CONNECTING CHOICES TO COSTS:

HEALTH SAVINGS ACCOUNTS: THE FUTURE OF HEALTH CARE FOR KANSANS (FlintHills.org, 2/14/05)

From the standpoint of health economists, the essential problem in health care is too much third-party payment. Third parties — government, employers or insurance companies — pay for about 85 percent of all health care received today. The proportion of health care paid directly by consumers has been falling for years:

• In 1960, consumers paid about 50 percent of health care directly.

• In 1980, the proportion of health care costs borne directly by consumers had fallen to about 24 percent.

• Today, consumers pay about 15 percent of health care costs.

Most of the funds consumers pay directly for health care purchase over-the-counter (OTC) drugs, vision care, dental care and cosmetic surgery such as Lasik. Unfortunately, because of third-party payments most medical services are free (or cost little) at the point of service. Consequently consumers and doctors have the incentive to use as many services as insurers are willing to pay for. In other words if consumers only pay 15 percent of medical costs directly, they have an incentive to consume care until the last dollar spent is only worth 15 cents to them. From an economic standpoint, this is very wasteful. Patients would consume fewer medical services, and pay less for health care in the long run if most incidental medical services were paid out-of-pocket.

An additional problem with giving more control to third parties is that consumers have fewer choices. Our current system of health coverage functions like an “all you can eat buffet” that isn’t of our choosing. An employer contracts with a managed care organization to select the medical menu, pay the tab and tell us how much we’re allowed to consume.

When third parties control our health care dollars, medical care will always be rationed. For instance, managed care was supposed to counter the tendency to over-utilize care by telling patients which medical services they needed and could have. This attempt to control the amount of medical services consumed resulted in a backlash from consumers. Third parties also have higher overhead and administrative costs since many of their procedures are designed to ensure that only appropriate care is given and claims are not fraudulent.

Finally, too much payment by third parties reduces patients’ ability to express preferences and make the tradeoffs that are common when purchasing other types of goods and services. Third-party payments also create moral hazards. This is another way of saying that consumers do not bear the burden of their own poor lifestyle choices.

For instance, those that choose to smoke or engage in other types of unhealthy behaviors generally do not pay more. Consequently, they have few incentives to change their behavior. Likewise, people with first-dollar coverage for medical care and prescription drugs are not penalized for wasteful spending on unnecessary physician visits. Nor are there incentives to choose low-cost generic drugs over name-brand drugs. Thus, we all have little reason to be prudent consumers of health care.

Why Health Costs Rise

Prices for medical services have been rising faster than prices of other goods and services for as long as anyone can remember. A primary reason why health care costs are soaring is that most of the time when we enter the medical marketplace as patients, we are spending someone else's money. [...]

One of the ways employers are attempting to connect employees with decision-making is through defined contribution health insurance. Employers “define” their contributions while employees choose among the types of policies they purchase. An employee wanting a richer benefit package might have to contribute additional money out-of-pocket to cover the cost. On the other hand, employees choosing less expensive (high-deductible) health plans might have funds left over to deposit into a personal health account, such as a flexible spending (FSA) or a health savings account (HSA). This works because high deductible policies are less expensive than policies offering first-dollar coverage. Funds placed in an FSA or HSA are used to pay for incidental health care needs up to the level of the health insurance policy deductible. Employees also may shore up these accounts by depositing additional funds into them tax free.

How HSAs Work

HSAs are the most flexible, consumer-friendly accounts yet devised. They allow individuals and employers to make deposits each year equal to their health insurance deductible. The health insurance policy that must accompany an HSA is required to have an overall deductible of at least $1,000 for an individual or $2,000 for a family policy. A typical plan will work like this: When individuals enter the medical marketplace, they will spend first from their HSA. If they exhaust their HSA funds before reaching the deductible, they will then pay out-of-pocket. Once they reach their deductible, insurance pays all remaining costs. Unused funds roll over each year for use in subsequent periods. These balances remain the property of the account holder until they are used. Annual tax-free deposits to an HSA cannot exceed the amount of the health insurance deductible, and typically cannot exceed $2,600 for individuals and $5,150 for families.

Hard to see how you ever get the discipline that consumers bring to bear until you restore such choice to health care.

Posted by Orrin Judd at July 2, 2005 11:00 PM