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Sayonara MSAs


Tags HealthMoney and BanksCapital and Interest TheoryInterventionism

12/25/2000Dale Steinreich

Beside signing appropriations bills containing $20 billion in pork before leaving town last week, the 106th lame-duck Republican Congress left another nasty surprise for individuals wanting to save money on their health care expenses: it failed to renew the pilot program for medical savings accounts (MSAs).

MSAs were introduced in the U.S. four years ago in the Health Insurance Portability and Accountability Act of 1996. The program expires on December 31, 2000. Although current account holders can continue to have their accounts beyond the program's New-Year's-Eve expiration, individuals wanting to open new accounts will not get them. In fact, many insurance companies have been refusing to open new accounts since December 1 given that the future of the pilot program was uncertain.

To understand the alleged value of the MSA, one has to consider the history of medical insurance in the U.S. throughout the last 60 years.

Health Insurance: Singing the Blues

Before World War II, medical insurance in the U.S. was much different than it is today. It was popularly known as "hospital insurance;" this reflects the fact that it was, unlike today, true insurance. True insurance is based on statistical probability where the occurrence of the insured event is in doubt. The policy holder, facing risk under uncertainty, pays insurance premiums to minimize the potential losses from unfavorable future events. Hospital insurance conformed to this actuarily sound vision. Heads of families, concerned about falling prey to sickness or work-place injury, could purchase insurance policies to have genuine financial contingencies covered.

During World War II, this actuarily sound system was transformed. Wage and price controls instituted by the federal government during the war prevented large employers from competing for labor based on wage rates, so they competed based on the quality of fringe benefits. The most effective fringe benefit for luring labor to large employers was no longer wages but generous hospital-insurance policies. The decision by the federal government to allow these large-employer benefits to be obtained tax-free while effectively taxing plans purchased by small businesses and the self-employed created a system where medical insurance became attached to employment. Thus the relative price of health insurance became not only perversely tied to employment but also to the size of a worker's employer: the price of health insurance for many small and retail businesses became too high.

After the war ended insurance itself was redefined. Blue Cross, first founded in 1929 as a hospital insurance program for school teachers, had its symbol adopted by a commission of the American Hospital Association (AHA) in 1939. AHA adopted the symbol as an endorsement of insurance plans that met certain standards. Also in 1939, the first Blue Shield plan was created in California. Blue Shield was a hospital insurance plan created by physicians.

The twin Blues, 43 years before their merger in 1982, immediately started securing government-enforced competitive advantages to other insurance programs at the state level. Setting up their "own" form of insurance allowed doctors and hospitals freedom from dealing with insurers who didn't adopt Blues-type practices.

Blues-type practices were a perversion of the concept of insurance in four ways:

1. Hospitals were paid on a cost-plus basis. Physicians were compensated no matter how many dubious tests and procedures they performed on patients. The proper role of insurance, according to the hospital- and physician-run Blues, was to pay the bill regardless of size, with no questions ever asked.

2. All services were insured, even routine checkups and tests. This spelled the end of hospital insurance. What replaced it ("health insurance") was not insurance at all but prepaid consumption that encouraged overuse of services. The end result is somewhat analogous to an all-you-can-eat five-star buffet at a Ritz Carleton Hotel that's been underpriced at $1.99 per person. When the buffet is re-stocked the price jumps to say, $100 per person.

3. Insurance premiums based on "community rating." The word "community" meant that every person in a specific geographic area regardless of age, habits, occupation, race, or sex was charged the same price. For example, the average 60-year-old incurs 4 times the medical expense of the average 25-year-old, but under community rating both are charged the same price, which is another way of saying that young people are overcharged and old people undercharged.

4. Pay-as-you-go system. Unlike sound hospital insurance, which placed premiums in growing reserves to pay claims, "health insurance" created by the Blues collects premiums that only cover the expected costs that will be incurred by policy holders over the following year. If a large group of policyholders becomes ill over the course of several years, the premiums of all policyholders have to be raised to cover the increase in costs.

These four practices were also incorporated into the federal Medicare and Medicaid programs when they were created in the mid-1960s. The net effect was not only an abolition of true medical insurance but also an abolition of price competition and close cost-containment oversight by third-party payers.

The only area where price competition survived was cosmetic surgery, which is not paid for by any form of health insurance. The old system can still be seen in markets for cosmetic surgery where prices are provided up front to patients in advance, they can be bargained down between competing suppliers, and they remain relatively low (close to cost of production) and stable.

Since the early 1970s, community rating and cost plus collapsed. Young people (either self-employed, attending college, or working in uninsured, unskilled jobs) who were overcharged by community rating refused to buy insurance and were not the worse off since they were generally more healthy as a group.

Cost-plus reimbursement collapsed when large corporations, which had as much political clout as the Blues, created and managed their own health-care plans and paid hospitals fixed charges for services, bargaining down prices wherever possible. The practices of pay-as-you-go reimbursement and insurance of routine services both continue and have played an important role in continually driving up the prices of medical services over the past 55 years.

Cost Containment: Medical Savings Accounts

Resurrecting at least part of the pre-"health insurance" health-care system was the goal of the creators of medical savings accounts (MSAs). MSAs are individual investment accounts initially capitalized through savings created by choosing higher deductibles on current policies and diverting the savings from the new lower premiums to the MSA. Over time the reserve builds up and any routine expenses incurred are paid from it. As the funds build up in the MSA, the reserve can be used for medical expenses after retirement or even as a source of additional income.

What in particular MSAs seek to create is a de facto elimination of insurance of routine practices and procedures. This in turn would also eliminate pay-as-you-go practices over the long run as the old hospital insurance system returned under its current name, catastrophic care. Although they would do nothing to eliminate restrictions on the supply of doctors and hospitals at the state and federal levels (and hence would have no effect on the supply side of medical markets), MSAs could potentially reduce demand and reduce the rate of growth in medical prices.

As previously mentioned, MSAs were introduced in the U.S. in a pilot program in the Health Insurance Portability and Accountability Act of 1996. To qualify for an MSA in the U.S., an individual must have been an employee of a firm with an average of 50 or fewer employees during either of the last 2 calendar years. The employee must also have a high deductible health plan (HDHP). An HDHP has higher annual deductibles than typical health plans and maximum limits on annual out-of-pocket expenses. These limits depend on the type of coverage sought by the worker.

If the aforementioned criteria are met, the MSA is set up through a trustee such as a bank, insurance company, or other IRS-approved institution. Employers can make tax-free contributions to the MSA or the employee can make contributions that are tax deductible. Employers and employees are not allowed to both contribute in the same year. There is also a limit on the size of the contributions. Tax-free withdrawals from the MSAs can be made for only specified expenses. Withdrawals for non-medical reasons are subject to taxation. The account holder can continue to hold the MSA if he/she changes employers only if the new employer continues to meet the criteria of the MSA program. Otherwise, the worker loses the MSA. Contributions to the MSA are limited and either based on the annual HDHP deductible or worker earnings.

A program with such heavy restrictions attached to it has been of little value in returning the U.S. health care sector to relatively low and stable prices. Indeed, the program at the outset was doomed to fail in reaching this goal since the number of MSA accounts was subject to a quantity ceiling of 750,000. With this limit, only 60 insurers decided to offer MSAs.

The prohibition against employers and employees sharing the cost of the program made MSAs too costly for many small businesses. The difference in savings between traditional and MSA plans was unimpressive. The city of Jersey City, New Jersey entered into an MSA plan for its employees. The taxpayer price for the old traditional policies was $6,776 per family compared to $6,505 for the MSAs.

With the December 31, 2000 expiration of the pilot program, the future of MSAs in the U.S. is very much in doubt. The items at the top of the current Bush agenda seem to be the elimination of the estate tax and the marriage penalty (with at least half of the promised $1.3 trillion 10-year tax reduction certain to be bargained away). But even a renewal of the current MSA program would be terribly insufficient in reforming the health-care system.

The current pilot program has all the fingerprints of the insurance industry. Requiring the purchase of high-deductible health plans guaranteed that the industry would have policies to sell under the pilot program. Enrollment, contribution, and withdrawal restrictions more lenient than the current program would certainly be opposed by the Blues given that a much freer MSA program would pose a threat to their business.

Indeed, what the failed MSA experiment has shown is that, like school vouchers, MSAs are a dead end instead of an ever-widening road to health freedom. A first step toward genuine health freedom would be an elimination of all federal restrictions on supply and demand factors in medical markets. This means no more millions of dollars in federal subsidies to hospitals to train fewer doctors, and the abolition of Medicare and Medicaid. Medicare and Medicaid have only worsened the problems in the health-care sector by adopting Blues-type practices which have in turn encouraged an over-consumption of health care services among the poor and elderly.

Beyond this point free-market health-care reform becomes a tricky matter since some of the most oppressive restrictions (physician and hospital licensure, restrictions on midwives and pharmacists) have been enacted at the state level. It would be a violation of states' rights to advocate that the federal government override these restrictions.

Here's where public awareness has to play a part. Americans must be made to understand that restricting labor supply in medical markets so that general practitioners can earn 3 times what they would earn in a free market has been a disaster. The average new physician, if he's still accepting new patients, is not Rolls Royce in quality but a tired, hurried man who can barely contain his irritation at having to listen to your symptoms before scribbling a prescription on his pad and running off to his next patient.

Americans must also understand that a system that places the average hospital half a county away and makes you wait a fortnight for its service is not about quality but about extracting monopoly-level profits from patients and taxpayers. Expecting the public to become better informed seems like a lot to hope for, even naive. However, some of the most liberating developments in health freedom will not occur in the absence of this process. The public doesn't receive tremendous potential benefits now because it doesn't understand them, and having traded freedom for an illusory security, doesn't deserve them. The great tragedy is that an ignorant public drags the rest of us down with it.


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