Policy Analysis No.
220
March 14, 1995
MORE THAN A THEORY:
MEDICAL SAVINGS ACCOUNTS AT WORK
by Peter J. Ferrara
Peter J. Ferrara is a senior fellow of the National Center for Policy
Analysis.
Executive Summary
Economists from across the political spectrum
understand
that one of the major factors driving health care costs is
our third-party payment system that insulates consumers from
the cost of
their health care decisions. Medical savings
accounts (MSAs) are the one
health care reform proposal
designed precisely to counter that fundamental
cost-control
problem. They restore direct incentives to consumers to
control costs and stimulate true market cost-control competi-
tion.
MSAs are far more than a theory. Despite the heavy
discrimination
against them in the current income tax code,
employers and workers across
the country have already begun
establishing and using MSAs in place of
traditional third-
party insurance. Among the companies currently using
MSA-
type insurance plans are Golden Rule Insurance Company,
Dominion
Resources, Forbes magazine, Quaker Oats, Indresco
Corporation, and dozens of
small businesses across the coun-
try. In all those companies, MSAs have
proven highly effec-
tive at controlling costs, as well as highly popular
among
workers.
The experience of private companies currently using
MSA-
type approaches to reducing health care costs proves that
MSAs can
control rapidly rising health costs, while preserv-
ing both quality and
patient choice. By enacting federal MSA
legislation, Congress would
establish a fully comprehensive
cost-control system that would restrain
costs without impos-
ing rationing by either the government or insurance
bureauc-
racies.
Introduction
In offering his health
care reform plan last year,
President Clinton said that one of his primary
goals, in
addition to universal coverage, was to control rapidly ris-
ing
health costs. But ironically, the president's proposal,
and similar
proposals offered by both Democrats and Republi-
cans, would only have made
the fundamental problem worse.
By expanding to everyone traditional
third-party insur-
ance and covering more services, with minimal deductibles,
the reform proposal would have actually maximized the per-
verse,
cost-increasing incentives of third-party coverage.
With a third party
guaranteeing payment of all medical
bills, neither patients nor doctors are
significantly con-
cerned about costs. The result is the cost explosion we
have seen over the past 30 years.
Medical savings accounts (MSAs)
are the one reform
proposal designed precisely to counter the fundamental
cost-
control problem.(1) They restore direct incentives to consum-
ers to
control costs, which stimulates true market cost-
control competition.
Moreover, they are the only reform proposal for con-
trolling costs
that is consistent with maintaining quality
and consumer choice. All other
cost-control proposals in-
volve shifting more power and control to some
third-party
bureaucracy, either the government or insurance companies,
that would then limit and ration care to reduce costs. MSAs
put
individual consumers in control of their own health care
decisions.
Consumers, not the government or insurance com-
panies, decide whether a
procedure or treatment is worth the
expense.
MSAs are far more than
a theory. Despite the heavy
discrimination against them in the current
federal income
tax code, employers and workers across the country have
already begun establishing and using MSAs in place of tradi-
tional
third-party insurance. The results: MSAs are indeed
highly effective at
controlling costs, as well as highly
popular among
workers.
Why MSAs Work
The Third-Party Payment
Problem
Economists from across the political spectrum under-
stand
that one of the major factors driving health care
costs is our third-party
payment system that insulates con-
sumers from the cost of their health care
decisions. In
health care, a third party--a private insurance company or
the government through Medicare and Medicaid--is usually
paying the
doctor and hospital bills for the patient (Fig-
ure 1).
As a result,
the patient lacks market incentives to
control costs. The patient is not
concerned with avoiding
unnecessary care or tests or shopping for the best
priced
care.(2)
Because consumers lack market incentives to control
costs, doctors and hospitals do not compete to reduce costs.
Because a
third party is paying the bills, patients do not
choose doctors and
hospitals on the basis of cost-effective-
ness, balancing cost and quality.
Rather, they seek to
maximize quality without regard to cost. If an extra
proce-
Figure 1
Percentage of Personal Health Expenses Paid by
Third Parties,
1965 and 1990
1965 1990
Hospital 83.2% 95.0%
Physician 38.4% 81.3%
All Services 48.4% 76.7%
[Graph Omitted]
Source: John C. Goodman and Gerald L.
Musgrave, Patient Power:
Solving America's Health Care Crisis
(Washington: Cato Institute,
1992), p. 77.
dure or test is of
even the most marginal value, they will
demand it. The result is runaway
costs.
The incentive to ignore the cost of even marginal in-
creases
in quality can been seen particularly in the devel-
opment and purchase of
new medical technology and equipment.
In most other markets, new
technological advances operate to
reduce costs. But in health care,
observers have long no-
ticed that such advances often seem only to sharply
increase
costs. That is because of the incentives. Health care
providers
are generally looking, not for new technological
advances that would reduce
costs to consumers, but primarily
for those that will improve quality
regardless of cost,
because that is what patients are looking for.
The result has been a "medical arms race" with provid-
ers adding
ever more expensive technology even if it produc-
es only minimal increases
in quality. Attempts to control
the growth of medical technology outside a
functioning mar-
ket have resulted in arbitrary regulatory procedures and
requirements, such as certificates of need, that limit con-
sumer choice
and have had an adverse impact on the quality
of care without significantly
affecting costs.
The evidence confirms the conclusion of the theoretical
analysis: third-party payment is the main factor in rapidly
rising
health costs.
* The rapid increase in health expenditures in recent
years has occurred in tandem with rapidly rising third-
party payment.
From 1965 to 1990 the percentage of
health expenses paid by third parties
soared from 48
percent to 79 percent. Over the same period health
care
spending as a percentage of gross national product
doubled from 6 percent to
12 percent (Figure 2).(3)
* Cost increases have been much greater for
health care
services with greater third-party payment and much less
for
those with lower third-party payment. Third-party
payment covers 75 percent
of hospital costs and 80
percent of doctors' bills. Yet it covers only 47
per-
cent of dental bills, 26 percent of drug costs, and 32
percent of
vision care. From 1965 to 1990 hospitaliza-
tion costs, with the greatest
third-party payment,
increased over 350 percent in real terms after
adjust-
ing for inflation. Real doctors' costs, with the sec-
ond most
third-party payment, increased over 250 per-
cent. But real costs for
dentists, with lower third-
party payment, increased 200 percent. And costs
for
drugs and vision care, with the lowest third-party
Figure
2
Consumer Out-of-Pocket Payments vs. Health Care
Spending
[Graph Omitted]
Source: John Tottie,
"Cutting Health Care Costs: A Private-Sector
Success Story," Citizens for a
Sound Economy, Washington, April 9,
1994.
payment, increased 150
percent, relatively close to the
real growth of GNP of almost 100 percent
over the pe-
riod.(4)
* The rapid rise in health care expenditures
has oc-
curred mostly in expenditures by third-party payers
rather than
out-of-pocket payments. From 1960 to 1990
out-of-pocket health spending
relative to personal
income did not increase at all. Yet total health care
spending relative to income tripled during that pe-
riod.(5)
* The
RAND Corporation conducted a rigorous scientific
study of the health
expenditures of 2,500 families from
1974 to 1982. The families were each
provided with one
of four different insurance plans, ranging from a zero
deductible and all health expenses paid, to 5 percent
of the first
$1,000 in expenses paid and 100 percent
after that. The families with no
deductible incurred
53 percent more in hospital expenses and consumed 63
percent more in doctors' visits, drugs, and other
health services than
did the families with the highest
deductible. Yet the study found no
difference in
health outcomes for the various groups.(6) Many other
studies find similar results.(7)
* A recent econometric study
published by the Cato
Institute examined the different responses to
different
levels of third-party payment in health care and esti-
mated
that third-party payment had effectively doubled
total health costs in the
United States because of the
effects of incentives.(8)
Third-party
payment increases health costs in at least
two other important ways. First,
as indicated above, the
degree of third-party payment varies greatly among
different
types of health services. That often leads patients and
doctors to choose services with greater insurance coverage
even though
alternative services with less coverage may be
at least as effective and
less expensive overall. For exam-
ple, a patient and doctor may choose
hospitalization and
surgery, which are completely covered by insurance, to
treat
a condition, even though the condition could be treated at
least
as well with far less expensive drug therapy, for
which there is little or
no insurance coverage. A recent
study by the National Center for Policy
Analysis estimates
that that effect unnecessarily increases national health
spending by about 16 percent, or $140 billion per year.(9)
Second,
excessive third-party coverage with low deduct-
ibles unnecessarily and
inefficiently increases administra-
tive costs. Many relatively small bills
must be submitted
to and reviewed by the third-party payer and checked for
accuracy. The payer must also maintain some system for
ensuring that the
prices charged are reasonable and that the
services provided were medically
necessary and appropriate.
That often entails a costly bureaucracy of
gatekeepers and
medical reviewers, who add nothing to health care. Indeed,
they often get in the way of good quality care. Economist
Stan Liebowitz
estimated that excessive third-party insur-
ance unnecessarily adds $33
billion per year in administra-
tive costs.(10)
The MSA
Solution
MSAs are designed precisely to correct the third-party
payment problem. They allow individuals to save money in
tax-exempt
accounts, in much the same way they can in indi-
vidual retirement accounts
(IRAs) now. They can use that
money to pay routine medical expenses. Then,
instead of
expensive first-dollar insurance policies, they can purchase
relatively inexpensive catastrophic insurance policies to
protect
themselves against major medical expenses.
For example, today it costs
an employer more than
$4,800 to provide health insurance for a typical
American
worker, a spouse, and two children. Would it not be better
if,
instead, the employer bought a catastrophic policy
(with, say, a $3,000
deductible) for approximately $1,800
and paid the worker the $3,000
difference? The worker could
then put that money in an MSA (Figure 3). Any
unspent money
would roll over to the next year. Since 90 percent of
Amer-
icans spend less than $3,000 per year on health care, in a
very
short time a worker would have a tidy pool of money
available to use in the
future. When the balance reached a
certain level, the worker could transfer
the funds to an IRA
or other retirement fund.
With MSAs, therefore,
workers would effectively be
spending their own funds for noncatastrophic
health care.
As a result, they would have full market incentives to
con-
trol the costs of such care. They would seek to avoid un-
necessary
care or tests and look for doctors and hospitals
that would provide good
quality care at the best prices.
That, in turn, would stimulate true cost
competition among
Figure 3
How MSAs Work
[Graph
Omitted]
Source: Cato Institute.
doctors and hospitals. Since
consumers would be choosing on
the basis of cost as well as quality,
providers would com-
pete to minimize costs as well as maximize quality, as
in a
normal market. Moreover, since patients and health provid-
ers would
be concerned with reducing costs, developers of
innovations and new
equipment would compete vigorously to
produce new items that reduced cost as
well as improved
quality.
Data on health costs and premiums, as well
as the expe-
rience discussed below, show that the amount saved in
premi-
ums by switching to a policy with a $3,000 deductible would
be
almost enough in the first year alone to cover costs
below the deductible
with no greater out-of-pocket payments
by the insured than under a
traditional policy.
In addition, the distorting effect of varying
third-
party coverage for different services would be eliminated,
because
funds in an MSA would be equally available for all
health care services.
Finally, administrative costs would
be sharply reduced. About half of all
health expenses would
no longer have to be submitted to and processed by
third-
party payers. Those payers would no longer have to monitor
and
check payments to determine whether they were accurate,
whether the price
charged was reasonable, and whether the
service was medically necessary and
appropriate.
That would add up to an enormous reduction in spiraling
health costs. Moreover, MSAs are the only means of control-
ling health
costs consistent with consumer choice and peo-
ple's control over their own
health care. Other proposed
health care reforms, such as managed
competition, would
force people into health maintenance organizations
(HMOs),
in which a bureaucracy working for the insurer ultimately
decides what care patients will get, or include global bud-
gets, under
which the government dictates how much may be
spent on health care, reducing
resources and ultimately
services for the middle class and the elderly.
The public proved in the health care debates of last
year that it
will not accept such rationing and third-party
control of its health care.
MSAs are not only the most
economical means of controlling costs, they are
the only
politically feasible reform.
Other Advantages of
MSAs
In addition to controlling costs, MSAs would provide
several
other advantages. First, MSAs would improve the
quality of health care.
Patients paying for their own
health care out of MSAs would not have to
worry about ob-
taining permission or approval from third-party gatekeepers,
or whether the insurer would pay for the services or treat-
ment that
would be best for them. Increasingly, patients
are being given lower quality
drugs, pacemakers, joint re-
placements, hearing aids, and other items
because the third-
party payer refuses to pay for the more expensive higher
quality ones. That would no longer be the case with MSAs.
To the extent
that patients paid for health care out of
their own MSAs, they would
eliminate the excessive third-
party interference, which is increasing today,
in the doc-
tor-patient relationship.
Second, MSAs would help to
reduce the number of unin-
sured. Those without employer-provided coverage
would be
able to get the same tax advantages that are provided today
only to those who do have such coverage. That would reduce
the net cost
to the uninsured of purchasing coverage. MSAs
would also enable the
uninsured to rely on low-cost cata-
strophic coverage and reap the benefits
of avoiding unneces-
sary expenses, through end-of-year rebates of unspent
MSA
funds. In addition, with MSAs the uninsured would escape
most of the
cost of the many unnecessary benefits state
governments require be included
in insurance policies, as
such mandates would have only a small impact on
the cost of
a high-deductible catastrophic policy. Finally, MSA funds
could be used to pay premiums for catastrophic insurance
during periods
of unemployment, enabling workers to maintain
coverage during such periods.
Third, MSAs would be completely portable. Workers
could take their
MSAs with them from job to job. Conse-
quently, workers could avoid "job
lock"--being tied to their
current jobs only to keep the health insurance
they provide.
Finally, MSAs would provide funds that could be used in
the future for long-term care, for long-term-care insurance,
or for
other postretirement medical needs not covered by
Medicare.
More Than a Theory
Medical savings accounts have long
been advocated by
academics, health economists, and others in the public
poli-
cy community. However, increasingly, MSAs are far more than
a
theory. Employers and workers across the country have
already begun to adopt
them. They are finding that the cost
savings, efficiencies, and other
advantages of MSAs outweigh
even the stiff disincentives for using them
under current
tax law. Examples of the leading MSA programs in use, and
how they have worked, are discussed below.
Golden Rule
Insurance Company
Perhaps the leading example of MSAs at work is
Golden
Rule Insurance Company in Indianapolis, Indiana. The 1,300
workers at that company have the option of choosing either
traditional
insurance coverage or an MSA. Traditional cov-
erage includes a $500 annual
deductible and 20 percent co-
payment on the next $5,000 in expenses, for
maximum out-of-
pocket payments of $1,500 per year.
Alternatively,
each worker can choose an MSA. For
family coverage under this option, the
employer purchases a
catastrophic policy that pays all expenses over $3,000
each
year. The employer then deposits $2,000 in a personal MSA
for the
worker's family. Those funds can be withdrawn for
health expenses below the
deductible, leaving a maximum
potential out-of-pocket expense of only
$1,000. For indi-
vidual coverage, the employer purchases catastrophic
insur-
ance covering all expenses over $2,000 each year. The em-
ployer
then deposits $1,000 in the worker's MSA that can be
used for medical
expenses, again leaving a maximum out-of-
pocket expense of $1,000. Whether
coverage is individual or
family, the worker can withdraw remaining MSA
funds at the
end of the year for any use.
Golden Rule first offered
the MSA option to its workers
in 1993. Approximately 80 percent of the
workers chose MSAs
that year. Those workers each withdrew an average of $600
in remaining MSA funds at the end of the year to use however
they chose.
In 1994 about 90 percent of the workers chose
MSAs.
Health care
costs dropped precipitously for those work-
ers. In addition to the $600
average remaining funds for
each worker, health costs above the $3,000
deductible
dropped 40 percent from previous projections in 1993.
Work-
ers who saved on costs below the deductible ended up not
spending
the substantial amounts over the $3,000 deductible
that they would have
spent with traditional insurance.
At the same time, Golden Rule
employees increased their
use of preventive care. About 20 percent of the
workers
with MSAs reported that they used their MSA funds to pay for
a
medical service they would not have bought under the tra-
ditional health
insurance policy. That is because the MSA
provided funds at hand that they
could use to pay for such
services, whereas the traditional policy imposed
deductible
and coinsurance fees that actually discouraged the use of
such services. Moreover, the traditional policy might not
cover some
services, and the uncertainty alone discouraged
workers from obtaining
preventive care. But workers know
that MSA funds can be used for whatever
services they
choose.
Finally, even the sickest workers were better
off under
the MSAs at Golden Rule. Those workers faced only a maximum
out-of-pocket cost of $1,000 every year with the MSA. Under
traditional
insurance, those workers could incur annual
maximum out-of-pocket expenses
of $1,500.(11)
Dominion Resources
Another company that
uses MSA incentives is Dominion
Resources, a utility company in Virginia
with 200 employees.
Workers there may choose coverage with an annual
deductible
of $3,000 for families and $1,500 for individuals. Workers
with family coverage who choose the high-deductible option
save almost
$1,100 per year in premiums, which they may keep
in personal MSAs and use
for expenses below the deductible.
For individuals the annual premium
savings is almost $500
per year.
In addition, workers whose expenses
stay below the
deductible receive a share of the company's health care
savings. In 1992 the company paid $800 in such bonuses to
each worker
who qualified. Workers can also receive a well-
ness rebate of $600 each year
based on five key health fac-
tors--blood pressure, weight, smoking,
cholesterol, and seat
belt use. The rebates can be saved in each worker's
MSA.
MSA funds can be withdrawn for any expense, health-related
or
other, at any time.
Approximately 80 percent of the company's workers
have
chosen the high-deductible option. Since 1989, when the new
system
was started, the company's health costs have risen
less than 1 percent per
year, compared to 20 percent per
year for other companies in Virginia. By
1992 the company
was underspending its projected health budget by almost
one-
third. The program is highly popular among workers, who are
able to
control much of the system's funds directly and gain
personally from
conserving on health expenses.(12)
Golden Rule's Experience with
Small Business
Golden Rule Insurance Company has also now sold MSA
coverage plans to a number of small businesses. One example
is Templeton
Oldsmobile in Virginia with 81 employees.
Workers there can choose
traditional insurance that provides
family coverage with a $100 annual
deductible for each of as
many as three family members and up to $1,500 in
additional
copayment charges, for maximum out-of-pocket payments of
$1,800 per year. Individual coverage includes a $100 annual
deductible
and up to $500 in additional copayment fees, for
maximum annual
out-of-pocket payments of $600.
With an MSA, in contrast, a family gets
a catastrophic
policy that pays all expenses over an annual deductible of
$2,000. The employer then contributes $1,000 to the work-
er's MSA,
leaving the worker with maximum annual out-of-
pocket expenses of only
$1,000, compared to $1,500 under the
traditional policy. The individual
worker gets a cata-
strophic policy that pays all expenses over a maximum
annual
deductible of $1,500, with $750 contributed to the worker's
MSA,
for a maximum out-of-pocket expense of $750. The work-
er can withdraw any
unspent MSA funds at the end of the year
for any purpose.
The
remarkable fact is this: the total employer cost
for MSA family coverage,
including the MSA contribution, is
$3,840.52, compared to $10,384.50 for
traditional coverage.
For individual coverage, the total MSA cost is
$1,788.84 per
worker, compared to $3,858.72 for traditional
coverage.
Another good example is Halls Construction in Shaws-
ville,
Virginia, with 22 employees. The traditional family
coverage there includes
a $250 deductible for each family
member up to a maximum of three, plus
another $600 maximum
in coinsurance expenses, for a maximum out-of-pocket
expense
of $1,350. The individual traditional coverage provides for
a
$250 deductible and $200 in maximum coinsurance expenses
for a maximum
out-of-pocket expense of $450.
With the MSA, a family gets a
catastrophic policy pay-
ing all expenses over a $2,000 annual deductible.
The em-
ployer contributes $1,400 to an MSA for the family, leaving
a
maximum out-of-pocket expense of $600, compared to $1,350
under traditional
coverage. Individuals get catastrophic
policies that pay all expenses over a
$1,500 annual deduct-
ible, with $1,050 deposited to an MSA, leaving a
maximum
out-of-pocket expense of $450, the same as under the
tradi-
tional policy. Workers, of course, can withdraw any unspent
MSA
funds at the end of the year for any use.
For the employer, the total
annual MSA cost for each
family's coverage is $3,505.52, compared to
$5,261.52 for
the traditional policy. (The traditional policy costs about
50 percent more.) For individual coverage, the total em-
ployer cost is
$1,954.68 for each worker, compared to
$2,243.88 for the traditional policy,
which costs about 15
percent more.
Golden Rule has sold similar MSA
programs to Arlington
Urology in Indianapolis with 16 employees; Medical
Special-
ties Inc. in New Orleans with 17 employees; Numerics Unlim-
ited
in Dayton, Ohio, with 10 employees; Bobb Chevrolet in
Columbus, Ohio, with
74 employees; Weiss Ale Hardware in
Glenview, Illinois, with 11 employees;
and Fred W. Laubie
and Associates in Columbus, Ohio, with 11
employees.(13)
Thompson and Associates
Thompson and
Associates, a health insurance marketing
firm in Kansas, is marketing
another MSA-type plan. They
combine the funding of employer-provided health
care and
retirement benefits in one fund for each employee so that
retirement funds for the workers automatically increase as
the workers'
health expenses decline. Under that approach,
the employer purchases
catastrophic health insurance that
pays all expenses over $3,000 or $4,000
per year for each
employee. The employer then puts an amount equal to the
insurance deductible into an individual health and retire-
ment account
for each worker. Those funds can be used to
pay for medical expenses below
the deductible. Any unspent
funds at the end of the year automatically go to
support
higher retirement benefits. The unspent funds can also be
used
to reimburse day-care expenses or to cover medical
costs that may not be
covered by the insurance, such as eye
examinations and eyeglasses, dental
care, and prescription
drugs.
Thompson and Associates cites as an
example a client
who implemented the new system in 1983. The old health plan
provided traditional insurance with a $100 deductible and 20
percent
coinsurance payments on the next $1,000 in expenses,
for a maximum
out-of-pocket expense of $300. The new plan
provides catastrophic coverage
for all expenses over $3,000,
with $3,000 deposited in each worker's
individual savings
account. The worker consequently has no out-of-pocket
ex-
pense. Funds unspent at the end of the year automatically
support
higher retirement benefits, or they can be withdrawn
for day-care or
uncovered health expenses.
Remarkably, total health costs as a
percentage of pay-
roll fell by one-third in the first year, 50 percent below
projected levels under the old plan. By 1991, nine years
later, health
costs as a percentage of payroll were still 24
percent below the 1982 cost
under the old plan.
In addition, sick leave dropped precipitously from
7.5
percent of payroll in 1982 under the old plan to 0.1 percent
in 1984
under the new plan. Apparently, employee efforts to
avoid medical costs
under the new health plan translated
into fewer illnesses requiring sick
leave. That prompted
the employer to add a sick leave allocation to each
worker's
individual account, so sick leave is drawn from the account
as
well. Unspent sick leave funds are automatically left in
the account for
other purposes.(14)
Plan 3 Insurance
A health benefits
consulting firm that markets insur-
ance in the Washington, D.C., area, Plan
3 Insurance, is
selling still another version of MSAs. Under this approach,
the employer self-insures health benefits for workers but
buys a
catastrophic policy with a high deductible covering
all of the company's
health expenses above the deductible.
For example, a firm with 20 workers
might buy a policy cov-
ering all expenses above $100,000 for the workers as
a
group. Such a policy would cost only a small fraction of
traditional
first-dollar insurance coverage. The employer
would then place the huge
premium savings in a health fund
reserve to pay for employee medical
expenses below the de-
ductible limit.
The employer covers all
employee health expenses with
no out-of-pocket costs for the worker. But the
employer
sets a reference amount equivalent to a high deductible,
perhaps $3,000 per year, and allows employees who incur less
in covered
health costs to withdraw the difference from the
health fund reserve after a
waiting period of three years.
The three-year waiting period allows the
funds in the
reserve to grow. That allows the employer to set the
refer-
ence deductible at higher and higher levels over time, cov-
ering a
higher proportion of total health spending with the
cash rebates. Moreover,
while funds are in the employer's
health fund reserve, investment returns on
the funds are
tax-free.
In the last five years Plan 3 has sold such
health
plans to nearly 60 small businesses with an average of 10 to
20
workers each. One example is the Rubber Manufacturers
Association, which
provides coverage for 30 employees and 20
retirees. It now pays only about
25 percent of its health
funds to an insurer, which covers all health
expenses over
$10,000 for each employee. The rest of the funds go into
the health fund reserve, which has grown to about $90,000.
During the
five years the new plan has been in effect,
health costs to the employer
have not increased at all.
Moreover, last year the employees were able to
withdraw
$12,000 from the health fund reserve as a result of the
lower
costs. This year such employee withdrawals are ex-
pected to total
$20,000.
Another example is Clinical Radiologists, with about 90
employees. In just two years under the program, employer
health costs
have been reduced by 30 percent. Combined
employer savings over the years
have totaled $180,000, or
about 40 percent of total annual health costs at
the
start.(15)
Windham Hospital
Dramatic savings
from using MSAs have also been
achieved at Windham Hospital in Willimantic,
Connecticut,
with 1,000 employees. In 1993 the hospital switched from a
pure first-dollar coverage plan with no deductible or co-
payments to a
plan with a $500 deductible. It also contrib-
utes $10 a week, or $520 per
year, to an MSA for each work-
er. In addition, the hospital negotiated
discounts for its
employees when they pay for health services with MSA
funds.
The hospital itself offers discounts of 30 percent, area
doctors
offer price reductions of 20 percent, and drugstores
cut prices by 10
percent.
Under the old plan, the hospital's employees used medi-
cal
services 35 percent more than the community average.
After one year under
the new plan, however, the entire 35
percent excess was eliminated.
Moreover, projected health
costs for the hospital employees were reduced by
about 50
percent.(16)
The Health Wealth
Plan
Progress Sharing, an insurance-marketing firm in Saco,
Maine, markets another MSA plan called Health Wealth. One
of its clients
is Spurwink School in Portland, with 220
employees. Under the plan, workers
are offered a high-de-
ductible policy, and premium savings are placed in a
mutual
fund account for each worker. The funds can be used to pay
out-of-pocket health expenses or withdrawn for any purpose
at the end of
the year. Health costs at the school have
actually dropped in four of the
six years since the plan was
adopted.
The Health Wealth plan is also
used at Knox Semiconduc-
tors in Rockport, Maine, with 42 employees. The
company has
experienced only two premium increases in the six years it
has used the program. It has saved $100,000 in health costs
over the
last three years alone. Progress Sharing has suc-
cessfully implemented its
Health Wealth program at 43 other
small employers in Maine as
well.(17)
Quaker Oats
The cereal-manufacturing firm
provides workers with a
high-deductible policy. It also pays $300 each year
into
the personal health account of each employee, which the
worker can
use to pay health expenses below the deductible.
At the end of the year,
workers can withdraw any unspent
balance for any purpose. Over the past 10
years under this
plan, the company's health costs have grown at a 6.3
percent
annual rate, compared to more than double-digit rates for
the
rest of the country.(18)
Forbes
With 500 employees in
New York, Forbes, Inc., pays each
worker a bonus of $1,200, which is reduced
by $2 for every
$1 of medical claims the worker submits. The bonus can be
spent or saved by the worker without restriction. In 1993
Forbes paid
about one-third of its eligible employees the
maximum $1,200 bonus. Yet its
health costs fell 12 percent
for the year, after falling 17 percent in the
prior year,
when the new system was started.(19)
Indresco
Corporation
In 1993 Indresco Corporation provided its nonunion
workers with health insurance subject to an income-related
deductible.
Workers earning less than $30,000 have a $1,000
deductible and maximum
out-of-pocket expenses of $4,000.
Workers earning from $30,000 to $50,000
have a $1,500 de-
ductible and maximum out-of-pocket expenses of $7,000.
Workers earning over $50,000 have a $2,000 deductible and
maximum
out-of-pocket expenses of $10,000. Health costs for
Indresco's workers fell
17 to 22 percent in the first
year.(20)
Jersey
City
Employees of Jersey City, New Jersey, will soon have an
option for MSAs as well. Workers will each be able to
choose a
traditional policy leaving each covered individual
subject to a $100
deductible and 20 percent copayment of the
next $2,000 in expenses, up to a
maximum out-of-pocket ex-
pense of $500, for two family members. Additional
family
members will not be subject to copayments or deductibles.
With
MSAs, in contrast, the employer will buy an insur-
ance policy that covers
all expenses over a $1,500 annual
deductible for individuals and a $2,000
annual deductible
for families regardless of size. The employer will then
deposit $1,500 in an MSA for each individual and $2,000 in
an MSA for
each family. Everyone will then be covered for
all expenses, through either
MSA funds or the catastrophic
coverage. Workers can withdraw any unspent MSA
funds at the
end of the year for any purpose.
The MSA will cost the
city a little less than tradi-
tional coverage, even though workers with MSAs
will avoid
the out-of-pocket expenses of traditional coverage and will
be able to withdraw up to $2,000 per year in unspent funds.
Workers will
also be able to use MSA funds for checkups and
other preventive care that is
either not covered under the
traditional policy or subject to the deductible
and copay-
ments. The city expects to benefit from reduced health
claims
in the future and reduced administrative costs of
reviewing most medical
bills below $2,000.
The United Mine Workers Union
The
demonstrated success of MSAs and their appeal to
workers led the United Mine
Workers to successfully negoti-
ate for them in its most recent contract.
Under an agree-
ment with the Bituminous Coal Operators Association,
cover-
ing about 15,000 employees, coal mine operators now provide
workers insurance with a $1,000 deductible replacing a zero
deductible
under the old health plan. The employees are
each provided a $1,000 cash
bonus at the beginning of the
year that they can use for health care
expenses below the
deductible. At the end of the year, workers can keep for
any use whatsoever any portion of the bonus they do not use
for health
care.(21)
The mine workers consequently still have first-dollar
coverage. But they also have incentives to reduce costs and
can gain
directly by doing so. This example demonstrates
better than any other the
strong appeal of MSAs to workers.
Council for Affordable Health
Insurance
Leading advocates of MSAs have also gotten into the
act. In 1993 the Council for Affordable Health Insurance in
the
Washington, D.C., area dropped HMO coverage with a $250
deductible and
bought insurance with a $1,000 deductible for
each employee. The annual
premium for the new plan was
about $1,000 less for each worker. So the
council granted
each worker a savings plan with $1,000 for the year, which
the worker could use for medical expenses below the deduct-
ible.
Whatever the employees do not use for health care,
they can keep at the end
of the year.
The National Center for Policy Analysis in Dallas,
Texas, has adopted a similar plan for 1995. That plan in-
cludes a
deductible and a savings account of $2,000 for
families and $1,500 for
individuals.
State MSAs
Seven states have now enacted
legislation providing for
MSAs in their state income tax codes. Although
states can-
not reverse the federal tax discrimination against MSAs,
they
can eliminate any state tax discrimination, putting
MSAs on an equal paying
field under state law with tradi-
tional insurance and HMO coverage. The
preceding discussion
shows that MSAs can still be viable, attractive, and
effec-
tive even with present federal and state tax discrimination.
Given
that, removing the state tax discrimination would be
effective in advancing
MSAs further. The specific legis-
lation adopted by each of the seven states
is discussed
below.
Arizona
Starting in 1995
workers and employers will receive tax
deductions for MSA contributions of
up to $2,000 for each
worker, plus $1,000 each for as many as two
dependents.
Those maximum contribution limits are indexed to grow with
inflation. Investment returns are tax-free, but all with-
drawals, even
those for health care, are included in taxable
income. Funds deposited in an
MSA may not be withdrawn
during the year for anything but health care. Funds
with-
drawn for other purposes are subject to an additional 10
percent
penalty, similar to the penalty on premature with-
drawals from IRAs. At the
end of the year, all funds re-
maining in an MSA may be withdrawn without any
penalty.
Colorado
Starting in 1995 employer
contributions to an MSA of up
to $3,000 for each employee will be
deductible. Investment
returns are tax-free, but all withdrawals are fully
taxable,
even those for health care. Remaining funds at the end of
the
year may be withdrawn for any use without additional
penalty.
Idaho
Starting in 1994 employer and worker
contributions of
up to $3,000 to an MSA are deductible. The contribution
limit is indexed to increase with inflation each year.
Investment
returns are tax-free, but all withdrawals, in-
cluding those for health care,
are fully taxable. MSAs must
be established through an employer, so the
uninsured cannot
start them on their own to obtain coverage. Remaining funds
at the end of the year can be withdrawn for any use without
additional
penalty.
Illinois
Starting in 1994 employer and worker
MSA contributions
of up to $3,000 for each worker are deductible. The
contri-
bution limit is again indexed to inflation. All investment
returns are tax-free, but all withdrawals are taxable. The
MSAs must be
established through an employer. Any funds
remaining in the MSA at year-end
can be withdrawn without
additional
penalty.
Michigan
Starting in 1994 employers and
workers could receive a
tax credit for up to $3,000 in contributions to an
MSA for
each worker. The tax credit is equal to 3.3 percent of
contributions, which is the equivalent of a deduction at a
3.3 percent
income tax rate. The contribution limit is
indexed to inflation. Workers can
establish MSAs indepen-
dent of employers, which helps to expand
coverage.
Mississippi
Starting in 1994 Mississippi
allowed employers and
individuals to establish MSAs. Contributions are tax
de-
ductible, and the interest is tax-exempt. The maximum limit
on
contributions is $2,250 for individuals and $3,500 for
families, but
contributions may be no higher than the de-
ductible in an accompanying
catastrophic health insurance
policy. Funds withdrawn for health care are
tax-free, but
funds withdrawn for any other purpose are subject to the
regular income tax. Only funds in excess of the deductible
of an
accompanying catastrophic health insurance policy may
be withdrawn for
nonmedical purposes.
Missouri
Employers may establish
MSAs for their workers, but
individuals may not establish them
independently. Contribu-
tions are not tax-deductible, but returns on MSA
savings are
tax-exempt. Withdrawals for medical expenses are also
tax-
free, but any other withdrawals are subject to regular in-
come tax.
MSA funds may be withdrawn for nonmedical expens-
es to the extent they
exceed a minimum balance established
each year by state
regulations.(22)
Congress Should Act
If MSAs are so
successful, why have they not been more
widely implemented? The problem is
that current federal tax
law discriminates heavily against MSAs and in favor
of tra-
ditional third-party insurance coverage provided by employ-
ers.
All that is needed is to remove that powerful tax bias
and tax MSAs and
traditional insurance equally.
If an employer pays for traditional
third-party insur-
ance for an employee, the employer receives a full tax
de-
duction for the premiums. None of the premiums are included
in
employee income. All health insurance benefits are also
tax-free to the
worker. Moreover, any returns on health
insurance reserves are not taxed,
unless retained by the
insurance company as profit.
In contrast, if
an employer contributes to an MSA,
although the employer still receives a
deduction for the
payments, the total of those payments is included in the
employee's taxable income. While the funds are in the MSA,
any returns
are subject to triple taxation--the corporate
income tax, the capital gains
tax, and the individual income
tax. That cripples private savings as an
alternative to
full third-party insurance coverage. Finally, any
withdraw-
als from an MSA not previously taxed are included in employ-
ee
income and fully taxed, even if the withdrawals are used
for entirely
legitimate medical expenses. Moreover, if an
individual contributes to an
MSA on his own, he receives
absolutely no deduction for his contributions.
Because tax rates are so high, tax discrimination makes
a big
difference. For even a moderate income worker, MSA
funds included in taxable
income would be subject to a 15
percent income tax, and effectively the full
15.3 percent
employer and employee shares of the Social Security and
Medicare payroll tax. If the worker is subject to a common
6 percent
state and local income tax as well, MSAs are ef-
fectively subject to a 36.3
percent tax in comparison with
traditional employer-provided insurance, on
which the em-
ployer pays no tax.
For higher income workers, the tax
penalty is even
worse. Their MSA funds would be subject to at least a 28
percent federal income tax, a 15.3 percent payroll tax, and,
most
commonly, at least a 6 percent state income tax, for a
tax penalty of nearly
50 percent on MSAs.
If MSAs are ever to be fully effective in reducing
costs and providing the other benefits discussed above, the
heavy tax
discrimination must be removed.(23)
Conclusion
The
experience of private companies currently using
MSA-type approaches to
reducing health care costs shows that
MSAs can control rapidly rising health
costs, while preserv-
ing both quality and patient choice. Policymakers
should
fully use this tool to control costs throughout our health
care
system. By ending the tax bias against MSAs, Congress
would establish a
fully comprehensive cost-control system
that would restrain costs without
imposing rationing by
either the government or insurance bureaucracies. That
is
because the system would provide the right incentives to
weigh costs
against benefits and allow patients and consum-
ers to decide on the basis of
their own preferences.
MSAs would accomplish that by expanding the
freedom and
the control of workers, patients, and consumers over their
own health and its care. Instead of rationing, MSAs would
expand
individual choice and control. Instead of granting
even more power to
government, big insurance companies, and
bureaucracies, as last year's health
reform proposal would
have done, MSAs would do just the opposite. They would
shift power and control away from government, insurance
companies, and
employers to individual consumers, patients,
and workers and the doctors and
hospitals they choose to
serve them.
In short, MSAs would solve the
health cost problem by
giving power to the people.
Notes
(1) For a detailed discussion of medical savings
accounts,
see John C. Goodman and Gerald L. Musgrave, Patient Power:
Solving America's Health Care Crisis (Washington: Cato In
stitute,
1992).
(2) For a more detailed discussion of the third-party pay
ment
problem, see Stan Liebowitz, "Why Health Care Costs Too
Much," Cato
Institute Policy Analysis no. 211, June 23,
1994.
(3) John C. Goodman
and Gerald L. Musgrave, "Controlling
Health Care Costs with Medical Savings
Accounts," National
Center for Policy Analysis, Dallas, Texas, Policy Report
no.
168, January, 1992, pp. 2-3; John C. Goodman and Gerald C.
Musgrave,
"Personal Medical Savings Accounts (Medical IRAs):
An Idea Whose Time Has
Come," National Center for Policy
Analysis, Dallas, Texas, Policy
Backgrounder no. 128, July
22, 1993, p. 11.
(4) Liebowitz, pp. 13-15.
(5) Goodman and Musgrave, "Personal Medical Savings Ac
counts," p.
10.
(6) Robert Brook et al., The Effect of Co-Insurance on the
Health of
Adults (Santa Monica, Calif.: RAND Corporation,
1984); and Willard Manning
et al., "Health Insurance and the
Demand for Health Care: Evidence from a
Randomized Experi
ment," American Economic Review, June 1987.
(7) See, for
example, Paul Feldstein, Healthcare Economics
(New York: Wiley, 1988); and
Alan Sorkin, Health Economics
(New York, Lexington Books, 1992), p.
31.
(8) Liebowitz, pp. 16-17.
(9) Gary Robbins, Aldona Robbins, and John
C. Goodman, "In
efficiency in the U.S. Health Care System: What Can We Do?"
National Center for Policy Analysis, Dallas, Texas, Policy
Report no.
182, April 1994.
(10) Liebowitz, pp. 20-21.
(11) The Golden Rule
experience with MSAs is discussed in
Peter J. Ferrara, "The Health Policy
Debate: Options for
Reform," National Center for Policy Analysis, Dallas,
Texas,
Policy Backgrounder no. 132, July 7, 1994, pp. 29-30; and
idem,
"Medical Savings Accounts: The Private Sector Already
Has Them," National
Center for Policy Analysis, Dallas,
Texas, Brief Analysis no. 105, April 20,
1994.
(12) See Peter L. Spencer, "New Plan Cuts Health Care Costs
in
Half," Consumer's Research, October 1993, pp. 16-19;
Nancy P. Johnson,
"Utility Rebates $800 to Employees with
Lower Health Costs," Business
Insurance, May 14, 1993,
pp. 1, 16-17; Ferrara, "The Health Policy Debate,"
p. 29;
and John Merline, "Employees as Health Reformers: Medical
Savings
Accounts Curbing Premium Costs, Investors Business
Daily, March 18, 1994,
pp. 1-2.
(13) These examples are provided by Golden Rule Insurance,
Indianapolis, Indiana.
(14) Ron Thompson, "Employer Benefits: A Tale of
Success,"
Thompson and Associates, Council Grove, Kansas, 1992.
(15) The
information on Plan 3 was provided by Dennis Kelly,
president of Plan 3,
Bethesda, Maryland.
(16) The experience of Windham Hospital is discussed in
Vera
Tweed, "Medical Savings Accounts," Business and Health Maga
zine,
October 1994, p. 44.
(17) The experience of the Health Wealth plan is
discussed in
Merline, p. 2; and Tweed, pp. 44-45.
(18) The Quaker Oats
plan is discussed in Ferrara, "Medical
Savings Accounts," p. 30.
(19)
The Forbes plan is discussed in ibid., p. 29; and Tweed,
p. 45.
(20) The
Indresco plan is discussed in John C. Goodman and
Gerald L. Musgrave, "The
Economic Case for Medical Savings
Accounts" (paper presented at American
Enterprise Institute
Conference on Reforming Health Care, Washington, April
18,
1994).
(21) The United Mine Workers example is discussed in Ferrara,
"Medical Savings Accounts," p. 30; Merline, p. 2; and Tweed,
p. 45.
(22) For additional information on state-level MSAs, see
Council for
Affordable Health Insurance, "Health Care Reform
in the States," Alexandria,
Virginia, August 1994,
pp. 19-24.
(23) Interestingly, current tax
treatment of health care is
not the result of deliberate policy decisions;
it is largely
a historical accident. During World War II American
busi
nesses simultaneously faced a labor shortage and wage-price
controls. As a result they began to offer health insurance
benefits as a
way to lure workers. After the war the prac
tice was sufficiently widespread
that it became ensconced in
the tax code. For a detailed look at how that
policy devel
oped, see Stuart Butler and Edmund Haislmaier, A National
Health System for America (Washington: Heritage Foundation,
1989).
Published by the Cato Institute, Policy Analysis is a
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series evaluating government policies and offer-
ing proposals for reform.
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should be construed as necessarily reflecting the
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of the Cato Institute or as an attempt to aid or hinder the
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Contact the Cato Institute for reprint
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