In a few years, the baby boomers will retire and two things will happen. They will have to retire later in life, and the country will have to borrow money to pay for the rest.
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In 2004, the Nobel Prize in economics was shared by Edward C. Prescott and Finn E. Kydland, for advancing the concept that business cycles are caused as much by what people expect to happen as by what actually does happen. By this reasoning, myriads of individual decisions are constantly made in the direction suggested by simple undeniable truths. What truths face us? Demographic facts related to how many people have already been born, and how fast they are dying, force everyone to acknowledge that both Social Security and Medicare are seriously underfunded. Consequently, it seems inescapable that the boomers must work longer and retire later. To whatever degree they don't, the country must go deeper into debt.
Prescott, writing in the December, 2006 Wall Street Journal, stated this truism slightly differently to reach the next step: the national debt must increase. Increasing the national debt raises interest rates, which is good for savers. At the moment, the main savers are American retirees and foreign governments. However, the bond market is and always has been a zero-sum game. What's good for American retirees is bad for American business. And mortgage-holders. And everyone else who is in debt. Higher interest rates, which are seemingly inevitable, encourage saving and discourage borrowing. Prescott seemingly welcomes those features, because he is remarkably cheerful about the inevitable coming demographic crunch.
There are at least two things about it which should be bothersome. The first is that the boomers will not be borrowing money from their own generation but from their children. Getting the chance to live longer than their parents, they seemingly want to retire at the same age or earlier, asking their children to pay for the unearned twenty-year vacation. Boomers simply must be shamed into later retirements. The American Gross Domestic Product has a long term growth rate of about 3% per year; 2% of that total comes from increased productivity, about 1% from population growth. Extending domestic working years has the same economic effect as, say, illegal immigration; it's good for the whole country to make this nativist substitution.
The other disturbing consequence of borrowing our way out of debt is the effect on banks. That's harder to explain, but the interest rates we have been describing are long-term rates, established by the world marketplace. Short-term rates are independently set by the Federal Reserve to control (or "target") inflation, and currently they are higher than market-set long term rates. Any sensible saver will therefore use moneymarket funds rather than buy bonds. That's mostly bad for banks because their profit largely derives from "borrowing short and lending long". The so-called inverted yield curve, then, is good for old folks and bad for banks. If the Treasury fails to issue enough long term bond debt, or the Federal Reserve fails to issue enough short-term debt, banks are in danger of going broke. To summarize the whole puzzle, the government clearly will become more deeply indebted, but it must preserve a proper balance between short-term and long-term borrowing. Otherwise, either a bank crisis or inflation will sink us.
As a guess, I would say that banks are the likeliest to fail. They are in precarious condition anyway because of wrenching changes in technology. And they are in the process of discrediting themselves by failing to pass along the currently soaring short-term rate bonanza to the public. Just compare your own money-market interest rate with the 5.25% which the Federal Reserve has dumped on the banking system, and see if your blood doesn't boil a little. If this pick-pocketing continues much longer, banks will be in a bad public relations position when they must come to the public with hat in hand.
So, there's only one defensible response to this demographic retirement problem. The baby boomers, having been handed several years of unexpected longevity, must spend a portion of it working longer.
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Political Cartoon
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Western civilization now takes One-man, One-vote for granted in any variant of national governance, and a good thing, too. The Romans modified ancient Greek democracy models into a Republic, allowing slightly modified democracy to become practical for larger governments. Citizens elect representatives, and it is possible to imagine groups of representatives electing their own representatives to higher bodies, and so on, up to the line. As long as democracy remains inflexibly the model for a united Europe, other mechanisms must be adjusted for the obvious inequalities of huge population masses. Since money is the main means of exchange in national systems of compromises, it is a handicap for them to freeze a monetary system in place before governance negotiations have even begun. As a reminder of the American experience, remember that in 1787 Virginia was by far the largest and richest state, not at all the case at present. Indeed, the political landscape then consisted of nine small states ranged against four big ones. Virginia, Pennsylvania, and Massachusetts are no longer considered big states, and New York is fast receding from the top tier. Organizing monetary structures around the size can prove crippling to future designs of unified government, particularly if sufficient time elapses between the two steps. At the very least, leisureliness creates an opportunity to cloak opposition to unification within delaying tactics, presenting arguments to "wait and see" how the monetary system works. At worst, it creates an incentive to make certain the monetary system will not work.
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Bitting Gold Coin
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However, a bridge player must play the cards as they are dealt with him, and Europe has decided on a piecemeal approach to organizing an eventual political union. The first step of monetary union is in its tenth year, and in deep trouble. Therefore, a new alternative to be considered is whether to have a monetary union without a government to oversee it. Since the Spanish doubloon was for centuries the medium of maritime exchange for the whole western world, it can be done. The doubloon was a gold coin worth its weight in gold, the so-called "piece of eight". Since that kind of money proved entirely workable, the issue of feasibility is one of backing for the currency. When gold from the New World ran low, it was hard to support a growing world economy with a shrinking currency; the price of everything went steadily downward, and local shortages were common. So silver was substituted, and then the coinage became fractional. That is to say, paper money was issued in a fixed ratio to the gold in government vaults. Finally, paper money had no metal backing at all and was issued by central banks in response to the prevailing prices of goods. Using an arbitrary figure of 2% to represent population growth, if the consumer price index plus 2% goes down, the Federal Reserve (or equivalent national central bank) prints more money. Conversely, if it goes up, the Federal Reserve bank stops issuing paper money. The currency is thus "inflation indexed" and its worth guaranteed by the government against an international financial panic. World opinion has a lot to do with the value of a national currency, although in theory, the financial reserves are the sum total of all businesses and property available to the government to confiscate. By encumbering its national property, the government monetizes its assets. Even if it were possible to arrive at a tolerably accurate estimate of the total net worth of a nation, much of it is illiquid and has a considerable cost to monetize it. In practice, however, everyone realizes that the government will never sell an island or peninsula, probably going to war to prevent it happening, or simply going bankrupt or defaulting on its debts. The reserves which are listed as backing its money supply are largely frozen in the face of an actual financial panic. Everyone could name a dozen nations which would probably default, should creditors ever trust them, and there are many more who would seriously consider it. However, there are enough "speculators" who take a chance on this scenario for a fee, to keep the system running. If things start looking ugly, these intermediaries quickly disappear and the "markets are frozen". To protect their economies from this sort of chaos, governments look to merging their currencies, or to promising to rescue other member nations in trouble. A big pool of reserves is inherently safer than a small one, so currency unions are attractive to almost everyone.
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GooseStepping
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Currency unions, however, look like sausage factories when you get inside and look at the details. Some parts of New England are essentially piles of pebbles with a thin layer of topsoil, while the topsoil in Illinois is mostly four feet deep. Some rivers are full of fish, others are full of pollution, and so forth. As long as we are one united country, local differences are largely ignored; if you can't farm the pebbles in Connecticut, you can move to Greenwich and sell Credit Default Swaps. If that doesn't work, you can move to Illinois, and if you don't like big city political machines, you move to Utah. There's a frictional cost to all of this, but it remains a practical alternative. For Europe, it's not so easy to learn a new language, the schools are not so good in Kosovo, and the price of a taxicab in Paris is astonishing. If you are a gypsy, you are very likely to encounter pitchforks after your first night in the campground. No doubt most of this difference between the continents would disappear after fifty years of political unification, but there would be enough problems to make the survival of the E. U. somewhat questionable for two generations, at least. During all of that time, interest rates would reflect the existence of a real risk, and occasionally crises will appear. Madison, Jefferson, and Hamilton were bosom chums in the 18th Century; within five years of the new nation, they were at each other's throats. Founding Father Robert Morris, one of the richest men in America, was denounced and his motives questioned on the floor of the Legislature by a Western Pennsylvania nobody, within weeks of the Constitutional Convention. Vice President Aaron Burr put a bullet through Secretary of the Treasury Alexander Hamilton. Social upheavals are just that: upheavals. The problems associated with piecemeal approaches to the monetary union and the political union have been mentioned. The other side of it may be that many of the unique monetary problems of Europe have been brought to the surface by the current financial panic, and political solutions to monetary difficulties can be devised in advance if anyone has time to do it.
The political side of Europe is becoming plain. The Germanic tribes to the North are rich and have a history of trying to conquer all of Europe; the Latin tribes of the South are poor and nurse a fairly recent memory of defeated military occupation. The Germans are nevertheless the only possible rescuers of the present financial panic. It will not be easy for the Latin component of Europe to humble themselves before a German financial rescue, but they must do so for decades into the future. Although both groups suffer from the debility of a Welfare mentality, the South has it worse and their financial reserves are very questionable. Unless they are ready to do unlikely things like selling real estate sovereignty, they are going to find the ownership of their companies in German hands, and very likely have to endure the sight of the children of Wehrmacht officers managing their local economy. They will have to be tolerant. The Germans are not happy to work long hours so the Greeks may work shorter ones, and must be forgiven for indignation that German funds donated to rescue the Greek Welfare state are diverted for the personal use of corrupt Greek officials. Nevertheless, such affronts eventually become tolerable; a dozen American cities are at least as corrupt, and the California beaches appear to be utterly devoid of the famous American work ethic. Nevertheless, the most likely stark alternative would seem to leave only America, India and China in charge of major viable economies.
An entirely new concept like reconstructing health insurance on the "whole life" model can be expected to provoke concerns. Here are a few of what surely is not yet a complete list:
Inflation. It is true that rampant inflation would be injurious to the whole idea of permanent health insurance. However, it is the job of the Federal Reserve to maintain price stability, and many changes have taken place in the Federal Reserve's methods of operation since 1913. The most notable one was the abandonment of the gold standard by President Nixon in 1972 as a late consequence of flaws first introduced at the Breton Woods Conference in 1945. Observers may be of the opinion that the gold standard was stronger protection against inflation than the present inflation-targeting one, but the latter is nevertheless the system under which we operate. It should be recalled that in 1945, America had two-thirds of all the gold in the world, and international trade was being stifled by the unbalanced distribution of any common means of exchange. The correction of this gold maldistribution finally came to an end when a correction was no longer necessary, and indeed in 1972, it was possible to foresee an American gold shortage if trends continued. The American currency is no longer supported by a link to gold or any other commodity. In its place, the Federal Reserve issues or withdraws currency from circulation in response to inflation, attempting to maintain a steady inflation rate of 2% to match the growth of the economy. There are disputes about exactly which inflation rate would be ideal, but the ability of the Federal Reserve to maintain its stated targets has been reassuring. While there is room for argument among economists about the precisely optimum inflation target, the variation has been less than 1/2 %, even in times of economic disorder as severe at the present one. The projected finances of funded health insurance can safely sustain much greater miscalculation than this. If a threat is present, it comes from other directions.
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Inflation
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The suggested choice of an index fund composed of the entire list of domestic American common stocks was intentional and may be vital. The Affordable Care Act's provision for mandatory universal coverage makes it official that the full faith and credit of the American taxpayer stands behind the funding, so the American stock market is a close surrogate of that pledge. Anything which could destroy the stock market would constitute a threat to America much greater than a collapse of its health insurance, and enormous efforts would surely be invoked to prevent such a disaster. The wisdom of ransoming the whole economy to a comparatively small component of itself can be questioned, but it is nonetheless difficult to imagine a default when such heavier consequences would follow it. The same can be said of a permanent stock market decline, a devaluation of the currency, or a bond market default. These things can happen, but injuring health financing would scarcely enter the discussion.
The Changing Mix of Disease. Most of the rest of the world still concentrates its medical attention on the treatment of contagious diseases. In America, contagious disease scarcely makes the top ten concerns. No one would have predicted this a century ago, and no one can predict the mix of diseases, or their cost, a century from now. We do know that people will continue to be born and invariably to die, but we do not know what will kill them or what it will cost. It is even possible that an epidemic will unexpectedly sweep the globe, or an asteroid will hit the earth, but in general, big changes occur over more than a decade and give some time for readjustment. We tend to feel confident that our longevity will continue to lengthen, although in Russia it has lately shortened. Generally, new treatments have patent and development costs at first, and then become cheaper. But even healthcare workers enjoy raising their own salaries. It is difficult to predict population costs for healthcare eighty years from now, or whether they will be distributed evenly throughout the population. Unfortunately, this uncertainty will bedevil any system of financing that can likely be devised, but that does not mean reimbursement systems cannot be designed to cope with it.
Therefore, it is essential that any long-term plan, not just this one, build an accordion system into its initial design, and assign the task of watching over this problem to a permanent oversight body, particularly one which is able to resist the general economic pressures bearing down on the Federal Reserve. Inevitably, there will be times when the two bodies are adversaries. The easiest approach is, to begin with, the first and last years of life as anchors, and extend the reimbursement to intervening years as needs can be projected. This is one of several reasons why it is advisable to anticipate two parallel systems, one paying the bills as they appear and raising premiums if need be, while the other reimburses the first one as its fund permit. If a cure for cancer or Alzheimer's disease should appear, there might be funds to reimburse the other system for eight, ten or more years, readjusting premiums as it goes. If those miracle cures prove to be astonishingly expensive, the accordion would contract the other way, or its premiums would readjust in the other direction. Let us be clear what we are attempting: to reduce the annual premium of health insurance for the working years of life as much as we can. We must resign ourselves to remaining uncertain how much the premium can be reduced in the far future. No one spends public money as carefully as he spends his own. Complexity is therefore useful in areas where moral hazard is an important issue. Otherwise, grown-ups will behave like children at someone else's picnic.
Fluctuating Interest Rates.
At the time of this writing, the Federal Reserve has forced American short-term interest rates almost to zero, and held them there for three years. Japan did the same thing two decades ago, and they have had the unprecedented experience of remaining near zero for nearly twenty years, held there against the will of the Ministry of Finance by what is known as a "liquidity trap". Meanwhile, by the Fed buying long-term bonds in what it calls QE3, long-term interest rates have been forced in the opposite direction to a higher level than normal by the Federal Reserve. It is not necessary to explain here how this was accomplished, or why.
What it is important to see is that the value of bonds, both short and long-term, can be manipulated by the Federal Reserve at the will of the Chairman or at most a handful of committee members. Therefore, predicting future prices or rates is nearly futile for everyone else, and investing in bonds is much riskier than it seems. However, there are economic consequences to interfering with markets, so over long periods of time, there are limits to what the Federal Reserve can do without destroying the economy. In a sense, this is one of the prices we pay for controlling inflation by inflation-targeting. There are boundaries within which the Federal Reserve can operate, and eventually, interest rates will revert to their long-term averages. In the very long run things will average out, and in the present context, we are imagining investment horizons of eighty or more years. This is why insurance companies can buy bonds with serenity, and just wait long enough for interest rates to normalize. But there must be an organization with some feature of immortality to intervene if the counterparty (The Federal Open Market Committee) is immortal and has unlimited funds at its disposal.
However, the Federal Reserve is not independent, no matter how hard we try to make it so. We are here discussing money which belongs to individuals who can vote, and who will surely be concerned about the investment policies of 17% of the Gross Domestic Product. The Federal Reserve can thus be easily imagined to develop an occasional severe conflict of interest between what is good for healthcare financing and what is good for the economy as a whole. The pressures which the public might decide to exert are not predictable, except that they would be hard to resist. The public has long proven itself to be a poor investor, buying high and selling low, even when it knows better. It almost seems better to avoid bonds in the portfolio of investments entirely rather than take the political risks, until it is recognized that this fund would soon develop the need to pay its claims every year, even if the stock market is at a low or stock dividends are zero. Therefore, it becomes clear enough that when bonds start paying 4% or more, the fund ought to buy some of them and hold them to maturity, just as life insurance companies do. Perhaps it becomes clearer why insurance companies hold a portfolio of 60% stocks and 40% bonds, but it is not exactly clear what to do when a fund of this size proposes to start when interest rates are at their present extreme. This sort of technical issue just has to be left to bond market professionals, since it involves short selling and other arcane issues that the public ought to know enough to stay away from.
The Investment Fund Becomes a Gorilla. Any insurance company must segregate a claims reserve fund, to assure it always has money available to pay its claims. In the system we envision here, the potential claims are too far in the future to be confident how much they will eventually become for a newborn baby, etc., but for the cohort just beginning that last year of life, the average cost of the previous year's Medicare claims will be abundantly clear in Baltimore, where they keep such records; it will probably be close to 20% of Medicare's budget. It certainly will be clear contributions to the pool of Health Savings Accounts cannot possibly match the claim cost of the first year in operation, and should try to do no more than reducing the initial end-of-life claims by whatever is available.
Adverse selection of beneficiary composition. Since the actual beneficiary would be the Medicare Trust Fund (and not the subscribers, who would then be dead) the impact of the news of this program would focus on the reduced Medicare premiums for younger subscribers. Medicare premiums would be reduced by no more than 20%, which would nevertheless probably be greeted as a windfall. The true beneficiaries would mainly be successor cohorts already in retirement, although paying off some of the Medicare debts dating back to 1965 would be a splendid idea. The fund will gradually level out, but it will likely take at least ten years to do so. Social Security and Medicare had the same problem at the time of their beginnings and elected merely to borrow the money, essentially never repaying it to the "pay as you go" system.
Eventually, Medicare will be put to the expense of developing premium billing systems of some complexity. At least, this new system has a source of revenue in the investment of its cash accumulations, with an estimated time of twenty years for it to catch up with itself. Much would depend on the medical costs of the twenty years prior to the individual last year of life; at the moment, they are might even be sufficiently lower to make this approach workable. But if some new treatments, for cancer let us say, are more expensive than the years they would add to longevity, this mixed blessing would have to be treated as an independent problem. Other solutions are available; the ability of the government to borrow at lower than prevailing rates are based on the assumption that it is a sovereign debtor. While this advantage is not guaranteed, it does exist and probably would be difficult to change. Furthermore, whether pre-funding would initially appeal more to younger or older people is hard to predict, calculating the potential source of revenue or losses from various mixtures would have to account for any difference in costs among various ages. Creating enrollment quotas for various ages in the early years of an accordion expansion might be workable.
And then, there are some macroeconomic perplexities. As mutual fund and index fund usage expand, fewer stockholders vote their proxies; the present proposal would make this problem worse so there would be even less resistance to lavish management salaries. The influence of family controlled stock within the portfolio, and of hedge-fund control would increase; possibly, foreign control would be easier. While true enough, these issues are not for this paper to deal with, only to mention.
The success of a pre-funded program would probably be judged by the extent of voluntary acceptance of it, and success would mean the endowment fund grows to be vast and well-distributed. Success would entail huge sums of money, potentially disruptive of the existing financial system. At peak capacity, the financial markets would have to absorb weekly inflows of about 1/4% of GNP, and eventually liquidations of double that size. Success might also entail a significant shrinkage of our oversized medical complex. Background churnings of that size would soon underlie every calculation in the markets, with uncertain consequences for what would probably be a steadily growing world financial marketplace, perhaps a disruptively international one. Not everything can be predicted so far in advance, but it is safe to say it would be tested for flaws until the markets conclude it is flawless, a very long time indeed. Such a Leviathan cannot be set on automatic pilot, but neither dare it relies on having the wisdom to make unblemished mid-course corrections. There are risks in attempting a middle approach, which must just be accepted as being less than the potential rewards of taking the risk.
All right, Health Savings Accounts once appeared to be merely Christmas Savings Funds, helping people of modest means accumulate the money for their high "front-end" deductibles. The high-deductible design of health insurance paradoxically reduces the premiums of catastrophic health insurance policies. At least that's how they began; with higher deductibles on the claims, annual premiums could become lower, and the effective deductible gradually disappeared with contributions to the Christmas Fund. Subscribers to the savings accounts did run a small risk they might not deposit the full deductible before serious illness appeared, but the serious illness itself was otherwise fully covered. In fact, the effective deductible was reduced by whatever they had deposited but the premium did not rise; after a few years most of them had no out-of-pocket deductible left to pay, at all, and no extra premiums to pay for it.
So the first consequence to appear from Health Savings Accounts was first-dollar coverage without higher premiums. A small risk of small ongoing outpatient costs remained, but after a few more years even that was covered, again without raising premiums. Financial protection gradually increased with time, starting first with the worst disasters, working down to trivial ones, eventually to none at all. To repeat, without a rise in premiums, so gradually the whole package provided better coverage without increased premiums. That's why they got cheaper; the former insurance profit turned into a consumer investment. Wasteful spending was also restrained by subscribers protecting their investments, an impact which actually increases over time. With a little luck, or else starting young enough, it was possible to slide past the risky period of time, unaffected. That pretty much summarizes the medical part of the two-part plan to surpass "first dollar coverage" as fast and as cheaply as possible. The power of the Christmas Savings Fund was much greater than it appeared to be.
But after that, subscribers still had an increased cost of retirement income to worry about. It's an integral part of the medical issue because retirement costs inevitably rise with improved longevity. That's not hard to see, but if it's forty years away, it's easy to neglect. However, it becomes almost impossibly hard to get this result, if it's only two years away. That's called the "transitional problem"; everybody isn't twenty years old on the same day, and some people have simply lost their chance. Some people are already sixty-four, with variable amounts of savings. Since they can't arrange thirty years of retirement funding in a single year of saving, they have to fall back on the next-best approach. Which is to make the whole thing cost as little as possible, thereby reducing the number of people hurt by differences in age.
Fine, but how would all that theory enhance retirement income, except in pitiable amounts? What's been accomplished so far, has been accomplished collectively. The rest is up to the individual. Everyone can, for himself, make it less pitiable.
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At 6.5% compounded quarterly, it's impossible to catch up with $400 at birth, with annual deposit limits of $3350 after age 59.
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Be Frugal If You Must Spend From This Pocket. It's surely pitiable if you spend it as fast as you save it, but can build to a meaningful level in retirement if you just don't spend it. Our national leaders often say we don't spend enough. But they are talking about investing in factories, not spending on hula hoops. Nobody seriously sees any value in useless spending except a salesman. Frugality almost has to become a way of a person's life, because its impact consists of many small savings in accumulation, then multiplied by compound interest. For example, people have trained themselves to avoid paying cash for whatever insurance already covers. Here, many must deliberately re-learn to pay cash for small services, even if covered by insurance. That may sound like paying double for medical service, but its intention is to save the tax exemption for bigger things later. Let's examine that in detail, later.
Usually, premiums are set a little high to provide a margin of safety; a resulting surplus is diverted to reducing future premiums. If you think it through, the insurance company shifts its own risk onto future subscribers. (If the company goes broke, the remaining subscribers may find the risk shifted to former subscribers who dropped their policies.) Insurance companies call this a defined-term, or "term" insurance model because employer-based groups contain people of all ages, so a one-year term of insurance risk is safer for them in dealing with older subscribers. That's a good thing, by the way; you don't want your insurer to go broke.
In employment-group health insurance, surplus or deficit is made up after a year or two of "experience rating", because final health insurance risk reaches an artificial end at age 65-66, with Medicare then shouldering the remaining healthcare risk. Unfortunately, the sharp pencils of the company groups tend to make the individual (non-group) policies serve as a sort of contingency-risk fund, although employers are generally unaware they are having this effect on people who do not share their tax exemption. Nevertheless, someday, current low-interest rates must go back up to normal levels, investment income once more becoming a meaningful gain; so look for investment income to return to normal for individual policies. There are myriad reasons behind the yield curve slope, which relentlessly defeat the convenience of any Federal Reserve Chairman who wishes to continue low rates. Call it supply and demand, for shorthand.
Individual ("non-group") insurance also contains people of many ages, but people using it are expected to know how old they are. Health Savings Accounts are always individual accounts, not pooled ones. (The required pooling of risk is situated within the catastrophic health insurance, attached to every savings account.) Individual unpooled accounts offer two advantages to younger people: of a longer time horizon to work out the leads and lags, plus some savings from not subsidizing older subscribers, as employer group policies tend to do. In an HSA you subsidize yourself at a later age, which is a whole lot different.
You do share your major health risks in the insurance part, but you don't share your individually compounded savings from frugality, in the savings account. Older working people might be wise to set aside some personal savings to supplement the one-year term health insurance, adjusting for the more frequent risk of a second sickness in older people. Because the Affordable Care Act mandates the deductible, it also mandates an "out of pocket limit" to recognize the risk of a second illness coming along too soon. So Health Savings Accounts usually do the same. That's safer but raises the cost. Furthermore, interest rates have been unusually low for nearly a decade, so banks have made a habit of paying lower cash dividends longer than rising earnings can justify. However, in spite of the superficial theory that Health Savings Accounts cannot accumulate much money for retirement, demand for them has been heavy and fairness has become balanced. At present, their aggregate deposits are already reported to be over $30 billion.
Deductibles vs. Copayments. This seems a good time to emphasize the good feature of a front-end deductible, compared with the uselessness of copayments (traditionally 20% of claims cost.) Both of them reduce premium levels, but for different purposes. Deductibles induce patient frugality, as we have noted.
The purpose behind the typical 80/20 co-pay is less obvious since it is only calculated after a claim is made, or let's say after a wasteful procedure has already been performed. Repeated studies have shown it has a little net effect on premiums or service usage. Instead, it is favored by negotiators who must make quick decisions in a bargaining session, because a 20% co-pay results in a 20% reduction of premium, a 40% co-pay would result in a 40% premium reduction, etc. Co-pay has the additional perverse effect of making a second supplemental insurance policy attractive to most subscribers, including a doubling of its insurance profit and overhead.
Consequently, we favor high "front-end" deductibles, but reject copayments from insurance design. And subscribers ought to do the same.
Perhaps not surprisingly, most new subscribers to HSA have been younger than age fifty, and forty percent have so far never made a single withdrawal from their accounts. It's hard to measure, but the aggregate small incentives of saving for retirement have resulted in 30% less spending for disease, so the
size of account balances grows faster than expected in spite of the current recession. Ultimately there must be some surplus because competition will force at least some savings to be distributed to subscribers. Subscribers are nevertheless on the lookout for investments which pay more than ordinary bank savings accounts; stock index funds ("passive investing") are the most popular alternative. Please notice that all of these explorations grow out of the unusual feature that Health (and Retirement) Savings Accounts are the only available form of health insurance which surrenders all termination surplus directly to the consumer, rather than return it to him via the insurance company as lower premiums. In theory, the amounts should eventually seem to be about the same, but compound interest over the fifty-year interval spreads them apart. (See the graph, above.)
Portability in a Larger Sense, Leading to Hidden Cost savings. The fact that HSA accounts are proving financially attractive, is surely a sign they may contain some previously unsuspected advantages, in addition to just being portable between employers. Additional portability -- between only paying for health care and paying for retirement in addition -- is more smooth and natural than we expected. Improvements in longevity reflect improvements in health care and are the natural consequence of the population getting healthier. (The saving in one compartment, is a cost for the other, with compound interest exaggerating the difference.) Furthermore, there is a consequence more evident to physicians than to patients: if you get really sick, you won't need to worry much about retirement costs, so here too a saving in one is still a cost in the other but in reverse. By far the largest accelerator to the balance is to overfund it up to the legal limit. No attempt is made in this book to claim we know what future costs will be, except to point out -- whatever they are -- increasing longevity will clearly push costs into different compartments, some upward, and some downward. It seems certain flexibility between compartments will become more desirable over time and might save considerable money. The clause in Health and Retirement Savings Accounts that any leftover tax-exempt surplus transforms into an IRA (Individual Retirement Account) when Medicare eligibility is attained, is probably the forerunner of others. More potential flexibilities are explored in this book, and advocates of other systems are invited to add features to their favorite program. In other words, at age 65, a subscriber does lose a doubly tax-exempt HSA with a surplus, but gets back Medicare plus a regular Retirement Account (IRA) in return, unless middle-men eat up the float. It's logical it would save money, but the heartening discovery is, it actually does.
The Battlefield. The HSA derives a double tax deduction in the sense that whatever is spent on qualified health service is not taxed, neither when it is deposited nor when it is spent. That appears to be a major inducement for HSA subscribers to be frugal, and the longer it continues the more it accelerates. That's in itself the main reason not to tamper with the incentive since the alternative incentive is to employ brute force to hold prices down, a probably futile gesture of amateurish administrators. Since a few dollars saved while young, compounds into many more dollars later, the double exemption is often the best investment an average person can find. It is, to say the least, an attractive alternative investment vehicle, if not a windfall.
Splitting the healthcare product into two compartments (savings account and Catastrophic health insurance) has proved particularly suitable for saving within the account for out-patient costs. Price-shopping for cheaper medical expenses seems irrelevant to truly sick persons in a hospital bed, however. Spread-the-risk insurance was inevitable for disrobed patients, whatever the related temptation for overspending. It's important for customers to be convinced the spread-the-risk quality of insurance continues but is confined to circumstances where it has no real alternative. Those professions coming from different cultures who scoff at the self-restraint of physicians are in some danger of enraging doctors into behavior everyone will regret, encouraging behavior which is being resisted. Nevertheless, some degree of slippage is inevitably part of insurance. As soon as you spread the risk, for example, it gets harder to itemize the bill fairly.
Be Careful Who Your Subsidy Partners Are. Insurance companies and hospitals both share risks with clients, and boast it reduces premiums. Young people almost always have lower costs than older ones, so it's tempting to mix a few expensive old folks with a large number of young ones in group policies. However, the client doesn't usually consider the overall effect of his choosing either a particular insurer or a particular hospital. No matter how old he is, he should want to be mixed with a lot of young clients (except premature babies).
The Affordable Care Act seems to have overlooked the refinements of this homily; by striving to include all the uninsured, they managed to include a large number of newborns and specialty children's hospitals, who are effectively (however reluctantly) subsidized by the rest of the community. Employer groups trying to do the same thing, necessarily avoid most people under 25 years old, who were suddenly included in population-wide averages of uninsured, by the new law. Patients over 65 may be similarly under-represented. Furthermore, about twenty cancer hospitals have been exempted from DRG constraints. Regardless of how it got composed, the ACA found it was subsidizing more than it expected, and (because they were the subsidizers) premiums for good people consequently threatened to rise more than expected, even though sometimes enjoying incomes which exceed the uninsured.
Employer groups were thus cross subsidized, but to differing degrees; outcomes were hard to predict and smaller groups proved more agile than larger demographic subgroupings. Out of these unexpected aggregate costs, arose a need to subsidize employer groups unexpectedly, and explains some unlikely favoritism for prosperous political groups originally targeted for income redistribution. In most employer groups, young people subsidize older ones; that's definitely not the same as rich people subsidizing poor ones. The detailed extent of these problems will probably not emerge until after the November elections.
Hospitals differ in their costs for similar case-mixture reasons. If you don't need a big-city tertiary hospital, you need to ask why you should pay for it by secondarily cross-subsidizing its expensive clients. This may explain some of the surprising successes and failures of HMOs, private insurance companies, and other allegedly share-the-risk groupings. Small, agile and for-profit companies seem to maneuver more readily than big non-profit ones.
Cheaper. These and other mechanisms probably underlie the claim that HSAs are 30% cheaper. Because there are many small explanations rather than a few big ones, they will be harder to imitate. Such an accumulation, doubly tax-exempt, over a period of several decades aggregates to a surprising amount of compound interest. Money at 7% only takes ten years to double, for example. Most people would have difficulty finding a superior way to save for retirement, then by reflexly putting any spare cash into an HRSA. It's true you have to get sick to be entitled to the double deduction, and you may not survive severe illnesses with much savings. But the peace of mind of just knowing you have been covered by shrewd exertions of skillful management creates some cost-free benefit not to be scoffed at. Everybody needs a consolation in despair, and this one turns out to be powerful.
"Overfunding" the Account. Therefore, enlisting patient participation extends the argument for durably separating the account from the insurance. Indeed, it makes a significant argument for overfunding the account among young people, who badly need to hear it. "Overfunding" in this case means trying to spend as little of the account as you carelessly might spend. If a considerable number of people become so-minded, a relatively realistic market price can emerge for out-patient costs. This is America, after all. That's not so true of inpatient costs, but it nevertheless provides a relative-value base for even those costs -- with a few adjustments in the regulations related to major changes in the diagnosis code employed.
Summary. So that's how we see the simple change in the payment structure into a Christmas saving account transforms a device for helping poor people afford insurance, and adds to it an incentive for the patient to be frugal for his vulnerable old age. Instead of paying to borrow money, he is paid to save it. Pinch pennies for healthcare, in order to save dollars for retirement. And then multiply it by compound interest A mutually beneficial system actually reducing medical costs, is the underlying description. It does this by providing a pathway, and an investment vehicle, for deriving meaningful retirement insurance out of unused health insurance. (This boils down to a sterner message: if you abuse the healthcare system, your own retirement will suffer.) The demographic group may not suffer, but because it's individually owned, the careless individual may shoot himself in the foot.
Resistance to Disintermediation. But, it must be noted, since this can also transform health insurance from a cost center into a revenue center, it creates some uncomfortable resistance from the financial community (because it seems to them to be a zero-sum loss). The resistance is this: financial transaction costs have declined 70% in the past ten years, so the financial community is hurting, at least compared with the Gilded Age. After all, declining prices of anything are a major reason for profitability to fall. If, in addition to attrition in revenue, a formerly insignificant income for the subscriber (interest on the accounts) transforms into an important mechanism for building up a retirement fund in six figures lasting thirty years -- it starts trouble with its zero-sum counterparty. Subscribers begin asking uncomfortable questions and making cost comparisons, at a time when the financial community sees its own income under stress. Already, there is agitation in Congress to replace buyer-beware with fiduciary advisors. The subscribers will win because they have the votes, and control the flow of funds into accounts. But it may turn out to be a slow bloody battle, notwithstanding its far more dignified potential for transforming into an attractive opportunity for both sides.
The Source of Subscriber Sluggishness. When individuals compete with corporations (tax authorities and investment managers), it is usually a matter of youthful inexperience futilely competing with the experience and immortality of corporations. It seems to take a long time for young people to discover how much difference a steady, small interest rate can make to the process of converting small savings into big ones -- providing one starts early in life. Immortal corporations do have a more distant horizon and an indelible memory. But the immortality isn't as great as many think; for a glaring example, it's a comparatively rare corporation which stays in business for a hundred years. The greater advantage which a corporation has is it has been given a solitary legal mandate to make as much money as possible. The movies call that "greed" but a corporation either sticks to its business (making money) or falls out of that business, sometimes after being sued by its stockholders.
A large corporation can lose lots of money. Those who wish to penalize excessive profits should more logically favor elimination of corporate income taxes, allowing high profits and large losses both to fall upon richer individuals. The present system, allowing profits to go to stockholders at lower rates than corporate taxes would, encourages corporations to get bigger, less profitable, and to flee the country which started them. None of these outcomes is likely to appeal to populists. Since healthcare has grown to 16-18% of GDP, the present tax arrangement of health insurance probably exerts an appreciable drag on the economy.
Imposed Self-control by Escrow Accounts. Young people constantly face the competing priority of consumption, and many never do learn to restrain it in order to accumulate larger savings. Others learn but too late, after several decades of potential doubling have been forever lost. Odysseus knew this but he also understood himself, so he had himself lashed to the mast of his ship while he sailed past the temptations. The shocking truth is that very small differences in interest rates, differences which some would have you believe are trivial, accelerate savings faster than most young people ever imagine. Taxing authorities and investment companies have already learned compound interest grows best over long stretches of time, and small differences in interest rate (as little as 0.1%) are quite sufficient if continued for a lifetime. This is a simple point, but so vital we must soon devote more time to the requirement of "escrow" accounts, perhaps more aptly termed "Siren Song Accounts". Call them to lose insurance or even credit default swaps if you please, but at least recognize they impose an opportunity cost.
True, many banks do offer Health Savings Accounts without either an attached health insurance policy or brokerage service. Both services are essential, but selecting insurance managers in these cases remains the customer's problem. You might think banks would have a similar response to the investment management of savings, except they have a complicated relationship with insurance companies they may not wish to disturb. By contrast, they also have a losing competition with investment banks, who have found cheaper ways to acquire large-sized investable funds by selling bonds and stock certificates. The time-honored method for banks to acquire funds is by dribs and drabs from the float of deposits -- quite an inefficient source, compared with $100 million bond sales. From time to time, as in the recent mortgage disaster, the government puts its thumb on the scales, and right now all banks are afraid to lose market share to competitors. Secret kickbacks may play some role in all this, so acquiring and integrating a whole company's operation seems a safer business alternative for them. One way or another, your account may be transferred to a different manager without your knowing it.
The conflicted outcome at present is for the potential HSA customer to discover which HSA vendor declines to make choices between insurance companies, but does look for ways to acquire the investment end of the business and overcharge for it, either directly or with kickbacks. In a curious twist, this pressure shifts to the customer to choose stock-pickers, whereas his best interest is usually served by choosing total-market index funds. Watch out for fees, however, which can upset any generalization about investment type. This situation can shift rapidly in the present environment since it would not be surprising for these financial behemoths to purchase market share indirectly, or else for failing stockpicker firms to sell themselves to banks of various descriptions. A much more productive approach for the small investor would be to look for a firm which will segregate accounts into "escrow, and non-escrow", leaving the choice of a high-deductible health insurer to the customer. Likewise, accounts could still be designated "captive, or self-selected", and leave the choice of investment management to the customer. It's true the average investor is often poorly equipped to make such choices but should have no difficulty in telling 1% from 8%, when (see below) the difference of one-tenth of a percent can result in a lifetime swing of $30,000. The importance of escrow accounts is described in the section which follows this one. Essentially, you can get a higher income if something forces you to shift short-term into a long-term investment.
The Importance of Small Differences in Interest Rates. To pay expenses in a stripped-down HSA, banks often charge for smallish balances, waived when the balance reaches their business break-even point, usually about $5000 per account. Similarly, investment latitude is often stratified, with larger accounts are given more choice of investments. Those are generally good arrangements because of their flexibility and elimination of conflicts of interest, but they impose some responsibility on the customer -- who must be willing to make security selections in return for possibly greater return. It's all quite understandable and suggests novel uses of the account. The best example before us is to "Overfund" it at the beginning, and use its surplus after compound interest, to supplement retirement income decades later; let's explain.
Improving the Retirement Benefit At present, the HSA law permits a maximum deposit of $3350 per year per person, with even higher limits for whole families. By constraining out-patient expenses or paying cash for them, the balance can thus build up to $5000 in less than two years, eliminating bank surcharges of roughly $50 a year by immediately reaching the waiver level. Since doing this also eliminates any remaining question whether the HSA will provide full coverage for hospital charges, it's pretty easy to endorse a $5000 investment which produces $50 a year tax-exempt income until Medicare kicks in, and then compounds it, adding more than 1% tax-free to its investment income. If the transaction then permits investment in total market indexes, paying off the investment was very wise. Let's now extend the frugal idea to more prosperous customers.
The Outer Limits of What is Possible. If an employee deposits the full limit of an HSA and makes no withdrawals from age 20 to age 65, his balance will be increased by $154,550. In fact, it should grow by more than that, possibly much more, if the income compounds. He can start with the present abnormally low-interest rate of 1%, and find annual maximum payments compound the balance to $196,225 in 45 years. With a more normal interest rate of 4%, this rises to $442,527. At 6.5% interest rate (which probably requires stock index investment to achieve), the result would be $959,760. Since the stock market for the past century has averaged 11% return, and inflation has averaged 3%, a net-of-inflation return of 8% is conceivable -- before taxes and expenses -- and so we'll set 8% as the theoretical maximum goal. $1,578,977 retirement account (at 8% net) is thus the utmost goal which is realistically achievable, adjusted for inflation. But the difference between roughly $908 thousand and $1.5 million ($650,000) is a difference still worth pondering since it identifies the maximum potential difference attributable to middle-man costs, and that's a lot. And if you think the bank is entitled to something, it probably can get compensated by compounding daily but paying compounding quarterly, and additionally by requiring deposits monthly but crediting them yearly. As far as inflation is concerned, these are uninflated numbers, both at deposit and withdrawal. That is to say, they are all in 2016 currency, and leave a generous potential profit for the manager.
Just squeezing out 6.6% instead of 6.5% makes for a final difference of $30,500, or roughly a fifth of the net (of medical outpatient expenses) deposited. Without resorting to insulting language, this large difference achieved by such a small income increment is a legitimate goal for technology improvements and management streamlining. The amount is seemingly within reach, and the consequences are worth it. So although the Standard and Poor 500 actually averaged 6.6%, and the modal return was even higher, we round it off to 6.5% in most of our illustrations. Several such small yield improvements can boost net returns by 1%, which makes an enormous difference in eventual yield after decades of compounding. That's particularly true in a compound yield curve which turns up at its far end. Since transaction costs have decreased by 70% in the past ten years, it definitely seems possible to extract an equal amount again by relentlessly pressing for it. It misjudges the public mood to say there is no room for improvement by educating the public. Right now, everybody involved would probably agree it is high time to increase the deposit limits, after several decades of their having remained stationary. That alone would significantly assist the transition from a nuisance to a central bulwark of retirement security. The financial industry wrongly misjudged this transformation to be trivial, so it's getting a little late to adjust it gracefully. Working out some examples from beginning to end, is very persuasive.
True, about a fifth of the contribution to this scheme is provided by income tax reduction, but the line between public and private obligations to health care is already too blurred to hope for an agreement on the fairness issue. Just look at the combined state and federal tax contribution to the cost of group employer-based insurance, which probably approaches 60%. Still more important is the hidden contribution to increased longevity made by medical care. It seems hardly debatable that improving health was largely responsible for lengthening the time in retirement. The problem of outliving savings is pretty much a by-product of improving medical care; if you want one, you must cope with the other. For this reason alone, it seems entirely proper to include rising retirement costs as part of the cost of improving health care. If you want to solve the whole problem, however, you look for any solution and forget about assigning blame. Is there anyone reading this chapter who doesn't want to live an extra thirty years?
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Girard College
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For many decades I have hungered to visit Girard College, sitting like the Parthenon on the Acropolis of Girard Avenue, even decorated with colored searchlights after dark. In its very earliest years, the estate of the richest man in America was entrusted to City Council, but the corruption and lack of progress toward stated goals forced modification. Unseemly behavior by political leadership caused the Board of City Trusts to be created with this monumental sum of money devoted to the education of "poor, white, orphan boys". For many decades, to be a member of the Board was the highest honor in the business community, and several large business empires were added to the responsibilities. Girard had the foresight to state in his will that no Pennsylvania property was to be sold, and when the downtown area began to surround Reading Terminal the wisdom became apparent. His farm was made into rental rowhouses of great profitability in South Philadelphia, a hundred million dollars worth of coal was mined in Schuylkill County, and the first Industrial Revolution grew up in the hinterlands in response to the blockades of the War of 1812. Girard's estate was well managed, indeed, was a showpiece of Philadelphia business acumen. He died with the greatest fortune in America, but that was only the beginning of the industrial power of the leaders who really ran Philadelphia. The school for white orphan boys prospered, not merely because of the corpus of the estate. Time wore on, however, and corruption wormed its way into the Board of City Trusts, the neighborhood around the school deteriorated, and Milton Hershey was able to compete for the dwindling supply of orphans with the benefit of Girard's mistakes and successes, in his own orphanage near Harrisburg. Finally, the great migration of black people from the South took over the electoral dominance of the city to the point of dominating the courts and politics, and black girls now outnumber white boys by a considerable number in the school. Some members of the Board have spent some time in prison, but most of the scandal attached to running an orphanage has migrated to the Milton Hershey School.
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Daniel Webster
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It is my understanding that the wall surrounding the school was considered to be entirely too high, so they tell me half of the stonewall is buried beneath the ground, to conform to the donor's wishes about height, but also to remain a more reasonable height on the outside. Girard also provided that no ordained minister should set foot within the walls, a provision which greatly discomfited the religion department. An old gentleman named Mr. Witherbee was once my patient and told me he refused his diploma at the Harvard Divinity School graduation ceremonies and spent the rest of his life teaching Religion at Girard College after the School found he had perfect credentials for the job but lacked the stain of ordination. The President of the Dallas Federal Reserve was once a student at Girard, as was the President of the Insurance Company of North America when it was the largest casualty company in the business. Daniel Webster was engaged to represent the College in Court while he was still in the Senate. I'm told that the boys were dressed by Brooks Brothers, and on and on. I'm also told the new managers of the Board of City Trusts ran down the endowment considerably.
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Girard College
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Well, I finally got a chance to see the inside of Girard College, when the Shakspere Society held its annual dinner there, and it is indeed everything it was reputed to be. The Society was in black tie, having cocktails on the portico of what looked like an exact replica of the Parthenon, wafted by spring breezes and later bathed in spotlights, just like the real Parthenon in Athens. There were real guards at the gates. Dinner was superb, held in the main library, beneath a 48-step marble staircase to the second-floor exhibition halls, overseen by a curator, and filled with Chinese porcelains, leather carriages, towering bookcases, and the like. The place was immaculate, and the staircases so wide you could climb dizzying heights without getting dizzy if you stayed close to the wall. No white orphan boys in evidence, however. And for that matter, no black girls, either. Looking out at Girard Avenue, you can see a splendid avenue stretching to the casinos at the far end. And the trees were so tall, you couldn't see what was behind them.
Originally the "lower counties" of Pennsylvania, and thus one of three Quaker colonies founded by William Penn, Delaware has developed its own set of traditions and history.
Start in Philadelphia, take two days to tour around Delaware Bay. Down the New Jersey side to Cape May, ferry over to Lewes, tour up to Dover and New Castle, visit Winterthur, Longwood Gardens, Brandywine Battlefield and art museum, then back to Philadelphia. Try it!
Millions of eye patients have been asked to read the passage from Franklin's autobiography, "I walked up Market Street, etc." which is commonly printed on eye-test cards. Here's your chance to do it.
In 1751, the Pennsylvania Hospital at 8th and Spruce was 'way out in the country. Now it is in the center of a city, but the area still remains dominated by medical institutions.
Grievances provoking the American Revolutionary War left many Philadelphians unprovoked. Loyalists often fled to Canada, especially Kingston, Ontario. Decades later the flow of dissidents reversed, Canadian anti-royalists taking refuge south of the border.
