Popping the Health Care Cost Bubble

Maybe health care would be cheaper if the customer actually paid for it.

"Starting this year, millions of Americans will be able to save money tax-free for their medical expenses, in a health savings account," declared President George Bush in his State of the Union speech. He clearly knows that health care will be the top domestic issue in the 2004 presidential campaign. Why? Because health spending in the United States soared by 9.3 percent in 2002, the largest increase in 11 years, according to a report from U.S. Health and Human Services officials in the journal Health Affairs. (The total spending was $1.6 trillion, around $5,440 for every man, woman, and child in the nation.) Health care expenditures now account for about 15 percent of the U.S. gross domestic product.

Most Americans (61.3 percent) are still enmeshed in the dysfunctional third-party payment system in which health insurance is supplied through their employers. Since the 1940s, Americans have had little reason to worry about how much they spend on medical care, because someone else usually pays for it. This is thanks to World War II-era tax laws that allowed employers to increase compensation without actually raising wages, during war-inspired wage controls, through non-taxed contributions of health insurance. Without that consumer discipline, doctors and hospitals have had little reason to control their expenses. The predictable result: spiraling health care costs.

In the face of double-digit health insurance premium increases, more companies are trying to rein in their health care costs by adopting "consumer-driven" health care options. Such plans are designed to make health care costs transparent to employees by making them responsible for managing their own health care costs.

One increasingly popular mechanism for this is the flexible spending account (FSAs) in which companies allow employees to make pre-tax payroll deductions that can be spent on unreimbursed medical expenses. For example, expenses incurred before the insurance deductible is met and currently uncovered vision and dental expenses. One catch: The employee must guess how much to deduct, and if she is wrong, she loses any money she doesn't spend during the year.

But as President Bush highlighted last night, there is now another option—Health Savings Accounts (HSAs). These new HSAs, included in the very flawed Medicare prescription law, offer a possible path out of the third-party payment hell in which employers, employees, and doctors find themselves.

Similar to FSAs, HSAs allow employees to set aside pretax money to cover routine checkups, co-pays, prescription drugs, vaccinations, and so forth, while costly medical procedures would be covered by high-deductible insurance policies. But unlike FSAs, employees may keep their own money, rolling over any unspent funds in their HSAs at the end of the year and investing the money for future medical expenses.

HSAs have many attractive features. They are available to anyone under age 65. HSA participants can deduct from their gross income all contributions equal to 100 percent of their policy deductible. (The maximum amounts for 2004 are $2,600 per individual and $5,150 per family.) And "high-deductible plans" aren't so uncomfortably high under this proposal, defined as $1,000 or higher deductible for individuals, $2,000 or higher deductible for families. Also, employers as well as employees may make contributions to HSAs, so instead of an employer paying money to insurance companies for low-deductible policies, they can give the money to their employees directly. And best of all for those worried about the instability of linking health insurance with steady employment, if a person loses her job, she can withdraw funds from her HSA to continue her family's health insurance coverage. Furthermore, President Bush wants to permit "individuals who buy catastrophic health care coverage, as part of our new health savings accounts, be allowed to deduct 100 percent of the premiums from their taxes."

Employers will be attracted to HSAs because they will be able to lower their health care expenses by offering their employees higher-deductible insurance plans. Such plans generally cost 20 to 60 percent less than conventional low-deductible health insurance policies.

HSAs are no longer just a curiosity for aficionados of market incentives in health care. For example, Blue Cross in Minnesota announced this week that it will offer a high-deductible policy combined with HSAs.

HSAs provide the best policy fix for spiraling health care costs. They'd function like training wheels for consumer-driven health care markets. As individuals become more knowledgeable consumers of health care services, they will shop around, demanding more for their money, not just blithely thinking, "the insurance company will cover it."

Eventually businesses could simply give their employees the option of either staying with the traditional one-size-fits-all health care plan chosen by the company or taking that money and buying health insurance on their own. Once people get used to shopping for reasonable prices and being able to keep the money they save from doing so, the whole cost-ballooning third party payment system could well unravel in health care, making it more like a normal market—that is, one in which the actual customer pays for what she gets and benefits personally from frugality. Of course, it is no crime for a rich culture to spend a lot on health care, especially when we are increasingly using new, and still expensive, treatments. But with HSAs, at least, health care costs can be as low as they could be instead of being as high as possible.