Philadelphia Reflections

The musings of a physician who has served the community for over six decades

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(2) Obamacare: Spare Parts for a Book
New topic 2015-07-22 16:02:02 description

Epilogue: Where Does All This Money Come From?

Although this book promised, and I hope delivered, a detailed discussion of how Health Savings Accounts might work if Congress unleashed them, the original question remains. Where does so much money come from? Well, in one sense, it comes from saving $350 per year, starting at age 25 and ending at 65, earning 8% compound interest. That's if longevity remains at 83. We assume the average person has medical expenses, but we don't know how to estimate them, so we put $350 a year in escrow, and average person has to contibute more cash for medical expenses at 80 cents on the dollar (the tax exemption) until experience shows he has five or ten years pre-paid, or until he reaches an estimated cash limit. Somewhere around that point, he can stop contributing, both to the escrow fund and to incidental medical costs, until the fund catches up with him. In plain language, he gives himself a loan if his expenses are too high. These figures are based on current average costs, so the money is calculated to be present in the fund but poorly distributed. After experience accumulates, these numbers can be readjusted from present over-estimates..

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The prudent way to manage future uncertainties is to over-fund them and transfer any surplus to a retirement fund. {bottom quote}
Planning For The Future.
Curiously, if longevity goes to 93, it would seemingly only require $150 per year in escrow instead of $350. Longevity could only add ten years if we had some medical discoveries in the meantime, so let's say both the added longevity and the added cost of it, appear fifty years from now. Our hypothetical average person born today contributes $150 per year from age 25 to age 50, when he discovers increased longevity requires him to contribute $ yearly until he is 65. After that, he is all paid up until he dies at age 93. Yes, he has Medicare to account for, but his payroll withholding has already paid a quarter of Medicare cost, and if he pays Medicare premiums he will have paid another quarter of Medicare. His lifetime Health Savings Account escrow contribution would contribute $ per year, which is the present deficit of Medicare, currently being subsidized.

The amount of contribution to the escrow fund could be reduced to actual costs over time, but the prudent way to manage uncertainties is to over-fund them, planning to roll any surplus over to a retirement account. Three-hundred-fifty million Americans, times $350,000 apiece in lifetime medical costs, results in a number so large it requires a dictionary to pronounce it correctly. Cutting it in half still suggests a financial dislocation of major proportions, so out of whose pocket would it come? Even if it's a win-win game, dumping that much money into the economy sounds destabilizing. These are not legitimate reasons to avoid it, but it seems hardly credible it could happen without someone noticing a big difference. What does it do to the monetary system?

If it is assumed funds generated by this system are ultimately used to pay off accumulated debts, the result should be some degree of deflation. The Federal Reserve has already purchased several trillion dollars worth of bad debt so debt repayment would not seem to pose a threat. By contrast, inflation could become a threat if corporate taxes are reduced too rapidly, but presumably, we have learned the lesson of lowering Irish corporate taxes too rapidly. Because of international ramifications, we have to assume this threat would be recognized. Because of the nature of compound interest, it has the least effect in its early stages, and there would be sufficient warning of inflation to mobilize action. Interest rates would probably rise, but there is a cushion of several years of subnormal rates, and most people would feel the elderly have suffered enough from low rates to justify some relief.

A certain amount of trouble resulted from using the "pay as you go" model, in which current premiums pay for current expenses. That is, the money from young healthy subscribers pays the bills of old, unhealthy, ones. By that reasoning, the original subscribers in 1965 got a free ride from Medicare and never paid for it. The debt has been carried forward among later subscribers, and although it is a debt which still remains to be paid, it seems very likely no one would ever collect it. Each generation makes it a little bigger by adding subscribers and running up hidden debt charges, but at least it is accounted for. In a way, there is enough guilt feeling about this matter, that it would probably be politically safe to create a balancing fund, to be used in case there are monetary issues with this unpaid indebtedness.

Let's remember that a major part of the health financing problem can be traced to the unequal taxation exemption of big business, which traces back more than seventy years to World War II. No one welcomes reducing net income in half by any means, but reducing corporate income taxes might just be one of the few ways it could be an inducement. No taxes, no tax exemption; it sounds pretty simple until you review the trouble the Irish Republic got into when it reduced them too fast. But when corporate taxes are the highest in the world, and international trade is threatened -- is certainly the best time to do it. And politically, when wealth redistribution has just been given a thorough pounding in the polls, is also a good time to advance the idea. If everyone would be reasonable about the details, an important tool for managing international trade could be fashioned out of needed healthcare reform. It certainly is a double opportunity.

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A fiduciary puts his customer's interest ahead of his own. {bottom quote}
The End of The World?
One way or another, the success of Health Savings Accounts will depend on crossing the tipping point, where investment income is greater than borrowing cost. These accounts will be forced to do a great deal of internal borrowing, particularly at first, when some financial information does not exist, and therefore must be deliberately over-funded. We have a reasonably workable idea of total health care costs and longevity, but an uncertain grasp of the shape of the revenue and cost curves in the middle. Inevitably, certain age groups will be in chronic debt, and others will run protracted surplus; the situation demands low-cost internal borrowing. Meanwhile, the overall prediction can be made that healthcare costs will generally be lower for young people, higher for the elderly. If the premiums of young people can be invested at least 8% net, the system should work. When we learn common stocks are averaging 11% returns, and investment intermediaries frequently capture 85% of it, the whole idea of passive investing is ruined until this is repaired. Requiring Health Savings Account agents to be, and to act like, fiduciaries is just about mandatory. A fiduciary puts his customer's interest ahead of his own. The day of opaque pricing must come to an end.

We mentioned earlier, Roger G. Ibbotson, Professor of Finance at Yale School of Management has published a book with Rex A. Sinquefield called Stocks, Bonds, Bills and Inflation. It's a book of data, displaying the return of each major investment class since 1926, the first year enough data was available. A diversified portfolio of small stocks would have returned 12.5% from 1926, about ninety years. A portfolio of large American companies would have returned 10.2% through a period including two major stock market crashes, a dozen small crashes, one or two World Wars hot and cold, and half a dozen smaller wars involving the USA. And almost even including nuclear war, except it wasn't dropped on us. The total combined American stock market experience, large, medium and small, is not displayed by Ibbotson but can be estimated as roughly yielding about 11% total return. Past experience is not a guarantee of future performance, but it's the best predictor anyone can use.

During that most recent prior century, we had a lot of crisis events, which normally bump the stock market up and down. A standard deviation is an amount it jumps around, and one standard deviation plus or minus includes by definition two-thirds of all variation. During the past ninety years, the standard deviation has been 3 percent per month or 11% per year. Standard deviations for the whole century are not meaningful because of more or less constant inflation. Throughout this book, we repeatedly describe investment income as 10%, for a simple reason: money compounded at 10% will double every seven years. Using that quick formula, it is possible to satisfy yourself what 11% can do if you hold it long enough. Since no one knows what will happen in the next 100 years, it is futile to be more precise. We may have an atomic war, or we may discover a cheap cure for cancer. But 10% is about what you can reasonably expect, doubling in seven years if you can restrain yourself from selling it during short periods when it can deviate less or more. The most uncertain time is immediately after you buy it before it has time to accumulate a "cushion". As we see, your money earns 11%, but it isn't necessarily what you will earn.

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Your money earns 11%, but that isn't necessarily what you will earn. {bottom quote}
Expecting it and getting it, can be two different things, therefore. And even if Congress establishes it, as they say in Texas, "You can't turn your head to spit." Because, for one thing, most expenses for a management company also come in its first few years, on their first few dollars of revenue. Wide experience with a cagey public, therefore, teachers experienced managers to get their costs back as soon as they can. Until most managers get to know their customers, in this trade, charging investment managing fees which amount to 0.4% annually is considered normal for funds of $10 million, so charging 1-2% for accounts under a thousand dollars is common practice. These things make it understandable that brokers are slow to lower their fees, or 12(1)bs, or $250 charges to distribute some of your proceeds. But our goal as customers is to negotiate fees reasonably approaching those of Vanguard or Fidelity, which have fees of about 0.07% on funds amounting to trillions of dollars. Such magic can only be worked by purchasing index funds from a broker who aggregates them, and also develops a smooth-running standardized service with minimal marketing costs to cover the debit card, help desk, hospital negotiating, and banking costs. And who, by the way, may make really serious income from managing pension funds, so they remain wary of antagonizing corporate customers who get a big tax deduction from giving employees their subsidized health insurance. Remember, stockbrokers are not fiduciaries; they are not expected to put the customer's interest ahead of their own. A broker sells stock to anyone who wants to buy it, even if two successive customers are bitter rivals of each other. One of the better-known brokerage houses advertises charges of $18 a year for HSA accounts over $10,000, but only after it reaches that size will it permit the customer to choose a famous low-fee index fund. With $3300 annual deposit limits, it eats up three years of your earnings even to get there. You really have to feel sorry for an industry experiencing such a general decline of net worth, but the incentive it creates is obviously for you to get the account to be over $10,000, as fast as you possibly can. To many people, those sound like staggeringly large amounts, but they are realistic at this stage of the market, if not entirely accessible to everyone.

The last few paragraphs sound like a digression, but they aren't. The question was, Where does all this money come from? Would there be wealth creation if the system favored the retail customer more, or wouldn't there be. I don't know the answer, but one likely approach is, let's try it.


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