Health Care and Health Savings Accounts (Part 2)

The Health Savings Accounts (HSAs) program, in effect since 2004, provides tax deductions to individuals on condition that they spend the tax-free money on health care needs. The Bush administration's rationale is that "market forces" will drive down health-care costs, just as they drive down the costs of other commodities.

In the previous column I argued that this rationale is fallacious, since health care is unlike ordinary commodities: Evaluation of health care needs, ordinarily the function of a doctor, is disconnected from the selection, benefit and payment for health care, usually the functions of the consumer or insurance company.

Despite the emptiness of the abstract appeal, HSAs might have value. To decide what that value might be, we must look at the specifics.

Health Savings Accounts are one part of a two-part scheme.

The other part consists of highdeductible health care policies (also called High Deductible Health Plans, or HDHPs). Taking out such a policy is one of the requirements for establishing a Health Savings Account. The yearly deductible for such a policy, roughly speaking, runs from $1,000 to $2,500 for single coverage and from $2,000 to $5,000 for a family. Because deductibles are higher than in the usual insurance policy, premiums are lower. Preventive care is included and does not count toward the deductible.

The Health Savings Account itself consists of money contributed by the individual consumer or by his employer (or both), up to a limit that does not exceed the amount of the deductible for the high-deductible policy. These contribution are tax-deductible. (Note the hidden government expense in the form of the tax deductions.)

The funds in an HSA may be spent, tax-free, on a wide range of medical expenses, including, for example, dental and vision services. Any amount not used in one year is rolled over to the next year and accrues interest. The account is portable, i.e., it doesn't vanish if the individual changes employers. Contributions must stop when the individual enrolls in Medicare, but remaining funds can still be used for medical purposes, tax-free. Or they can simply be withdrawn, in which case they are taxed.

A proposed addition, which may or may not go anywhere, is to grant tax credits, totaling $3,000 a year, for low-income families (those making $25,000 per year or less) to apply to the high-deductible policies and HSAs.

How valuable are HSAs? This divides into two questions:

1) How well do HSAs reduce health-care costs for the nation as a whole?

2) How well do HSAs serve the individual consumer?

We must be careful to consider HSAs apart from the high-deductible health-care policies (and from the tax credits, if they ever come into being), for the one can exist without the other. However, since the high-deductible policies are a prerequisite for the HSAs themselves, let's take a look at them.

Employers providing health-care benefits appreciate the high-deductible policies because they take some load off the employers' shoulders (lower premiums) and shift it to the employees (higher deductibles).

And they work well for individual consumers as long as the consumers stay fairly healthy and as long as they can afford whatever premiums they have to pay. But if health-care expenses begin to mount, the consumer will have to pay out of his own pocket until the expenses add up to the deductible amount, which may be several thousands of dollars in a year.

The high-deductible policies do not, in themselves, serve to reduce overall costs; in this respect they are on a par with any other health insurance policy. It might seem that the high deductible would make consumers less likely to seek care for trivial ailments, but by the same token, the high deductible might make consumers less likely to seek care for the initial stages of a serious illness.

Now let's look at HSAs themselves. As mentioned above, their purpose is to use tax deductions as a way of motivating consumers to use their own money for the more ordinary, nondevastating health-care expenditures. This will presumably encourage wise and thrifty behavior on the consumers' part, which in turn will engender competition and lower prices on the part of providers.

The idea of making consumers more thrifty by making them more responsible for their own care is not a new idea; in fact, it has been a commonplace of the insurance industry, signified by the somewhat misleading term "moral hazard." This refers to the fact that when a person is insured and doesn't have to bear the burden of his misfortunes, he may become more lax in protecting himself. For example, a moral hazard in home insurance would be the insured person's failure to protect the home against burglars.

Insurance protects against moral hazard through deductibles and copays, especially the latter. These make the insured person pay some- not all- of the cost of a loss or other expense. And that is just what HSAs are meant to do: The consumer pays some of the cost of a health-care incident because the money comes from his own pocket. But he's not paying for all of it; his cost is reduced by the amount of the tax deduction he has received by putting money into his HSA.

Thus an HSA is like a governmentprovided health insurance policy with an extremely high co-pay. For persons in the 15% income-tax bracket, the co-pay is 85%. For persons in the 25% bracket, the co-pay is 75%. And so on.

Any way you look at it, the purpose is to encourage thrifty, competition-inducing behavior on the part of consumers.

That is the theory. What is the reality?

In judging the benefit from HSAs, the first thing to consider is that they have virtually nothing to do with the most serious illnesses- chronic conditions, cancers, heart disease, and so on. These eat up the lion's share of health care expenditures (for example, about one-fourth of all Medicare expenditures occur in the final year of patients' lives), and they will quickly gobble up whatever a consumer has been able to set aside in his HSA, leaving the greater amount of those costs for the highdeductible insurance policy.

So the cost-reduction effects of HSAs are minor at best. But within their own limited sphere, how effective might they be- in particular, how effective might they be in comparison with other kinds of programs?

There are several ways in which HSAs might work to produce lower costs:

• Consumers will not make unnecessary (i.e., non-emergency) trips to emergency rooms, where costs are much higher than for ordinary trips to doctors' offices. This would certainly save money. But when people go to emergency rooms for non-emergency reasons, it is usually because they are financially desperate, not because they are unwise or spendthrift. The remedy is to provide them the funds they need, by way of insurance or tax credits, neither of which is part of the HSA program per se.

• Consumers will not seek care for frivolous complaints. This could also result in savings. But when is a complaint frivolous and when not? And who is to decide? Here the disconnect between selection and evaluation comes into play: Only a doctor has the expertise to evaluate a complaint. If a consumer unknowingly judges his symptoms to be frivolous, the result may be a serious illness and serious expenses.

• Customers will take better care of their health. When consumers switch to a more healthful lifestyle, and when they seek more preventive medicine, savings result. Therefore it's a good thing that high-deductible health care policies exempt preventive care from their deductibles. But what do HSAs have to do with prevention? If a person strives to continue in sound health, it is because he wants to live longer and be stronger, not because of the few dollars he might save.

• Consumers will "shop around" for doctors who give the best price, thus bringing about price competition. This is apparently the main thrust of the argument for HSAs.

Can shopping around reduce the amount of health care provided? Not very much, because the amount of health care is not in their hands. Here the disconnect between evaluation and decision-making comes sharply into play. Doctors, not patients, are qualified to make the crucial decisions as to what care is needed. The medical profession has made efforts to cut down on unnecessary tests and procedures, but these aim at doctors' decisions, not patients'.

Can consumers bring down the price of a given amount of health care? Well, let's ask plumbers and auto mechanics. We pay our own money for their services, but that hasn't served to bring their prices down. Doctors, like these other groups, are few enough in number that even without overt collaboration they can hold the line on prices and tell customers to "take it or leave it." Indeed, doctors are in an even stronger position than plumbers and auto mechanics because the crucial importance of health care leads many consumers to choose on quality (or reputation) rather than price.

In short, the doctors have all the market power; individuals have none. But this very fact points to a better way of keeping prices down3the way Medicare does it, using its greater market power to negotiate with providers, telling them to take it or leave it. (An instance, let us note, wherein government accomplishes what the mythology claims for the free market.)

Also consider this: Those who have HSAs are essentially in the same position as the more than 40 million persons in the U.S. who lack health insurance. In both cases, whatever money they spend on health insurance is their own (excluding expenses paid by the high-deductible insurance). No one, to my knowledge, has claimed that the behaviors of the uninsured bring prices down. And if their behavior hasn't made a dent in costs, why should we expect HSAs to make a dent either?

So overall, considering all the specific pros and cons, I can't see HSAs as having much of an effect on health-care costs. My wild and uneducated guess is that they may knock one or two percent off the national health-care bill, no more.

Then what about the other major question: How much do HSAs benefit the individual? They have some virtues: the wide scope of benefits; portability; the roll-over provision. But their basic fault stems from the same feature that is touted as their strong point, namely that the individual uses his own money.

Here two considerations are in play: risk and responsibility. HSAs are put forth as a way of increasing individual responsibility. But to make the individual responsible means, in the nature of the case, that the individual is subject to risk, including risk he has no control over. Protection against undue risk is the function of insurance plans. Considered as an insurance plan, HSAs offer feeble protection (remember the extremely high co-pays), so under an HSA regime the individual will simply have to hope he's lucky. Those unlucky enough to be hit hard by illness will still suffer, and those unlucky enough to be poor may not be able to afford HSAs, much less the high-deductible insurance.

In short, HSAs favor the healthy and the wealthy3the healthy because they get the tax break for whatever they put into their HSAs without having to spend much of that tax-deferred money for health care (in effect, they get an additional IRA); the wealthy not only because they can more readily afford an HSA but also because they are in the higher income-tax brackets and therefore enjoy larger tax deductions.

(Incidentally, the attractiveness of HSAs for the healthy leads to concern about a sort of reverse cherry-picking that healthy consumers will flock to HSAs, leaving the existing conventional insurance plans holding the bag with all high-risk, high-cost customers in it.)

Of course, the proposed tax credits would help those at the lowest end of the scale, with incomes under $25,000, yet that proposal does nothing for families with incomes above $25,000 but still hard-pressed by health care expenses. Furthermore, the tax credits would be separate from the HSAs themselves, and if the government is going to spend $3,000 per family, why not simply buy them a health insurance policy?

So from the individual's viewpoint, HSAs are better than nothing, but that's all I can say for them.

All in all, some features of the HSA program are commendable, for example, the wide range of covered expenses, and portability as well. Extensive copays in cases where the consumer really has a choice, e.g., where he can choose generic medications, is also a worthwhile idea. But from any point of view the program as a whole is clearly not the answer to the problems of health care, and it is no substitute for a comprehensive program of health insurance.
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Volume 2, Issue 5, Posted 12.40 PM / 08th March 2006.