Chocolate and Gold Coins

Thursday, February 16, 2006

Health Saving Accounts

President Bush in his State of the Union address pushed for Health Savings Accounts (HSAs) to help reduce medical expenditure. HSAs have gotten a mixed reception from the blogosphere. The current way we do health care in the U.S. is very expensive and a move to put more of the burden of spending on the individual should reduce costs, but it also might increase risk.

The main health risk that individuals would face if they self-insure is chronic disease: diabetes, HIV, cardio-vascular, and cancer are the big ones here. These diseases pose a serious problem for private health insurance. I wrote an essay about that last year.

A year ago, I wrote Dual Insurance for Health Care. It is a good essay about the problems associated with private medical insurance and how we could mitigate those problems. Here is an excerpt:

A good example of private insurance as it should work is private automobile insurance. If I have a car, I am required by law to provide proof of liability insurance. I just show up at the insurance office and ask for a quote. They type in the information into their computer and determine what premium would cover my expected annual automobile insurance cost. Private insurance does one thing well, computing my expected payout. They charge this amount, plus a little commission, and they pay out the actual payout. Simple.

Now suppose a person comes into the insurance office and says “I need auto insurance.” “Why certainly, what type of car do you have?” asks the agent. “I don’t have a car anymore. I totaled it this morning. That’s why I need auto insurance.” This guy isn’t getting any private insurance. He needs social insurance. [Link]

Coincidentally, there were some interesting articles on Health Savings Accounts (HSAs) recently in the Washington Post and on Econlog.

Washington Post:

Health savings accounts are ostensibly supposed to fix the health system. Right now, tax rules subsidize company-provided health insurance, but they're less generous toward out-of-pocket medical payments; as a result, company health plans pay most bills and patients have no incentive to shop around for the best bargain. Health savings accounts end this tax bias. Anyone who buys an insurance policy with a deductible of $1,050 or more can open an account and save $5,250 a year toward out-of-pocket health costs, tax-free. This will shift control of medical spending into the hands of consumers, who will discipline overpriced hospitals and clinics.

Or so goes the theory. In practice, probably less than half of all health spending outside Medicaid and Medicare would be affected by the new consumer-driven discipline. Many hospital stays cost more than any deductible, so consumers would have no incentive to bargain; emergency-room patients aren't in a fit state to negotiate prices with their doctors. But consider an even more basic question: Is the ostensible reason for health savings accounts the real one?


In sum, health savings accounts are not just about ending the tax bias in favor of traditional company health plans. The administration is proposing a new kind of 401(k), and using it as an inducement to quit low-deductible insurance. Rich people, who gain most from the tax breaks on saving, will be first to sign on; healthy people, who subsidize sicker people in company health plans, will be right behind them. Their exit may force traditional health plans into a death spiral. The loss of the subsidy from healthy workers will drive premiums up, which will drive more healthy people into health savings accounts, which will drive premiums up further. [Link]


First of all, when he says that $5,250 is too much money to shelter, I totally disagree. To start with, I think that deductibles ought to be at least $5000. Moreover, I think people need to accumulate a lot of money in health savings accounts if they're going to be able to afford health care when they get old. Unless you want to count on Medicare, which if it were a private firm would be declared bankrupt, with its CEO under investigation for financial fraud.

And if traditional health plans--which are not real health insurance--go into a death spiral, why is that not a good thing? Let people buy catastrophic insurance instead. Let the government focus on paying for health care for the poor and the really expensively sick, instead of doling out tax subsidies for employer-sponsored prepaid health plans.

Another point that I would make is that the more you make a fetish out of taxing the rich, the more likely you wind up being opposed to anything that might increase private saving. You can preach about progressivity and you can preach about the need for increased saving, but not in the same sermon.

My problems with HSA's are more that I have a general aversion to programs that are beloved by wonks and operate through the tax system. Maybe that makes them politically clever, but I think you lose a lot in terms of consumer clarity and economic efficiency.

Finally, I worry that special savings buckets might create more substitution than net saving. People who would have saved the money anyway in other accounts put the money into HSA's because they get a better after-tax return. Not whole lot of net benefit there. [Link]

Also there is the Becker-Posner blog - a good discussion but not very quotable.

The current American health system, where most people get insurance from their employers, is the Ferrari plan (based on this analogy). Single payer health care advocates are pushing for the Yugo plan but most people see this as a really bad idea. I think it would be best to go something closer to the Accord plan, with a Bajaj plan for the poor, but I think the free market will not work so well for health care unless some provisions are made. I will explain.

The idea of HSAs is that we can self-insure most of the less expensive medical conditions. In theory, this is exactly right. We could be much more economical about health care if we each paid for it out of our own pockets. We could force health care costs down by shopping around for a better deal.

But opponents of HSAs have a valid point: these accounts might make it easier for firms to basically dump health care. What might happen is that firms will economize by raising the deductible. Since HSAs give the same tax benefits that employers get for offering health care, this would seem to be a move from the Ferrari plan to the Accord plan. But wait! What if you get a major disease like diabetes? What happens then? You’ll be paying maximum co-pays and deductibles every year for life. You’ll end up paying $100,000’s more than your neighbors. It will be exactly like not having insurance on your house and seeing it burn. It would be very bad indeed.

HSAs would work okay for minor medical problems but not for major medical conditions (like cancer) or chronic problems (like diabetes). We still need insurance for these types of problems. Now ordinary health insurance would work fine for short-term medical conditions like broken bones or non-chronic diseases. But I don’t think a private company will do so well in insuring against chronic problems for several reasons:
1. They won’t cover pre-existing conditions. If you are already diagnosed with diabetes, they won’t want you or they will want to charge you more - which is effectively like not having insurance against diabetes.
2. They will want to discriminate against you if you have a bad family history or bad genes. This is reasonable from the company’s point of view – they need to know their risks.
3. Once they know you have a chronic disease, you become a liability to the company. I don’t know about you but I would hate to deal with a company that wishes I were dead. Most of the nice experiences we have with companies stem from the fact that they are profiting from the relationship. Once they are losing money on the relationship – the relationship sours, (think landlord and tenet in a rent controlled apartment).
4. Insurance for chronic disease is an extreme risk for the insurance company. They run the risk that some chronic disease that would just kill you today will be treatable in the future with obscene amounts of money (much like AIDS). This risk could bankrupt the insurance companies.

My feeling is that chronic disease insurance is basically social insurance - it's like the guy above asking for insurance on a car he already destroyed. This is a type of risk is best treated with risk pooling: everyone puts in a piece of his income and each will get back money from this pot according to his medical state – if you have a chronic disease this money will cover (most of) that. If it sounds vaguely Marxian – “From each according to his ability, to each according to his needs” – it is. But I think this is what most people would want. They don’t want to run the risk of getting a chronic disease and not be covered for it. And this leaves the entire medical industry to be free from government intervention.

This is an important point: we can make a basically free market for health care if we separate the social insurance aspect of our current health care system. We can be free to contract directly with the insurance company of our choice and find the plan that fits our budget: the Accord plan.

Where do HSA’s fit in here? They could be used to cover co-pays and deductibles. Your social insurance would not cover 100% of your medical bills so you might need to add some of your own money. But I agree with Arnold Kling and others: why not just end the deductions for health care and make everything taxable? This seems easier and better than making a new class of savings account.

There is one potential advantage of a special medical account could have (but that the HSA's don’t currently have): the ability to give virtually unlimited credit. The account could be like a credit card with either positive or negative balance. Unlike ordinary credit cards that would limit your debt, this one could be virtually unlimited since presumably no one would really want to run up a huge medical debt unless they needed to. The advantage here is that in an emergency, people could get immediate care without the hospital needing to find out how the patient would pay for this care (an important consideration). People could just show their medical credit cards and get immediate care.


  • Hiren Shah wrote (in another post but intended for this post):
    Very comprehensive and informative write up I must say.

    Since you have started with Bush, should not one add that following wrong policies like the Iraq war which can prove hazardous to a lot of families from health perspective.

    what you have written is looking at the problem from the effect level whereas to solve any problem one has to contemplate at the cause level. In short, Bush is beating about the bush.

    By Blogger Michael Higgins, at 11:02 AM  

  • Hi Hiren
    The issue of the cause of chronic disease is interesting. Most chronic diseases have the very real possiblity of moral hazard - ie the insured person increased the risk of the disease by his/her own willful negligence. For example HIV (careless sex), Diabetes (obesity), heart disease (obesity - too much cholestorol), cancer (smoking).

    I would argue that social insurance for chronic diseases should make allowance for people who keep themselves healthy by good habits. So people who are obese, or smokers, or heavy drinkers would pay more premiums.

    It is just like a reckless driver has to pay more in auto insurance. Other people shouldn't have to pay for the risks that you take.

    By Blogger Michael Higgins, at 11:11 AM  

  • It is said about democracy that people get the government they deserve. The inequitable, unworkable and unsustainable American health system is also a system that people deserve.

    Whether we Americans realize it or not, it is our ever increasing demand for better and better services, and our unbridled consumerism, that have created the Ferrari health system that no society can fund perpetually. As my orthopaedic surgeon friend likes to say, especially after a couple of Black Labels, "I have 70-year old patients who complain to me that their knee replacement was not done properly because now they cannot play tennis." What a sense of entitlement! At age 70, I should be able to play tennis as vigorously as I did at 60! And let medical science provide me with that ability, AT WHATEVER COST!

    Medical malpractice awards contribute far less to our high medical costs than this ongoing drive for Ferrari medicine for all. It is as impractical as each neighborhood demanding an expressway within a 2-minute drive or a Harvard quality education for one and all.

    I think HSA is such a band-aid solution to a problem that is really caused by our mindset. We the "insured" demand perfection from medical science, we want the best care this country can offer, and yet we don't look at the 44 million uninsured Americans who will gladly settle for any type of medical care.

    By Anonymous Anonymous, at 1:25 PM  

  • Hi Sarat Dayal
    I agree for the most part except I am sure that if people did pay a bit more for health care they would think twice about spending so much for certain proceedures.

    By Blogger Michael Higgins, at 5:30 PM  

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