(k)?

A recent article in the Wall Street Journal announced to the world that Health Savings Accounts were a better bargain for the investor than were 401(k). That's certainly true if you spend the money in an account for approved medical expenses, or if you roll it over into an IRA at the time you receive Medicare. But it's also even arguable if you spend it in any other circumstance.

Let's put it this way: If you had an IRA or 401(k) but not a Health Savings Account how would you justify it? The HSA gives a double tax exemption for health services, but you are no worse off if you remain healthy. Of course you are better off with an HRSA. Of course, that may change, but then the oceans might some day pour over Chicago.

Well, you can't have an HRSA if you are under 21, over 65, or covered by a health insurance policy that doesn't have a high deductible. The Affordable Care Act mandates high deductibles for everybody, but there are still occasional loopholes, probably soon to be closed. If your policy has co-insurance features, that's actually probably an argument to switch out of it. You can't have an HSA if you are also covered by some other government plan. All three plans are sometimes subverted by self-serving intermediary fees, but you just have to shop around for the ability to choose your own investments. That may cause you to pick an inferior health insurance plan, so keep looking. Eventually, some people will reach their limits and need more than one retirement plan, but that's different. Although Health Saving Accounts are spreading nicely, there must be a hundred million people who have no reasonable answer to the question of why they have a 401(k) but not an HRSA, so please read on.

Most of the arguments for having an HSA rather than a 401(k) boil down to saying they are the same thing, but HSA gives you some health options in addition, so why not have them. However, it is possible that your employer has selected a poor 401(k) vendor, one who adds unnecessary fees and requires investments which themselves have poor performance because they are loaded with more fees. So, if you are dissatisfied with 401(k) results through your employer, you may wish to shop around for a better deal, and you might as well pick one with some health benefits attached. After all, the Affordable Care Act mandates high-deductible insurance, so that part of the requirement is likely to be fulfilled already. Since you picked it because of disappointment with your employer's 401(k) investment results, you may encounter some resistance from the Human Relations Department. All in all, there is little value in switching until the employer mandate issue is settled -- except the value of the uproar you create, trying to get treated more fairly. However, there are a few other issues if you have an agreeable employer.

Claims Adjusting for Trivial Claims. In the first place, the HSA wanted to make it possible to skip the middle-man cost and oversight, and simply pay bills with a debit card. So an "allowable" medical expense is more broadly defined than what a health insurer might allow, or at the very least it dispenses with the cost (and delay) of insurance review prior to payment. Since the Account part of the HSA was mainly intended to pay for deductibles, it didn't seem cost-effective to subject extra costs to fruitless but expensive insurance scrutiny. It also eliminated the delay occasioned by remaining on the desk of the hospital billing department for several weeks before someone submits it to the insurer to pay -- when the debit card could just as well have paid it immediately. Just how much these thoughtless design features actually add to the cost is uncertain, because it's used as an excuse for delays which may have other causes.

Skipping Insurance Claims Entirely for Small Claims. As things have turned out, forty percent of HSA accounts have never submitted a claim. Maybe they don't get sick, but more likely the client calculates it is cheaper for him in the long run to pay his small out-patient charges in cash, while letting the Account gather compound interest. Aristotle is said to have complained that most debtors don't realize how compound interest is itself compounded, and rises with time. But maybe debtors are now smarter than Greeks in a toga. A debit card directly adds 2% to the cost, while interest rates vary with the economy. Incurring costs greater than the net is a waste of money, largely growing out of a supposition the employer is paying for this as a gift, and taking a tax deduction at higher corporate rates. That's only true half the time, but the other half haven't marshaled their lobbyists to equalize the tax exemption. Apparently, Congress believes the self-employed don't deserve this tax exemption as much as employees of major corporations do. Or possibly eighty years isn't long enough for Washington to fix the flaw. Let's go on with this, a bit.

Non-trivial Returns From Saving Small Scraps. We were saying HRSAs were a better investment than 401(k). To go forward with the logic, the client is effectively taking out a loan from his 401(k) when he pays his medical bills from it, or in cash, if the purpose is to preserve the preferable interest-bearing account. Assuming both accounts pay the same (you didn't get sick), the result is a wash. But as time goes on, the effective compound interest rate will steadily rise; so the extra profit was made without incurring any extra risk. That may not seem like much, until you employ the old maxim that money at 7% will double in ten years. Two, four, eight, sixteen, thirty-two -- it rises 3200% in fifty years. The stock market may rise or fall during those fifty years, and the client may get any one of a thousand diseases. Inflation may intervene, wars are likely to break out. But the relentless superiority of this riskless choice will persist. And get this: at the conclusion of the exercise, the client who gets sick pays no tax, while the one who was scared to do it, pays the higher progressive tax rate he attains later in life. The hypotheticals have to be carefully chosen to reach any other conclusion. But remember to get started young, because to wait ten years will reduce the multiplier from 32 to 16. The millennial generation complains the tax laws are stacked against them, but I don't see it. They are offered the chance of a lifetime, but they will only get one bite at the apple.

Is that all? Well, no, but there are competitors. The deposits in a Health and Retirement Savings Account, just as surely as the deposits in a 401(k), are occasionally subject to rather extreme middle-man costs. The stock market has steadily risen by 11% for the past century. Never mind that it's true past results can be unsound future predictions, just recall that even the "buy and hold" philosophy has seldom presented the investing customer with more than 5% net-of-inflation return. That's because inflation took away 3%, and hedging against "black swan" crashes (by putting 40% of the portfolio into bonds) has taken away 2% more. That leaves about 1% for the customer and the broker to fight about. More than anything else, this slim working margin has driven the investor to choose "buy and hold" over "market-timing". The evidence continues to accumulate that "buy and hold" is at least as successful as "market-timing", but people continue to market-time when they are desperate for the occasional big winner, never mind that big losers outnumber them. To me, the conclusion is clear the public will increasingly squeeze their friendly advisors for a wider slice of the pie. And in this, our central theme is repeated; the HRSA will out-perform the 401(k). Because the shopper for an HSA manager is the customer, whereas the choice of a 401(k) manager is made by the employer. Pass all the laws you wish about kickbacks; allowing the customer to select the manager will usually beat letting the employer do it for him. There's often nothing so expensive as getting something free.

Martin Feldstein Does It Again: Eliminate Tacit Tax Exemption for 70% of Workers Denied To the Rest

Headlines in the Wall Street Journal announced collapse of Congressional healthcare reform. In the same edition a small short article buried in its depths, described a possibly major step toward its reform. Martin Feldstein calmly observed, a tax exemption for healthcare insurance of 2.9% really amounts to a wage increase whose elimination might go a long way toward paying for the eighty-year mess Henry J. Kaiser had created. (In fact, it was effectively taxable income of 4%.)

It was all so simple: healthcare extended longevity, created thirty years of new retirement cost. In turn, exempting the premium for healthcare became a tax-exempt increase in wages -- for the 70% of employees getting insurance as a gift. Maybe not at first, but wages adjust to expect it during eighty years. Social Security could not cope with an extra thirty years, so SSA was going broke, while health insurance was actually the main cause of increased longevity.

But notice how unused Health Savings Accounts automatically turn into retirement accounts (IRAs) for Medicare recipients. So if you are lucky and prudent with healthcare, or if you overfund an HSA, unused healthcare money makes a reappearance in retirement funds where it belongs. If you have used up the money, you have probably been sick, and maybe won't need so much for a shortened retirement. Increasingly, expensive healthcare hits the elderly hardest, so there are many years during which compound interest overcomes inflation. At the rate things are going, retirement may become four times as expensive as Medicare, so let's consider that future.

Medicare doesn't save its withholdings, it uses "pay as you go" and spends the money on other things, like battleships. Therefore, to make any use of this windfall, it is necessary to save it, invest it, and use it for retirement. Just doing that much might redirect the other 30% of withheld tax to its intended purpose. So the economic effect would be considerable, just by stirring around in that corner of it.


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Classical Health Savings Accounts (C-HSA)
In a big legislative package, there are technical areas where the lobbyists have considerable sway in the outcome. Here are a few.

Some Unintended Opportunities
A concept is offered, hoping others can find a way to make use of it.

Good Ol' Health Savings Accounts
Possible fixes in HealthSavingsAccount to adjust to Obamacare. HSAs remain available and have millions of pleased subscribers. A debit card pays (tax deductible) medical expenses, and does the book keeping. High-deductible health insurance is also required, mostly to cover hospitalizations, but primarily to smooth out the unevenness of disease. Bronze plan is the cheapest Obamacare option, but private catastrophic coverage would be cheaper.

Commentary: Agency for Mid-Course Corrections
New blog 2014-09-24 23:43:43 description

Fun With Numbers

Expanding the Money in a Health Savings Account
New blog 2015-06-05 23:38:33 description

Black Swans and Portfolio Content.
New blog 2015-06-07 16:31:32 description

Longevity, a Moving Target
New blog 2015-06-08 02:26:37 description

What HSA Does for Poor Folks: A Proposal
New blog 2015-07-08 15:32:19 description

Investment Advice for Non-Investors
New blog 2015-07-15 20:25:54 description

Eligible Health Expenses

Almost Good Enough
New blog 2015-08-24 21:34:42 description

Simplified Math
New blog 2015-10-29 23:50:09 description

(Second Edition)Exit Strategy, Health Savings Account Death Balances
New blog 2016-02-04 20:32:53 description

HRSA preferable to 401(k)?
New blog 2016-02-05 23:26:12 description

Martin Feldstein Does It Again: Eliminate Tacit Tax Exemption for 70% of Workers Denied To the Rest
The Henry Kaiser tax exemption for health would pay toward Social Security, indirectly paying for retirement, which health insurance prolonged.