How Health Savings Accounts Work

We recently blogged about health insurance, which garnered some thoughtful comments on both sides of the debate. Solving our healthcare challenges is certainly beyond the scope of our blog. On the other hand, we agreed to provide a little bit more about the HSAs and how they work. So we offer the following with the caveat that future posts will deal more directly with finance.

Health savings accounts (HSAs) are tax-protected savings accounts connected with a high-deductible, low-premium plan. Most HSAs provide for a fully covered annual physical and then a high deductible for any other medical needs. The HSA account carries over year to year and can be used tax-free to pay for any medical, dental and most alternative medicine treatments. Upon retirement HSA funds can be withdrawn without penalty for retirement (however funds used for expenses other than medical are taxed as income).

Setpoint (Joe's company) adopted a HSA plan in 2004. While this type of insurance takes some getting used to, it has been a real benefit to Setpoint and to Setpoint's employees. For example, Setpoint had two very serious medical issues with employees and/or spouses. With a traditional plan, Setpoint's medical costs went up dramatically. When they switched to the HSA, they worried about how the plan would affect the two employees. (One of the arguments against HSAs is that they cost less for the healthy but more for those with serious illnesses). For Setpoint, both of the serious cases saved thousands of dollars with the HSA plan. These are the reasons why. First, Setpoint was able to save on premiums and was able to contribute those savings to the employees' HSAs. Second, the employees no longer had to contribute as much to insurance since the premium was lower. Third, Setpoint chose a plan in which employees have 100% coverage once the deductible is met. Taking all of that together, the HSA saved those with health challenges thousands of dollars on an annual basis.

With the HSA, Setpoint's premium increases stabilized and the healthy employees are saving for the future. Clearly, every plan is different, and our sample size is small, but we felt this was worth a discussion.

The financially intelligent message here comes from Joe's personal experience. When he or someone in his family needs medical care, he lets the provider know that they are on an HSA, and they pay cash. This usually leads to discounts. Joe and his family always ask for and understand the costs of procedures. One of the many problems with the economics of healthcare is the lack of transparency of costs. In our current system we typically pay a fixed co-pay, so consumers (and sometimes the providers) of healthcare have no sense of the real costs. It seems to us that one of the many first steps in controlling costs is that consumers must understand the true costs of their care.

In Joe's first year with the HSA his son needed a simple surgery. He asked for a cost estimate and the response was, "Why does it matter? You have insurance." After explaining why they needed the information, the administrator still could not come up with a price (although he finally did after several phone calls). That was in 2004. Today costs are easier to get, and the transparency issue seems to be improving.

We believe that free market based plans like HSAs are our best chance to control medical costs. As medical costs become more transparent and providers become better equipped to give estimates, consumers will become more aware of and concerned with the true cost of medical procedures. Then providers will innovate and find ways to deliver services at lower costs.

We also believe that providing for the poor and uninsured should be a priority of healthcare reform. HSAs are only part of the equation.

Reframing the Healthcare Debate in Business Terms

The issues, concerns, and variables involved in finding solutions to the healthcare crisis are too numerous to list. Joe has been involved with healthcare issues for a number of years and in 2007 he was asked by the U.S. Chamber of Commerce to testify before the U.S. Senate finance committee on the subject of healthcare.

Here, we'd like to begin to consider how a business might think about possible solutions. There are two frames that we think are interesting to consider. The first is how innovation and costs are typically related.

In most industries as innovations occur costs come down dramatically. For example, in the personal computer industry, costs have gone down year after year as technology has improved. Innovation is driven by a variety of factors, such as improved speed and functionality. But it is also driven by a desire on the part of consumers and businesses to reduce costs. The consumer reaps the benefit of a less expensive product, which then becomes more accessible. And the business can improve its profit, increase its market share, and offer a more affordable product.

In healthcare, innovation also is driven by a variety of factors, especially the desire to increase our ability to diagnose and treat disease, improving the quality of life — clearly an important driver. However, innovation could also be driven by a desire to reduce costs. But in healthcare, it typically isn't. New treatments and improved procedures can be more expensive, not less. Why? In part because the consumer (the patient) isn't paying for the services. So, the consumer, who is choosing to "buy" the service, doesn't consider the price of the service. All he may pay is his co-pay. So, he may think, "Why not? It doesn't matter how much it costs." So the innovators in healthcare aren't rewarded for lowering costs because that is not the variable that people demand. People demand a better test, a better treatment and so on. But if consumers also knew the costs, and they had to "pay" for it (more on that in a bit), then there would be a demand for innovation to reduce costs, along with improving care.

The second frame we'd like to consider is how insurance typically works in other industries.

Let's look at both auto and homeowner's insurance. We purchase that insurance to protect us from catastrophic risks. The insurance company underwrites the risk and we pay a premium for their protection. When we experience a serious loss to our home (fire) or auto (collision) the insurance steps in to cover our losses. We ourselves, though, pay to maintain our cars and homes. Maintenance costs are not covered by insurance. The market handles the cost and pricing on maintenance and up-keep on our homes, and auto and homeowners' insurance covers us when unusual crises come along.

Medical insurance covers both maintenance and catastrophic health issues. And, because medical costs aren't fully borne by the consumer (except for a co-pay that isn't related to the market price of the service) we as consumers can't gauge whether the service is worth the cost or even demand that innovation bring the cost down. We don't spend time managing it. And that means we very well might overuse the service, because we don't really have to pay for it. The result is that the price of services isn't market based (think supply and demand, costs, etc.) Insurers end up raising premiums to cover higher costs and usage.

Joe is an owner of Setpoint Systems Inc., a business based in Utah. Setpoint has struggled with the issue of health insurance costs for years. It had some employees or their families with severe health problems, and its health insurance premiums skyrocketed. In 2004, when Health Savings Accounts or HSAs, were introduced, Setpoint immediately signed up. They provided the company with a way to intelligently manage healthcare costs, allowing Setpoint to save dramatically on premiums and also saving employees thousands of dollars. Setpoint was even able to contribute substantially to its employees HSA accounts because of the premium savings.

HSAs also have features that drive cost innovation and mimic other types of insurance — consumer involvement in costs and payment of maintenance services.

In a future blog we'll look in more in detail at Setpoint's experience with its HSA plan and the pros and cons of HSAs.