SECTION THREE: Classical Health Savings Accounts: Many Surprises
One of the originators of Health Savings Accounts describes their advantages over existing health insurance. Improvements are suggested for the regular HSA. More dramatic cost improvement emerges from a lifetime HSA version, substituting whole-life approaches for pay-as-you-go. Most of this requires legislation, but could reduce health costs dramatically.
A standard deviation is the amount of deviation which is seen in two-thirds of cases, and usually refers to the minor dips and bumps seen in a year. The standard deviation of the stock market in a year is about 2% -- and can be ignored for this discussion. A much larger set of crashes occurs about once every thirty years and is characterized by a crash of 30 to 50 percent. No one can afford to ignore something like that.
Protecting the investor against black swans is one of the few legitimate reasons for an investment return of less than 12%. Let's first look at how most big endowments handle the issue. A museum or university typically depends heavily on its endowment to keep it going. If it spent the full 12% of potential average endowment income in the good years, it might be unable to keep its door open during a black swan. It could set aside 30-50% of its endowment as a reserve for such contingencies, but income between recessions might go up to 15% and they would have missed it. A more conventional response has been to adjust the investment portfolio, so it maintains an annual investment return from a portfolio which is 60% stock and 40% bonds. In the long run, that typically starts with a stock return of 12% and reduces it by a third to 8%, while investing the remaining third in bonds yielding 5%. Unfortunately, the long term experience is that inflation will nevertheless reduce all yields by 3%. So by prudent management of the endowment, a stock market yield of 12% is reduced to a spending rule of 5% (after inflation) representing what can safely be spent. Ouch! .
30% Dips, lasting several years, Every 28 years, on average.
Now, just a moment. We are talking about a Health Savings Account, not a university or an art museum. We aren't paying a big staff during hard times, we are investing for the far future, except for the fact the far future holds a different sort of terror for some than for others. The young person may think he needs to pay his rent more than his drugstore bill. But he has so many years ahead of him, that may prove to be a very bad bargain, since depleting his account by a few hundred dollars may cost him thousands of dollars after he retires. If he can possibly borrow from his family, or reduce his college expenses right now, he should try to do it. A table should be prepared by his financial advisor at the HSA to convince him what is in his true best interests. It's a decision he should agonize over, not act on impulsively.
The converse is obviously true of a seventy-year-old, choosing between a new car and botox injections. Either one might be fine, but growing a fund he will never live to spend, is not so smart. And there are hundreds of situations between the two extremes. Here's one possible alternative, which straddles the issues:
Although the majority of situations vary from one extreme to the other in response to how old the person may be, financial managers often prefer solutions which tend toward one-size fits all because it creates a bigger pool, and maybe better returns. But it definitely wouldn't be wrong to get better returns for a little more risk. Especially for younger people when better returns cast a long shadow. Perhaps the portfolio should have a larger common stock content for clients up to age 50 than 60/40, perhaps 80/20 or even 90/10. The age of 50 is selected because health problems tend to increase after age 50. Or the ratio might be adjusted for the increased obstetrical costs of age 25-35, particularly for females. Actuaries should be consulted for more complicated issues. Since we definitely frown on kickbacks and other manipulations, perhaps fees should reflect the value of actuarial advice of this sort.