Indiana's Health Savings Accounts

I have often expressed the opinion that much of our nation's high cost for health care is the result of bad tax policy that allows taxpayers to make tax free payments for health care through an employer provided health care plan but forces them to pay taxes on out-of-pocket expenses for the same services(see here or here).  People rationally responded to incentives and made payments through their group plans.  As out-of-pocket expenses fell, consumers paid less attention to price. 

Employees also have little incentive to minimize health care payments made through their employers.  In essence, the group plan adds up all health care purchases made by members of the group, divides the sum by the number of members of the group, and charges each member the quotient.  The third party payment system through a group plan turns medical expenditures into a public good which theory tells us is overused and underfunded.  As an example, if 100 people belonged to a group that ran up an annual bill of $240,000, each member would be charged $2,400 ($240,000/100).  Suppose an average member of the group who ran up a medical tab of $2,400 this year were able to cut expenses in half the next, but everybody else maintained their original expenditures.  The frugal group member would decrease group expenditures by $1,200 or $12 per member per year.  Why would anyone cut their annual health care expenditures by $1,200 for a $12 savings?  
Mitch Daniels, the governor of Indiana, implemented health savings accounts that restore individual incentives to limit medical expenditures.  He describes the plan and its consequences in "Hoosiers and Health Savings Accounts," which was published in the Wall Street Journal. 

When I was elected governor of Indiana five years ago, I asked that a consumer-directed health insurance option, or Health Savings Account (HSA), be added to the conventional plans then available to state employees. I thought this additional choice might work well for at least a few of my co-workers, and in the first year some 4% of us signed up for it.

In Indiana's HSA, the state deposits $2,750 per year into an account controlled by the employee, out of which he pays all his health bills. Indiana covers the premium for the plan. The intent is that participants will become more cost-conscious and careful about overpayment or overutilization.

Unused funds in the account—to date some $30 million or about $2,000 per employee and growing fast—are the worker's permanent property. For the very small number of employees (about 6% last year) who use their entire account balance, the state shares further health costs up to an out-of-pocket maximum of $8,000, after which the employee is completely protected.

Because the plan is elective, it will only be chosen if it is better for state workers than alternatives.  Daniels writes

The HSA option has proven highly popular. This year, over 70% of our 30,000 Indiana state workers chose it, by far the highest in public-sector America. Due to the rejection of these plans by government unions, the average use of HSAs in the public sector across the country is just 2%...

State employees enrolled in the consumer-driven plan will save more than $8 million in 2010 compared to their coworkers in the old-fashioned preferred provider organization (PPO) alternative. In the second straight year in which we've been forced to skip salary increases, workers switching to the HSA are adding thousands of dollars to their take-home pay. (Even if an employee had health issues and incurred the maximum out-of-pocket expenses, he would still be hundreds of dollars ahead.) HSA customers seem highly satisfied; only 3% have opted to switch back to the PPO.

The state is saving, too. In a time of severe budgetary stress, Indiana will save at least $20 million in 2010 because of our high HSA enrollment. Mercer [an independent health care consulting firm] calculates the state's total costs are being reduced by 11% solely due to the HSA option.

Costs were lowered because people responded to incentives by reducing expenditures with no adverse consequences to their health.

Most important, we are seeing significant changes in behavior, and consequently lower total costs. In 2009, for example, state workers with the HSA visited emergency rooms and physicians 67% less frequently than co-workers with traditional health care. They were much more likely to use generic drugs than those enrolled in the conventional plan, resulting in an average lower cost per prescription of $18. They were admitted to hospitals less than half as frequently as their colleagues. Differences in health status between the groups account for part of this disparity, but consumer decision-making is, we've found, also a major factor.

Overall, participants in our new plan ran up only $65 in cost for every $100 incurred by their associates under the old coverage. Are HSA participants denying themselves needed care in order to save money? The answer, as far as the state of Indiana and Mercer Consulting can find, is no. There is no evidence HSA members are more likely to defer needed care or common-sense preventive measures such as routine physicals or mammograms.

Currently, I am nibbling at the bait that Daniels is offering, but I would need questions answered before I bought into this type of plan hook, line and sinker as a way to reform Medicare and Medicaid.  Is it actuarially sound?  Are the savings in Indiana due to young people signing into the plan who currently have low needs signing but who will eventually need to make health care expenditures that exceed their savings balances?  How would such a plan protect retirees and those near retirement?

With those provisos, such reform of Medicare and Medicaid, and altering the tax structure to treat out-of-pocket expenses the same as those made through a group plan should go a long way to ease future deficits and assure quality medical care. 

Eventually, health care providers will respond to frugal, price sensitive consumers and the real benefits of market driven reform will spontaneously materialize.  No new bureaucracy will be necessary.  Because the provision of good health will cost less, universal health care will be cheaper if majority of voters desire it.