Making Sense of Health Savings Accounts

Originally published in Rochester Business Journal
1/9/2009, 1/16/2009, 1/23/2009

Part One

Early signals from our health insurer led us to expect another double-digit increase in our insurance premiums—perhaps a 15% hit. Frankly, I thought that we were just being softened up for something lower—If I were led to expect 15%, then a mere 11% bump should make me (relatively) happy. I was stunned when the final price of the most popular of our plans would go up 21% in 2009.

The big increase in price led us to explore cheaper plans, particularly a policy that includes a “Health Savings Account” (HSA). The discussion below refers to the specific plans we were offered by Excellus BlueCross BlueShield.

CAUTION: The remainder of this column discusses insurance premiums, deductibles, out-of-pocket maxima and other arcane health insurance jargon. Readers looking for lighter fare might prefer IRS Publication 17 or, perhaps, a William Faulkner novel.

Let’s start with the bad news: Other than well-child visits and an annual checkup for adults, the community-rated HSA plan requires each of us, as participants, to pay a $1,300 deductible per person ($2,600 family maximum) before the insurance pays a penny. Even after the deductible has been satisfied, we pay 20% of the cost.

“That’s not insurance!” one of my colleagues exclaimed. This comment reveals a great deal about what we’ve come to expect of our health plans. Perhaps we’ve forgotten that a health plan is indeed insurance—just like life insurance, car insurance, an extended warranty on a flat screen TV, or a Lloyd’s of London policy on part of a film star’s anatomy.

Insurance is about risk sharing. We’re familiar with deductibles on our auto insurance policies. The Geico gecko will charge more for your auto policy if you choose collision coverage with a $100 deductible instead of $500 or $1,000. He’ll cheerfully cover you for every accidental scratch or dent, but you can expect to pay for the privilege in advance through your premium. The size of the premium depends on how you and the gecko split up the risk.

The same principle applies to health insurance. Health insurers will pay all of your out-of-pocket health care expenses—for a price. Yes, the HSA plan saddles you with a deductible. But the insurer charges you a much lower premium in exchange.

The HSA plan also comes with something called “co-insurance.” Even after we’ve spent enough to satisfy the deductible, we still pay 20% of added costs, although our financial exposure under co-insurance has a limit. We are protected from catastrophic expenses—costly events like a premature birth, complex orthopedic surgery, or cancer—because the 20% cost share is limited to an annual “out-of-pocket maximum.” In our plan, the maximum is $3,000 for an individual with a $6,000 maximum per family.

To sum up, an individual pays the first $1,300 outright plus 20% of the next $8,500 (where he or she hits the $3,000 maximum out-of-pocket). Then the insurer picks up the full cost of additional expenses without any co-payments. A family covered by this policy might spend as much as $2,600 outright (the deductible) and 20% of the next $17,000 (at which point the family hits the $6,000 maximum out-of-pocket).

The good news is that in exchange for the deductible and the co-insurance, the premium on the HSA plan is much lower—in our case, exactly half the cost of the traditional plan we selected. The annual cost of the HSA plan is $1,980 for single coverage and $5,244 for family coverage. And that’s how much we save in premium over the traditional plan, $1,980 for single coverage and $5,244 for family coverage.

The challenge each of us faced at CGR was deciding which of the two plans we preferred. Comparing the two plans isn’t easy, so buckle up!

For a family, the maximum out-of-pocket expense under the HSA plan is $6,000. The savings in premium is $5,244. Under the “worst case” the family spends $756 more over the year than the premium cost of the traditional plan. Under the “best case”—if the family had no health care expenses at all during the year—the savings would be $5,244.

A traditional insurance plan also has risk in the form of co-payments—and there is no out-of-pocket maximum. The plan we’ve selected is called the “15/25” plan, as the co-pay for a primary care office visit is $15 while the specialist co-pay is $25. We must compare the premium cost plus likely out-of-pocket expenses under the HSA plan to what we are likely to pay under the 15/25 plan in premium PLUS co-payments.

Let’s assume that my family’s healthcare costs during the year consist of:

• Two continuous prescriptions—twelve 30 day scripts for a “Tier 1” drug with a $5 co-pay plus twelve 30 day scripts for a “Tier 2” drug with a $25 co-pay,
• One event requiring a “Tier Three” prescription with a $50 co-pay,
• One ER visit with a $75 co-pay,
• Four diagnostic office visits at $15 each, and
• Two specialist visits at $25 each

Well-child visits, one adult checkup per year and routine gynecological exams are free under both plans.

This would not be an unusual year for a family, although the range in health care costs is quite significant. Co-payments under the traditional plan total $595. How much I would spend under the HSA plan depends on what the full cost of these services might be (see the spreadsheet for a full list of my assumptions). I estimate that the full cost of these services and prescriptions would be about $6,000.

Without any further adjustments, the cost of the traditional plan (premium plus co-pays) is $11,071. The HSA plan (premium plus out-of-pocket) appears to cost a bit more, about $11,200.

But this isn’t the whole story. Remember the co-insurance? Eighty percent of costs above $1,300 for an individual or $2,600 for a family are paid by the insurer. By my reckoning (and this depends on how the costs are allocated across family members), the insurer’s cost of co-insurance comes to about $2,700. This brings the total cost of the HSA plan to about $8,500, savings of about $2,600 over the traditional plan.

I did not “cook the books.” In fact, I was surprised to learn that none of the scenarios I tried showed the traditional plan to be cheaper. But don’t take my word for it. I’ve posted my spreadsheet HERE for the rest of you wonks to download and explore.

In Part Two I’ll confuse you further with additional thoughts on this subject. Specifically:

• At CGR we will be making the same dollar contribution to a family policy regardless of whether our staff member chooses the traditional 15/25 plan or the HSA plan. How does this change the decision for the staffer?
• What is a “Health Savings Account” and how does it change the nature of the risk proposition?
• How does an HSA compare to a Flexible Spending Account (FSA)? If you have both, how would you use them together?

Health Savings Accounts: Part Two

In Part One we explored differences between health savings accounts and traditional health plans, focusing on concepts like deductibles, co-insurance and out-of-pocket maximums.

Now I’d like to begin by introducing another wrinkle to the decision. Until now we’ve ignored the question of the employer/employee share of the premium. This is actually simpler than you might think. At CGR, like most firms, we decided how much money we’re willing to contribute to an employee’s health insurance. The employee gets to decide how to spend the money. By selecting family coverage, I know that CGR will contribute $7,333 to whichever health plan I choose.

The traditional plan—the Healthy Blue 15/25—costs $10,476 or $873 per month. The difference, if I choose this plan, comes out of my pocket. CGR kicks in $611 per month, leaving me with the remainder, $262 per month. I never see it, of course. It comes right out of my paycheck.

If I choose the HSA plan, CGR contributes the same $611 per month. But the premium for the HSA plan is about half that of the traditional plan, $437 per month. So CGR gets a deal, you say? Not so fast. I still expect the same $611 per month—CGR pays the premium on the policy and deposits the remainder ($174) into a “health savings account” which I set up independently and own. It isn’t CGR’s money anymore. Nor is it the insurer’s. It’s mine.

We’re back to the “which is better” question. IF my family has no health care costs in a month, I’m ahead two ways. First, I don’t have to contribute to the cost of insurance so my paycheck is $262 larger. In addition, I’ve gained a savings account with a balance of $174. I’m $436 ahead for the month. We covered the next step in Part One, i.e. what happens when we do get sick.

In Part One I argued that the HSA is typically cheaper overall. Let’s add the employer/employee share to the example we used in Part One. I estimated that the HSA plan would be cheaper by about $2,600.

In this example, the total cost over the year under the HSA is about $8,500, of which CGR pays $7,337, leaving me with a cash outlay of about $1,200. Under the traditional plan—even without co-pays—I’d have paid $262 per month as my share of the premium, a total of $3,144 over the year. So I’m ahead almost $2,000 already. When we add in the co-pays I WOULD have paid under the traditional plan, I’m ahead about $2,600.

That’s the same figure in Part One. As long as the employer is going to spend the same dollar amount regardless of which plan the employee chooses, the calculation of net benefit doesn’t change. The employer doesn’t win or lose—all the uncertainty of the decision (upside and downside risk) is the employee’s. I’ve edited my spreadsheet to allow you to incorporate your company’s contribution. Go to www.cgr.org and click on the link to our blog site if you want to download the spreadsheet and check it out for yourself.

In this example, I spend all of the money CGR deposited in my HSA. There isn’t any money left in the health savings account at the end of the year. I spend all of it on physician visits and drugs—plus a bit more.

This won’t always be the case. One interesting—and important—difference between the HSA and the traditional plan is that the HSA lets you spread your risk across years, just like an insurance company. Insurers have good years and bad years. Profits from the good years offset losses in the bad years. If you’re in the property and casualty business, the weather has a big impact on your claims in a particular year. A bad winter or an active hurricane season—even a single event like a Katrina or Andrew—can lead to lots of claims. The insurer sets rates based on an average of years.

When you sign up for an HSA plan, you are accepting more uncertainty in exchange for a lower premium. You are shifting more of the burden of the insurance from the insurer to yourself, becoming “self-insured” in a way that you aren’t with a traditional health plan. We can easily imagine the bad part of that proposition—that you get nailed with a big bill early in the year.

The good part is this, however: If you have a good year, you get to carry over your savings to the next year. Under a traditional plan, if you have a good year the insurer wins it all. With an HSA, you start the next year with savings from the good year banked in your health savings account.

Let me illustrate by returning to our example and making three changes.

• Remember the Tier 2 drug? The patent on the drug expires and my family member switches to a generic.
• The drug company selling that ridiculously expensive Tier 3 drug gets some competition from a new product. It is now a Tier 2 drug.
• We save an ER visit because the crisis happens during office hours. We trade the costly ER visit for another diagnostic office visit.

We’re looking at the same health events, just with different costs. Now the total cost is about $6,700. CGR contributes $7,337 and the difference—about $600—is left in my health savings account at the end of the year. I’m allowed to transfer the benefit of a low cost year to the following year. This is my money. I get to keep it and spend it on future health care costs.

An HSA works much like a Flexible Spending Account (FSA) with a few key differences:  Most important, the FSA has to be used within a specified period, usually about a year. The HSA, by contrast, is yours forever, just like an Individual Retirement Account (IRA). Like an IRA, you may spend your HSA for a different purpose, but you have to pay a penalty to do so.

The tax advantage of spending out of an FSA or an HSA is identical. By creating the FSA and the HSA, Congress has given individuals the ability to spend pre-tax dollars on health care. Suppose you’re in the 25% tax bracket for federal tax purposes (more than $31,850 for singles, $63,700 for married filing jointly) and the 6.85% tax bracket for NYS tax purposes. As “pre-tax” dollars, FSAs and HSAs boost your health care spending power by nearly a third. Every $100 you spend on health care through the FSA or HSA would shrink to $68.15 if you made the same purchases using after-tax dollars. “SALE on health care—32% off!”

Contributions to the HSA by both the employer and employee total $3,000 for individuals and $5,950 for families. (In 2010, these limits increase to $3,050 and $6,150). I’m saving $262 each month because I’m not contributing to the traditional plan’s health insurance premium. Rather than letting those savings go into my paycheck, I’ve created a forced savings plan that can be used pre-tax to pay my out-of-pocket health care costs. M&T Bank, which set up our HSAs, provides me with a VISA card that draws straight from my account. Whatever I don’t spend this year can be used to pay for health care in future years. Just like any other savings account, the HSA can be invested until I withdraw it. In 2010—after turning 55 in December—I’ll be permitted to make “catch up” contributions of an additional $1,000 (pre-tax, remember).

One important point: You cannot use both a health care FSA and an HSA. Your employer can develop a “limited” FSA that covers only vision, dental and childcare. But if you have an HSA, you cannot also have an FSA.

NOTE: As an example of just how complex this whole health care world really is, we reported in this column last year that you COULD use both an FSA and an “employer-only” HSA. Alerted by a respondent to this blog (Jane Ahrens), we went back to our insurance consultant and asked the question again. After additional research, the answer was clear—the HSA could accept both employer and employee contributions. And a health care FSA cannot be used in conjunction with it.  We apologize if any of our readers got caught in the same dilemma. If you want to know how we reversed the problem, drop a line to kgardner@cgr.org.

In Part Three we’ll answer the following questions:

• How does a consumer-directed health plan change behavior (it has already changed mine!)
• What are the problems with this approach? Is it for everyone?

Health Savings Accounts: Part 3

Summarizing what we’ve learned so far—The HSA-based health insurance plan CGR selected from Excellus Blue Cross Blue Shield was found to be generally cheaper than the more traditional policy on offer. Moreover, when the employer’s policy is to spend the same dollars regardless of the selected plan—which is typical—we found that the employee bears the responsibility for the decision, win or lose. In most cases, the employee is a winner in the HSA plan. In this week’s episode, we explore how cash flow affects the decision and the public policy implications of consumer-directed health plans.

You’ve heard of the economist who died on a hiking trip? He crossed a river with an average depth of three feet, but drowned anyway. If you are living from paycheck to paycheck, it is possible for you to get hit with expenses early in the year that you don’t have the savings—whether in an HSA, FSA or any other place—to pay. The HSA plan MAY cost a family $6,000 in the first month. Thus a family can end the year better off by having saved the difference in premium— $3,144 in our example—plus a host of co-payments, yet still get whacked with a nasty bill right off the bat. As we’ve discussed above, getting to the family out-of-pocket maximum in a single month requires significant health events for more than one family member. And if the unlikely happens, hospitals and physicians are usually willing to work out payment plans, particularly if you anticipate regular payments into your HSA and FSA. Nonetheless, this is what risk sharing is all about. If you want to be insured against all uncertainty, you have to pay for it.

On to the policy question: Why might an insurance company offer such a plan? Why did Congress pass laws making these plans possible? An HSA-based plan is called “consumer-directed health care” because of that shift of financial responsibility from the health care system (insurers and providers) to the consumer.

The issue is most easily illustrated with prescription drugs. Like many men my age, I’m taking a statin to lower my cholesterol, simvastatin in my case (the generic form of Zocor). When first prescribing the drug, my doc asked me where she should send the prescription. The Wegmans on Hudson Avenue is the most convenient. In Rochester lingo, I call this store “my Wegmans.” As my only obligation is the $5 co-pay, what matters most is convenience.

Not anymore! Until I spend up to my individual or family deductible, the entire cost of the drug comes out of my pocket. For the first time, I’m looking at the full price, not just my co-payment. Without curious customers, the prices of prescription drugs vary quite a bit from place to place. As the price of simvastatin isn’t printed in ads from Wegmans, Walmart, Rite-Aid and Walgreens, I had to call to find out what I’d be charged. As you can see from the table below, the price for a 90 day supply of 20 mg simvastatin varies by four times. I would save $596 over the year by picking the lowest cost Rochester source instead of the highest cost Rochester source.

^{*To be fair, I was told (only after I asked) that I could sign up for a discount card at Walgreens and get a better price. After paying $20 for the discount card, the price drops to $45.97. When I asked about discounts at Rite-Aid, the person to whom I was speaking said that there was some kind of a discount but he didn’t know anything about it.}

I’m not limited to Rochester, however. There is a lively market for prescription drugs on the Internet—and not just from spam artists selling Cialis and Viagra. A website devoted to the question, http://www.pharmacychecker.com/, pointed me to Costco.com for the best price on simvastatin. Costco is hardly a fly-by-night operation. A competitor to Walmart’s “Sam’s Club” in many markets, Costco was on Fortune’s list of the 20 “Most Admired Companies” in 2008. My first 90 day supply arrived last week for a total price (shipping included) of $9.93. Annual savings over my current source will be $320. I’ve found similar savings from shopping for other drugs that are routine for our family. Online isn’t a good option for something you want today—but price shopping locally still makes sense. If it’s your money, that is.

“Ah, but drugs are different from other health care expenses,” you say. In some respects, they are: Courtesy of the Food & Drug Administration, I’m confident that I’m getting the same stuff from Costco as I’ve been getting from Wegmans. Pricing for nearly-identical health services also varies, however. After turning 50, my wife & I signed up for the recommended colonoscopy. We picked the same doc and were given a choice of Westside Surgery or Highland Hospital. For reasons of convenience, she picked one and I picked the other. After the fact, the paperwork from the insurer showed that the cost had differed by several hundred dollars for the same doc and same procedure, but a different setting. Next time I’m given such a choice, I’ll ask if there is a cost difference. Because it will be my money.

I’ll also think twice before I ask my doc to look at my sore throat or get a blood test or schedule an MRI. “Is this really necessary, Doc?” I’ll ask. Or “Can’t we start with a cheaper drug and move to the cool drug only if the first one doesn’t work?” That’s what is meant by “consumer directed.” We’ll pull the consumer more fully into the decision-making process—not just about balancing the relative risk of alternative procedures or the likelihood that a drug will work, but about relative cost.

In a perfect world we’d all get the very best care—and we’d all be driving cars equipped with the latest safety gear and have a food system that tests for salmonella just before the food lands on our dinner plate. Yet as with every other human need, we have to balance cost and benefit. The rising cost of health care cannot be ignored or the problem of coverage will become even less tractable. Already serious, the cost problem turns critical as the Baby Boomers retire and swell the ranks of Medicare beneficiaries. Cost matters—we must involve the consumer in the difficult task of balancing cost and care alternatives.

Opponents of consumer-directed healthcare argue that some people will make bad decisions because they can’t or won’t pay the cost of proper care. They are right. A few years ago my brother cut his arm in a workshop accident (hardly an unusual occurrence among the clumsy Gardner brothers). The health insurance he had at the time wouldn’t pay to get it stitched up. After a bit of Internet research, he asked his skeptical wife to hold the wound closed and ran a line of cyanoacrylate adhesive (sold as Super Glue or Krazy Glue) down its length. Worked fine—but I confess that it gives me pause (although I keep a tube in my workshop). Being your own doctor has its risks. Where does regulation become paternalism? And when is paternalism appropriate?

These are difficult public policy questions that apply to many aspects of health care, not just to “consumer-directed” health plans. The complexity of the plans on offer highlights the challenge faced by President Obama and his designated “point man” on health care, Tom Daschle. The stakes are high—not only is the health status of the nation at stake, but the livelihoods of health care workers, the future of health-related businesses, and the stability of state budgets are also at risk. The immediate financial crisis aside, the new administration faces no task more difficult.

Download Health Comparison XLS

Kent Gardner, Ph.D. President & Chief Economist
Published in the Rochester (NY) Business Journal January 2009