Philadelphia Reflections

SECTION SIX: Condensed Summaries

Summary: The Shifting Environment of Health Savings Accounts.

And yet another way to describe Health Savings Accounts, is as a series of places to put money, voluntarily moving from one category to another in response to the age of the owner, but potentially to environmental pressures. If the environment changes, the money might need to migrate, but it never disappears unless the owner spends it. Ideally, the money moves smoothly around in a circle, but it could pile up if some subscriber had unexpected personal situations. It's the subscriber's money, so we wanted to avoid locking him in, except by suggesting the most advantageous way to grow it or spend it. Many voluntary features could have been mandatory, with about the same result, but we wanted subscribers to innovate. The philosophy was that of the college president who built a new college without sidewalks. Only after the students had worn paths of choice in the lawn, did he order the paths to be covered with concrete? Here is a summary of the environmental factors we felt might change enough to warrant new pathways. The same idea applies to repair the lawn after a hard summer.

Demographics. China found it didn't work to limit families to one child, and selective abortions in India caused the same disruptions. The baby boom bulge is a notorious example of a population bulge working its way through the steps, until it finally came to rest in Medicare, threatening the program with bankruptcy when later generations don't bulge enough to support their parents. Some bulges and shortfalls are predictable almost a century ahead, and while the migration of illness and good health is slower, it will pretty surely boil down to two enduring health costs: birth and death. So, the demographics of each generation are basic, and they are often predictable. In our society's view, there is little you could or should do about it, so although we can predict demographic surplus and shortage, we should accommodate the effects, not directly modify the cause.

Wars and Depressions; Inflation and Deflation. Major disasters affect all generations, but sickness concentrates by age. Furthermore, health disabilities from war affect those of military age and their successors, and recessions cast a long shadow over later income potentials. It might be helpful to set aside funds for these disasters since it is possible to estimate the coming economic effects and to start generating income for approaching shortages. There may even be usable information about earlier wars and recessions on which to base such estimates.

Economics is known as the dismal science, reflecting skepticism about the predictions of economists. However, they are getting better at prediction, and should be given a chance to estimate the future effects on health care costs, to the degree they modify the modifiers. The more we do this sort of thing, the more we may find certain predictions cancel each other out. And economists' predictions are likely to reinforce the opinion that the best option is to steer for price stability, rather than resort to violent course reversals, a view not universally held by politicians.

The Nozzle of Transfer Points. It took the Federal Reserve a long period of experimentation to discover its most effective tool for modifying economics in the currency markets was to adjust short-term interest rates. In the economics of health care, I would venture the most effective can be had with the least commotion, by adjusting the transfer limits as money flows between age groups. When the leverage at age 21 approaches over 500-fold, the ranges of power over health spending are enormous. Therefore, regular transfers from the federal Treasury may be quite small, but probably should be prevented from going to zero. Since it is envisioned that grandparents might bequeath a certain portion of their death surplus generated from Medicare without reducing Medicare benefits, the small initial cash deposit is a point which would be noticed least in a panic. Alternatively, adjustments of the amount the grandparent was allowed to bequeath could have a similar multiplier on far larger sums of money. Ultimately, such modifications would have to be reversed when such funds start to accumulate income, but considerable time would pass, between age 21 and 65, to accomplish it. Both government and subscriber must learn the cheapest time to pay bills is while they are small.

A second adjustment tool exists in the ability to require account balances to shrink or go to zero. The money would be given to the account holder, but would simply stop generating income until the required adjustment took place. Opportunities would appear at birth, at age 21, at age 65, and at death. Furthermore, large populations would achieve these ages at different times, so opportunities for adjustment would extend over a range of time. It took the Federal Reserve a long time to learn the sensitivity of adjusting interest rates, and it would take an equally long time to learn how to use these tools as well. It took a particularly long time to learn the most important lesson of all: what the limits were, for accomplishing anything worth-while with these tools, at all. Everything speaks in favor of establishing a monitoring agency, with defined powers and required limits, permanently devoted to this subject alone, periodically reporting its findings to the public.

What I Have Learned (1)

This book has been an education for its author. Ordinarily, an author starts with a general principle and offers a specific example of how it works. But I repeatedly found this field changed so quickly, changes in the numbers made the example seem awkward, if not invalid. Or one component changed, and balancing numbers were unobtainable. But I believe the underlying principles remain valid. It's better to earn interest on idle money than not to earn it, for example. But when the circumstances shift, the amount of interest to be earned -- and consequently the proportion of healthcare costs it will cover -- also shifts, allowing opponents to bring the underlying principle into doubt. When this process repeatedly leads to rewriting a whole book before it can be published, it essentially stifles debate. So I finally decided it was better to open the debate than worry about ridicule from hired political consultants over "framing the question" , or protecting my offended feelings. At my age, what would I care about that, for heaven's sake?

So let's follow the trail of the book, and put together what I think I have learned, in the order in which it appears.

Pay for important things, first. Health insurance began a century ago, with good motives, but the wrong approach. It's upside down, in the sense it started with the problems of poor people and extended the approach to non-poor ones. Consequently, it offered "first dollar coverage" but threatened savings running out for truly expensive items, life-threatening ones. The most suitable way to get around this seems to be to have a high-deductible policy, which lets the patient decide what is truly most important. But two things then come in conflict: the higher the deductible, the lower the premium. That's good, but what's bad is the higher the deductible, the fewer people can afford its out-of-pocket component. So the Health Savings Account addressed this dilemma by linking high-deductible ("catastrophic") insurance to a tax-deductible savings account. In effect, the poor person could build up the deductible on-time payments. It isn't perfect, but it was enough better so 15 million people adopted it, and their premiums became 30% lower. And so, more people could afford it.

Earn interest on savings. Then the patients taught me a lesson. In spite of abnormally low interest rates, people seemed to perceive that major illnesses come late in life, and longevity had lengthened considerably this century. And they liked the ability to judge their own health, letting the healthy ones pick stock investments if they chose to because low-interest rates shift many investors from bonds to stocks, which then rise. Sickly people could choose bonds or tax-exempt savings accounts. Quite unique to American retirement funds, this one gives a second tax deduction when you spend it (if you spend it on health).

If there is money left over, you get to keep it. Conventional health insurance spends any left-over money to reduce premiums, they claim. This one gives any money you save back to you, as an incentive to be frugal. I suspect some people thought a bird in the hand was worth two in the bush, which means they didn't exactly trust insurance companies to lower premiums fully, but might raise the salaries of insurance employees with some of the savings.

In time it develops a different significance: if you are lucky and healthy, you spend the left-overs at age 66, for retirement income. The news about the approaching insolvency of Social Security encourages that choice. At least, it begins to look as though Social Security benefits might not be raised, so you may need the money more at a later time; compound interest makes Health Savings Accounts worth more, later. Frugality early, leads to more income later.

If anybody gets a tax deduction, everybody wants the same. For eighty years, employees of corporations got health insurance with a tax exemption, but half of the population didn't. That amounts yearly to a couple of thousand dollars for a family, twice that much for the corporation itself (at its higher tax rates), and the possibility that even more of it escapes to foreign tax havens. By simply allowing the Health Savings Account to buy the catastrophic insurance which is required, this egregious inequity would disappear. If that gets blocked in Congress, then simply reduce the corporate tax rate, which corporations don't pay anyway because of the tax deductions. You might appear to be rewarding corporations, but you really are only shifting their deduction.

Save your deductions for later. It was a surprise to find 40% of subscribers to Health Savings Accounts paid for small health expenses out of pocket rather than take the tax deduction. It suddenly made sense that if the account would grow, and in any event, you would get it back at age 66. You should pay out of pocket when it is small, saving the deduction until later when it has grown.

Split the payment system. Cash for outpatients, insurance for helpless inpatients. When you take away someone's clothes, and he is too sick in the hospital to argue, competitive prices are meaningless to him. Prices should be set by outpatients, who are free to trade elsewhere. A surprising number of inpatient services are identical to outpatient services, which should set the price for both. Some are unique, so a relative-value scale should be constructed to include them in the relationship.

Both the DRG system and co-payments are abominations. Payment by diagnosis is akin to service benefits, wrapped in a rationing system. Pay a fair fee for a necessary service, don't pay for unnecessary ones. As for copayment, it simplifies collective bargaining, but creates two insurances for one service, and has been repeatedly shown to have no deterrence value.

Reverse the Maricopa Decision, preferably with legislation. Mrs. Clinton's plan of ten years ago was for a system of Health Maintenance Organizations (HMO). She can thank her lucky stars it didn't pass because the public rejected them. HMOs were in fact invented by groups of doctors and worked quite well. The essence of why they didn't work lies in the Maricopa decision that doctors were forbidden to run them. The Maricopa decision (4/3 on the Supreme Court) was based on a motion for summary judgment and never had a trial of the facts. Let's see if Congress can improve on that.

Substitute Catastrophic health insurance for any and all versions of limited benefits, including the Affordable Care Act. Catastrophic insurance is now privately run, and it is difficult to obtain data on costs and expenses. No doubt the plans vary considerably. But the system of indemnity insurance is superior to that of service benefits, and high deductible is superior to mandatory benefits. Catastrophic plans seem vulnerable to kickbacks, and should be examined to minimize that; perhaps I am wrong. Nevertheless, catastrophic was seemingly the cheapest of what's available and is certainly more flexible. If we must have mandatory health insurance -- and I'm not saying we must -- mandatory Catastrophic coverage sounds better than any alternative. But if we go that way, we need better studies of it.>/p>

What I Have Learned (2)

That's what I believe I have learned from the Classical Health Savings Account of 1981, and what I think will improve it still further. Essentially, that's a correction of the tax inequity, removal of the age restrictions to make it optional at any age, and an enlargement of the deposit limits. It requires very little legislation to accomplish those three things.

But my own horizons have been expanded by the reception of the original, simple proposal. So I have some additional suggestions for Congress to consider, for a New HSA which is an extension of the classical variety. These ideas tend to bump into other programs and require negotiation of the apparent difficulties, with resultant adjustments of other plans, originally intended or other purposes.

Encourage the use of index funds as sources of investment income for HSAs In this era of abnormally low interest rates, the public seems to like the substitution of common stock, even though it seems risky. I'm afraid we have learned that bonds are just as risky. But they pay considerably less, except in rare moments of "black swan" recovery from a stock market crash. Roger Ibbotson of Yale has published the long-term results of the entire stock market, which today we would equate with total market index funds. He found the results over the past century have averaged 11-12%. At a viewing distance of about three feet, regardless of many wars and stock crashes, if you had bought the whole market and forgot you had it, the average looks pretty much like a straight line. That's no guarantee it will be the same in the coming century, but it's the best guess you can make, particularly if you don't read the newspapers very often. Buy-and-hold almost becomes buy and forget.

That's the wrong risk to worry about, however. Inflation and imperfect agency are much greater risks for buy and holders. At 3% a year, inflation has reduced a dollar to a penny, in the past century. So, instead of 11-12 %, a buy-and-hold investor really only gets 8-9%, net of inflation. In addition to that, every 28-30 years he encounters a black swan stock market, loses at least 50% and lacks the courage to buy it back at its low point. From that point forward, the market "climbs a wall of worry", and he finally buys it back just when it regains its peak. The time-honored remedy is to buy a mixture of 60% stocks, 40% fixed income (bonds), which further reduces real income to 4-6%. If we ever cure this habit, gross stock prices will probably gravitate toward paying 5-7%, gross. Unfortunately, middle-man fees and kickbacks now result in the customer getting 4-6%, trying to avoid getting zero. Unfortunately, the majority of experts actually surrender somewhat less than that, and the reasonable investor simply buys index funds and forgets about them. That is, it comes out about the same, unless you get greedy, in which case most people end up losing money. For the most part, whether you win or lose, mostly has to do with where the market was when you started.

Consequently, we here advise "passive" investing, in an index mixture of total American stocks and bonds. You will do better than most people, and that's a pretty good badge of success. However, the puzzle is whether rules and regulations can improve on this result still further, by a tenth of a percent, here and there. Those who promise more will probably deliver less.

Stretch out the compound interest as long as possible. Since Aristotle, it has always surprised people to find compound interest rises at the end of its term, so the longer the better makes the best outcome. We make three suggestions:

1. Don't buy term insurance (like most health insurance), buy whole-life. You might turn the whole business over to whole-life life insurance companies with experience in these matters, but they are private companies who can do as they please. The next-best choice is a Health Savings Account, which rolls any unspent balance over to later years, and gives it back to you at age 66. It's tax-exempt, and if you spend it on healthcare, it is doubly so. If you waited another twenty years, it would grow quite surprisingly.

2. Use last year of life reinsurance. People die at different ages, but the last year is usually the most costly, and it happens to everyone. If you set aside a comparatively small amount of money at birth, it will multiply 289 times at 6.5%, by the age of 84, the current average longevity. If you got a 7% net, it would grow nearly 1000-fold. If transferred to Medicare, it reduces Medicare costs by at least a quarter, and Medicare really should refund a quarter of your payroll deductions as well as your Medicare premiums, maybe even more. The arithmetic is pretty complicated, but with luck, it might pay for all of Medicare, except for existing debts for borrowing earlier when we ran a deficit. Furthermore, Medicare is 50% subsidized, so that has to be figured, too. Extending this subsidy to everyone is a big argument against single payer, by the way.

3. Use first year of life reinsurance. This is the reverse of the above because the 3% of healthcare costs now thought to affect newborns is almost invariably donated by another generation. Young parents without much savings are strained to subsidize their children, so you might as well include children to the age of 21, which is 8% of healthcare costs. If you overfund Medicare by $100 at birth, it will grow by enough to subsidize grandchildren by the time grandpa dies. There are laws against perpetuities, but they limit inheritances to one lifetime, plus 21 years--plenty of time. This is a new concept which will take time to adjust to, but I can think of no other way to pre-pay a newborn. If you use some variant of this approach, health costs could be reduced by another 8%, for an additional cost of less than $100.

In closing, let me remind the reader health insurance is turning into a gigantic transfer system. The middle third of life is supporting the two-thirds, before and after. And only the last third has much sickness. People who are well don't like to subsidize those who are sick, and eventually may rebel. It's much better for young individuals to subsidize their own old age than for one demographic group to subsidize another group of strangers. Particularly if those few who are lucky and escape much sickness, get to keep the savings for their protracted retirement.