Philadelphia Reflections

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

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Personal Reminiscences
One of the features of aging past ninety is accumulating many stories to tell. Perhaps fewer are left alive to challenge insignificant details.

Expanded Health Savings Accounts

Paying in Advance is Cheaper

This chapter can be summarized: it's expensive to pay for things on credit, less costly to pay as you go. But payment in advance is cheapest by far. Fully funded prepayment offers a way to make medical care appreciably cheaper for the consumer without reducing services, charges or fees one bit. No rationing, no corner-cutting. Buy exactly as much, get it cheaper.

To understand what the magic is all about, just review some principles of compound interest which are both agreeable to hear and easy to prove. With some possibly exaggerated examples as beacons, the reader is asked to skip through a short description of the environment of complexity which potentially smothers serious proposals to pay a major share of health costs with internal investment income. A healthy distrust of pat answers is quite appropriate; the simplicity of concept does not assure ease of execution. However, since this is not a textbook for insurance executives, the reading public really only needs to extract a slogan: pre-funded health insurance is cheaper, makes medical care cheaper to buy. Have you got that? Cheaper.

Because unfunded health insurance is so traditional we all have a habit of thinking and saying that health costs to the public and receipts by health providers are the same thing. You obviously get the same total whether you add up everything the country spends on health or total up everything the health industry receives. It would seem equally certain that premiums collected by a solvent health insurance company must always, at a minimum, total up to the company's expenses.

However, that's not quite so. If your hypothetical company receives all its premiums in a lump at the beginning of the year, the company only spends the money gradually over the course of the year to reach zero balance on December 31. Since the company only uses one-twelfth of the money each month, it would put the rest into some form of liquid investment which might pay 8%interest in 1988. The whole melting lump would, therefore, generate a 4% return for the year. Consequently, $1000 in premium would buy $1040 in medical care; or, another way to look at it, $1000 of care could be bought for $960. To jump to the end of the argument, $1000 of care might be bought for $100 if prepaid thirty years in advance. Indeed, if prepaid sixty years in advance it could be bought for $9.62. That's the simple principle in the argument that pre-funded health insurance is potentially much cheaper than pay-as-you-go insurance, leading to the rather plausible proposal that we try to find a way to adopt the pre-funded approach. Mind you, there are lots of nits to pick. The rest of this chapter threads through the forest of insurance obscurities related to this idea. However, when saving of 1% translates into five billion dollars a year in the health field, most people would be willing to accept the contention that no amount of nitpicking will defeat the suspicion that pre-funded health insurance could be lots cheaper than our current "pay-as-you-go" approach.

To brush in another argument with broad strokes, it is fortuitous but ideal that heaviest medical care costs happen to be concentrated toward the end of life. If the appreciable medical cost of being born is considered to be the baby's own expense you can a curve of life medical costs which are J-shaped, heavy at the beginning, quite moderate for the next fifty years, then steeply rising. It is more realistic of course to attribute the cost of obstetrics and pediatrics to the young parents, so the most meaning curve is more U-shaped. In fact, a useful graph only begins with the onset of the earning period at about age twenty, has a twenty-year dip in the middle, then rises again. The vital point is there is a calm period in the middle, then rises again. The vital point is there is a calm period in the middle of the storm, just about where the baby boomers find themselves in 1988. If they pre-fund their health insurance, the boomers can have health care pretty cheaply when they need a lot of it. But if savings get dissipated on ski trips and divorces, that generation will have a dickens of time affording a twenty-year vacation after they retire. Provision for retirement is what will ultimately suffer since our whole social structure is organized around the imperative that access to quality health care is a right. If maybe you disagree with Oscar Ewing's 1950 social priorities it will make little difference, because our system of healthcare insurance is currently organized to make certain the vast majority of Americans can spend a lot of money on their health. My yuppie children assure me it is impossible to persuade their contemporaries to set aside investment money in their thirties to provide for a comfortable retirement. But that seems too grim a view of human nature because during the Great Depression era economists were at wit's end trying to get my parent's generation to stop saving so much money and spend a little. The current economic distortion is not either based on some flaw in human nature, it is a fad. The madness of crowds never lasts long.

A fortuitous parallel quirk of the American health insurance system is that very few policies vary the premium with the age of the subscriber, even though average claim cost obviously follows the U-shaped curve. Particularly in direct-pay policies (i.e. no employer in the middle), premiums are usually level across age groups, and the public is universally accustomed to this averaging of costs. If the yup generation started to demand some portion of their own health costs in late middle age, it is hard to see how the presently subsidized older generation would have many complaints, since relatively few of them had been direct-pay subscribers when they were younger. If you tried to switch to a pre-funded system, some gradual transition could probably be worked out by gradually increasing the share of excess premium which goes to permanent funding instead of subsidy for older subscribers. Balancing the basically political question of moral obligation to an older generation which loses its subsidy, there is an opposite political point helping the younger generation to compromise. The yuppie age group is accustomed to relatively high premiums, and might not rebel at continued high premiums which subsidized their own elderly costs rather than the health costs of their parents' generation.

We might now begin a fly-over of the obstacle course by noting that current insurance practice mostly does not even capture short-term interest on the premium "float". Instead of following our hypothetical example of paying the premium at the beginning of the year and reducing cost by 4%, most corporation benefit offices pay their premiums in monthly installments and thus retain most of the interest for their own use. To go a step further, about half of all employer health benefit is self-insured, which is to say the company pays as claims are submitted and therefore allows no interest generation at all. Whatever interest is generated is mostly at the expense of hospitals and doctors, through intentionally slowing down the payment stream, earning interest at the expense of creditors. The fourth section of this book ("Tangles") examines how this short horizon chiseling actually increases the cost of medical care quite a bit.

Furthermore, as mentioned earlier most state insurance commissioners are hostile to the internal accumulation of reserves in the health insurance industry. To understand what is at work here, it is necessary to know about The Premium Cycle. For reasons presently relevant, all competitive insurance goes through cycles in which premiums are unjustifiably low during lean years followed by fat years in which premiums are too high, subsequently followed by more lean years bordering on bankruptcy. Success in the commercial insurance world (outside of health insurance) mostly depends on being so well capitalized that the company can ride out the bad years and make enough profit in the fat ones to average out the cycle. 1987-88 happened to be lean years for the health insurance industry when it was a weekly experience to read of bankrupt HMO's or forced mergers of Blue plan or withdrawals by insurers from the PPO market. it is therefore almost certain we will soon be shocked to read of horrifying increases in premiums which are proposed by frantic insurance companies, and these shocking increases will be opposed by our hero the Insurance commissioner, friends of the people. Well, it's just the insurance cycle, folks. Reflecting the fact that reserves were not permitted to rise to an adequate level during the preceding fat years, the health insurance industry lives on the edge of oblivion, six years out of eight. The health insurance system is recognized to be unfounded; the unadmitted fact is that it is also under-reserved.

By trumping the misleading and largely untrue idea that the money being spent on employee health benefits is money which belongs to the employers, those employers have embraced a heavy trust obligation. If the health insurance company which the employer hires to administer health claims is under-reserved, surely it is essential that the employer maintains reserves at least to protect against the premium cycle. The argument would be that if they kidnap the interest float, employers then necessarily acquire the obligation to fund the reserves. In fact, employers would not dare to do so even if they perceived the duty. Since the tax laws do not permit them to carry benefit money from one year to the next, they may not sequester such reserves in an untouchable fund. However, to maintain large cash balances in the undesignated corporate treasury is a certain way to invite a corporate raider to start a greenmail operation or an unfriendly take-over. Or, in what amounts to the same thing, it tempts corporate management to raid the company in a leveraged buyout.

Health insurance money could finance other corporate raids, too. Health insurance companies are not a particularly profitable business, and most insurance conglomerates only provide health insurance as a service to customers who buy more profitable products. In the current dip in the insurance cycle, the insurance conglomerates have started to learn the old business lesson that "maintaining a full line of products" is almost always a management blunder. On the other hand, a barely-profitable health insurance company handles huge amounts of cash. If its owner happens to be in the greenmail, or arbitrage, or merger and acquisition business, it can be very handy to own a business which can produce millions of dollars on demand for thirty days. It's better than owning a bank since banks are not allowed to supply cash to their owners.

As soon as an investment gets much past one year, it becomes important to focus on "real" interest investment income. Another jargon phrase would be "net, net", which is net after inflation, net after taxes. For example, 15% interest paid during a 12% national inflation produces only 2% real income. If the income tax of 33% is then paid, only a 2% return that you could spend is left the net, net. Indeed, you had better watch yourself, become if taxed 33% of your 15% income, you may only have a 10% net return which inflation then reduces y 12%. You lost 2% that year.

True enough, but the country begins to fall apart when negative returns are more than temporary occurrences. The historical experience for this century is one of real interest returns averaging about 3%, while conservative long-term investing in stock market equities has yielded an 8% return. No one can predict the future, but these historical real interest rates are used as future assumptions throughout this book. The example given earlier should then be recast to propose that $1000 of medical care would cost $xxxx if prefunded thirty years in advance, or $xxxxx if prefunded sixty years ahead. 8% return is only plausible if the risk of investment in equities is built into the assumption. If these comments effectively deal with concerns about unpredictable interest rates and potential inflation, there remains a concern about technological medical inflation which will be addressed in a later chapter.

Meanwhile, the insurance field with singularities of tax treatment. Health insurance provided by employers uses before-tax money. If you earn ten dollars you might ordinarily have only seven dollars left to spend after taxes, but if its put into employer health insurance, you can spend all ten dollars. If that same process were permitted to occur with pre-funded health insurance, the real interest rate would be a third higher than applies to private after-tax investing. Furthermore, ever since the present income tax was imposed in 1913 Congress has made special provision to allow internally generated investment income to compound within life insurance, untaxed.

It now seems time to stop this digression into insurance minutiae and repeat the message worth carrying away from it: if we could find a feasible way to pre-fund health insurance, we would make health care much easier to afford. There is a second message too, which is at least as important. If we could create a trillion dollar investment fund where none now exists, the invigorating effect on the national economy would be astounding. After all, if someone pays 8% to borrow money he can only keep it up so long as he makes at least 12% in. whatever business he then creates with it. Cheer up, congressmen; he will pay half of the difference back to the Treasury as income tax. And he can only function if his employees pay still more income tax as a result of something else which would be created. Jobs.

Originally published: Tuesday, September 11, 2018; most-recently modified: Friday, May 31, 2019