Your New Health Plan

Health savings accounts, like 401(k)s, will give employees more choices -- but also a greater share of the costs

When the 7,500 employees of Meridian Health opened their 2005 medical-insurance enrollment packages in early October, they found something new. Along with the traditional plans offering a network of doctors was a new choice called a health savings account (HSA). The employees of the Neptune (N.J.) health-care company could opt to sock away as much as $2,000 of their own money tax-free next year in a 401(k)-like account. What's more, they could invest the money in stocks, bonds, or mutual funds and tap into the tax-free account to pay medical costs. They would also keep anything they didn't spend, which means money would continue to grow and be available to buy health care in future years. Workers would pay less in biweekly premiums with the HSA, too: $15, vs. $44 if they stuck with the traditional preferred provider organization PPO) plan.

So what's the catch? A hefty $3,000 annual deductible, vs. $1,000 with the PPO. To ease the pain, Meridian will match employee HSA contributions at 50 cents on the dollar, up to a max of $1,000. It also plans to give them information about the price and quality of medical care in their area, so they can make smarter decisions about what to buy and where to buy it. In 2005, the company expects only 5% to 10% of its employees to sign up, says Human Resources Senior Vice-President John E. Sindoni. But if the idea proves popular, HSAs, which Meridian hopes will give it more control over its medical tab, could become the company's only insurance option in two or three years. "We are looking to curb rising costs, and we want our employees to become more engaged in their care decisions," says Sindoni.

Get ready for the next great experiment in American health care. In the 1980s, employers embraced health maintenance organizations (HMOs) as the solution to runaway medical costs. But the ensuing backlash in the 1990s forced companies to ease HMO restrictions or replace them with looser PPOs that do little to limit care. When medical inflation returned to nosebleed levels, desperate employers began searching for yet another solution.

The latest answer: HSAs and their cousin, the health reimbursement account (HRA). In 2000, insurance companies first began marketing HRAs, which also allow employers to set up high-deductible plans with lower premiums. With HRAs, employers set up new company-funded accounts that employees use to pay out-of-pocket health costs for, say, visiting a specialist or getting treatment for the flu. Because workers can roll over unused funds at the end of the year, they have a big incentive to shop for cheaper doctors and hospitals.

The Bush Administration expanded the concept in last December's Medicare prescription drug law by creating HSAs, a favorite GOP idea that allows employees to kick in their own tax-free dollars along with their employers' -- and to watch the whole pot grow tax-free. Better yet, unlike HRAs, HSA money belongs to the workers, who can keep it to use for future medical spending even if they change jobs or retire.

HSAs, HRAs, and the notion of consumer-directed health care that underlies them hold tremendous promise -- and also much peril -- for the U.S. health-care system. At its most basic, the idea is to turn medical care into a service that consumers buy like any other. Doing so, the thinking goes, will force everyone -- doctors, hospitals, drugmakers, and medical-equipment companies -- to rein in prices. "HSAs are part of a larger transformation of the health-care system," says Paul Fronstin, an economist at the Employee Benefit Research Institute. "It is not as simple as mere dollars. It is about combining dollars with the ability to choose providers differently."

Yet there are plenty of pitfalls that make the outcome highly uncertain. HSAs may appeal mostly to healthy and affluent families who will opt for lower monthly premiums, betting they can handle big out-of-pocket costs if they get sick. But the less healthy may remain in traditional plans, making them even more costly.

Uncharted Waters

What's more, it's by no means clear that health care will conform to the logic of the market. If the forces that HSAs are designed to unleash don't curb prices, employees may end up shouldering more of their expenses. Indeed, many companies like the HSA idea because it allows them to manage costs better. If overall medical spending rises faster than expected, workers will absorb much of it through HSAs' higher deductibles. The concept is similar to 401(k)s, which limit employer retirement contributions rather than guarantee a monthly pension check. "The hope is that employers will shift the cost burden to employees, and employees will shift it to [health-care] providers," says Dearborn (Mich.) benefits consultant Maureen Cotter. If not, "employees will be left holding the bag."

The creation of HSAs received virtually no public notice last year, but Corporate America has snapped to attention. Already, about 10% of employers offer consumer-driven plans, mostly HRAs, although only a few million workers have signed up for them. But experts and corporate planners expect HSAs to jump-start the concept. Since the accounts are so new, most large employers haven't yet worked through all the complicated details involved in setting them up. So HSAs are being offered this fall only by several hundred smaller companies, plus a handful of large ones such as BASF (BF ), Intel (GDT ), Pitney Bowes (PBI ), and Textron (TXT ).

But by 2006, fully 73% of U.S. employers are likely or somewhat likely to be offering HSAs, according to a survey by Mercer Human Resource Consulting. Health economists aren't sure how many employees will buy in. But as many as 32 million people, or 20% of the 160 million Americans insured by employers, could sign up for some form of a high-deductible, consumer-driven account during the next five years, says Edward Kaplan, national health-practice leader at Segal Co., a consulting firm. Already, 10 million federal government employees will have an HSA option come January. "These are a big deal; this is what the industry is talking about," says Gary Claxton, director of the Health Care Marketplace Project at the Henry J. Kaiser Family Foundation.

Politically, HSAs could advance President Bush's goal of fundamental health-care reform. He pushed for the HSA provision in the Medicare bill, and he talks on the campaign trail about expanding it. The approach dovetails with his platform of new tax cuts to help Americans buy insurance on their own, instead of through employers. His aim is to give consumers incentives to shop for care and, in the process, help hold down prices. Conservatives hope that, ultimately, all these measures will entice Americans to abandon the employer-based system altogether. Doing so, they argue, would allow workers to tailor insurance to their own circumstances while simultaneously injecting much-needed market discipline into the industry. Such sweeping change would be far more radical than HSAs, but the new plans move in that direction.

Democratic candidate John Kerry, by contrast, is looking for ways to shore up the employer system. He backs an ambitious plan to subsidize about 10% of businesses' premium costs and insure most of the uninsured. This leaves him in an odd position vis-à-vis HSAs. Kerry doesn't oppose them, although he does object to ending employer-based care. If Kerry becomes President, he's not likely to seek to repeal the law that permits HSAs. But he surely wouldn't actively promote the plans as Bush will continue to do if reelected.

Consumer-directed health care is no panacea, but if it delivers on its promise, it could bring much-needed relief from the industry's punishing price spiral. For example, showing consumers the cost and health risks of a hip replacement could encourage them to opt for physical therapy. Or allowing them to compare MRI prices at three local imaging centers could spur competition. Advocates also say that giving consumers more responsibility will prod them to curb unnecessary care, which some studies peg at 20% to 30% of all U.S. medical spending. "This will be the most important effect of consumer-driven care," says Harvard Business School Professor Regina E. Herzlinger.

Overall, consumer-driven care could lower the $8,000 tab for the average worker's medical care by perhaps 5% to 10% over the long term, according to estimates by Emory University health economist Kenneth E. Thorpe. That won't solve runaway medical spending, but it would still ease some of the pain for employers and employees alike.

The groundwork for HRAs and HSAs was laid by employers in the late 1990s, when they started moving toward higher deductibles. As Corporate America has struggled with resurgent health expenses, companies found it difficult to shift more of the premium onto employees. After all, just keeping pace with medical inflation has doubled annual worker premiums since 2000, to an average of $1,565. But employers realized that increasing deductibles and co-payments was less noticeable, since most people don't use the medical system much in any given year. So they have been hiking annual employee out-of-pocket costs sharply in recent years. In 2004, they will top $1,000 per employee on average, up from $446 in 2000, according to Hewitt Associates LLC (HEW ). As a result, workers' share of total costs has jumped from 26% to 32% since 2000, Hewitt found, even though they still pay roughly 28% of premiums, the same as in 1998.

HSAs allow employers to continue down this path. Instead of taking painful steps to slow health spending, such as denying coverage for some treatments, high-deductible plans shift the burden of decision-making onto employees. They can opt for brand-name rather than generic drugs or go to a more costly specialist, but they pay more. Consumer-driven plans also allow families who don't spend much on care to save a bundle by assuming more risk. In effect, HSAs let employees cut back on their fixed annual costs while insuring themselves, up to the limit of their new deductibles.

Just as these policies will require workers effectively to self-insure for the first dollars they spend on medical care, it will let employers reduce the coverage they now provide for that same care. Consumer-driven plans "are shifting to the consumer a greater proportion of the responsibility," says Tracy Bahl, CEO of Uniprise, the UnitedHealthcare unit that markets HSA and HRA plans.

Take Cincinnati's American Financial Group Inc. (AFG ), which just rolled out the 2005 options for its 5,000 U.S. employees. They'll be able to choose between a $315-a-month PPO with a $250 deductible, a $235-a-month HRA with a $1,600 deductible, and a $65-a-month HSA with a $2,200 deductible. Workers who think they won't get sick might jump at the HSA. After all, they would be able to save a cool $3,000 in lower premiums next year if they don't use the medical system.

If they were real gamblers, workers could pocket all $3,000 and put nothing in their HSA, betting they would encounter no health problems. Or they could invest some of the saved premium, say $2,000, in their tax-free account. If they don't spend it on health care, it would remain to be used in 2006 and beyond -- along with any interest or stock gains it earned. Plenty of Americans might be willing to run these risks, since fully half the population spends little or nothing on health care in a given year, according to the Kaiser Family Foundation.

Sea Change

The larger goal is a profound shift in the relationship Americans have with providers of health care. Today, most people accept the doctor's treatment suggestions without question, including recommendations on which drugs to take or specialists to see. When it's their own money at stake, the theory goes, patients will question procedures and shop around for the best price and quality.

Some companies with HRAs say even this more limited form of consumer-driven care changes behavior. Last year, Equitrac Corp., a 500-employee document-management company in Plantation, Fla., replaced its PPO plan with an HRA. Financial Controller Michael Myers says the company is already saving money. Lilly Bailey, who works in Equitrac's accounting department, says she has been a more careful consumer since getting the plan. "Shopping around is a good thing; your objective is how much you can not spend."

Sounds sensible, but will it work on a large scale? For one thing, consumers can't buy wisely unless they know a lot about the price and quality of the medical services they buy -- information that is just beginning to become available today. And neither providers nor insurers have much incentive to show such transparency. Even if they do eventually make information available, individual consumers may not be able to get better deals than insurers with massive market clout. That's one reason why even employees with HSAs will probably continue to buy through provider networks, whose prices have been negotiated by insurers.

Another big question: Will high deductibles lead Americans to stop wasting money on unnecessary care? Or will consumers suddenly in charge of their own health care actually spend more as providers unleash their new marketing muscle? Just think about the proliferation in the past few years of companies hawking direct-to-consumer MRI screenings and do-it-yourself tests that check for everything from anemia to gout. Quest Diagnostics Inc. (DGX ) in Teterboro, N.J., began offering its QuesTest blood workups to consumers in 2001. By early next year, it will have 800 labs marketing everything from simple blood typing to a $115 "health profile" that includes information on your cardiovascular health, liver function, and immune system. Such tests may be a good deal for many newly cost-conscious patients, but slick marketing may also encourage some to buy more unnecessary care. "At the end of the day, is health going to be any better? The jury is out, but that's the challenge of market-delivered health care," says Eric B. Larson, chair of the Board of Regents at the American College of Physicians.

At the same time, there's a growing concern that HSA-type plans may prompt people to scale back care that is key to good health. In the long run, that could leave Americans sicker and make their eventual treatment even more expensive than under the current system. The issue is especially important for low-income workers and those with chronic diseases. After all, just five chronic conditions, including heart disease and hypertension, account for one-third of all health spending, Thorpe figures.

Indeed, scores of studies over the past 30 years suggest that many people will skimp even on necessary treatment if they pay for it out of their own pockets. For instance, a 2003 study reported that when one employer boosted prescription drug co-payments, 21% of patients in the plan stopped using cholesterol-lowering drugs, more than twice the rate of those who paid less for the same medicine.

In consumer-driven plans, once workers blow through their deductibles, they are back on insurance, so the risk is limited. Still, insurers leading the way, such as Lumenos, Aetna (AET ), and UnitedHealthcare, are aware of the problem and are trying to ease the burden by including free preventive care in their HSA or HRA plans. Employers may also exclude drugs for chronic illness from deductibles. In addition, companies such as Meridian are tying their high-deductible plans to disease-management programs, which identify people at risk for costly chronic illness such as diabetes or congestive heart failure and assign coaches to help with appropriate treatment. "If people make choices to avoid [needed] care, that's a mistake on our part," says Tony Miller, chief executive of Definity Health Corp. in Minneapolis, the nation's largest provider of consumer-driven policies .

Even if many families do become smart health-care shoppers, there's another big risk: that HSAs will separate the healthy from the chronically sick and undermine the risk-pool nature of traditional insurance. HSAs will probably appeal most to the 50% of Americans who spend virtually nothing on care in any particular year. After all, any unused HSA money is theirs to keep, while joining a PPO or HMO means shelling out higher premiums even if they never see a doctor all year. And if employees with heavy medical expenses remain in traditional plans without the current subsidy from non-users, those policies could become unsustainably pricey. That has not happened with the early HRA plans. But some analysts are worried. "Sicker people are going to wind up paying more," predicts Karen Davis, president of the Commonwealth Fund, which studies health-care issues.

Getting an Easy Ride

Some experts also predict that plans with high deductibles will be affordable only for those who are both healthy and affluent. HSAs open up a new tax-free savings strategy that's far more generous than 401(k)s, individual retirement accounts, or Roth IRAs. While all these allow either pretax contributions or tax-free withdrawals, HSAs are entirely tax-free, as long as you use the funds for medical expenses. "You get the Triple Crown of tax planning: It goes in tax-free, it grows tax-free, and it comes out tax-free," says Andy Anderson, a benefits attorney at Hewitt.

That may create a sweet new shelter for high-income families that have already maxed out on their 401(k) contributions. HSAs thus could offer a great way to save for post-retirement health care, which many employers have dropped. Yet even more companies may dump the benefit once their workers have a pot of money with which to buy their own.

Trouble is, most middle-income families pulling down $45,000 or $50,000 a year probably can't afford to put aside thousands of dollars, even if Uncle Sam kicks in so much. Fully 96% of workers already contribute less than the maximum to their 401(k)s. And many may feel compelled to choose between their 401(k) and an HSA, potentially diverting savings from retirement to health care. "We are concerned about that," concedes American Financial's director of human resources Scott Beeken.

It's too early to know whether empowering consumers will make a big dent in the nation's medical tab. If it does, families and employers will gain some much-needed relief and enjoy better health care. But the prognosis will be much more dicey if HSAs and HRAs attract mostly the healthy Americans who aren't much of the problem in the first place. Either way, workers are about to begin a new chapter in the great American health-care saga.

By Howard GleckmanWith Lorraine Woellert in Washington

    Before it's here, it's on the Bloomberg Terminal.