A Brief History of Health Savings Accounts

Special Publications | Health


Wednesday, August 11, 2004
by The National Center for Policy Analysis

As of January 2004, 250 million non-elderly Americans have access in principle to health savings accounts (HSAs). Individuals will now be able to self-insure for some of their own medical needs and manage some of their own health care dollars.

Origins. It appears the idea of health savings accounts was independently originated by many people. It was first introduced to the NCPA by Senior Fellow Jesse Hixson, who for many years served as chief economist at the American Medical Association. NCPA President John C. Goodman and Senior Fellow Gerald Musgrave developed the concept through many publications. Because of his role as a spokesman for the idea, Goodman was called the "Father of Medical Savings Accounts" by House Ways & Means chairman Bill Archer and the Wall Street Journal. More recently, he was called the "Father of HSAs" by the National Journal and many others.

It seems unlikely that HSAs would exist today were it not for the activities of the NCPA, although other groups were also important - including the Council for Affordable Health Insurance (CAHI), the MSA Coalition and the American Legislative Exchange Council (ALEC).

Early History. In January 1984 the NCPA published a plan to use individually owned "medical IRAs" to solve the long term problem of Medicare.1 Two months later, John Goodman and Richard Rahn, then chief economist for the U.S. Chamber of Commerce, outlined this plan in an editorial in the Wall Street Journal.2 That same year Singapore introduced a mandatory "Medisave" program, under which workers contribute 6 percent of their salary to accounts used to pay medical expenses not covered by insurance.

The NCPA produced several reports on the Singapore experience,3 and Goodman and Musgrave produced a first-of-its-kind study documenting the opportunities in the United States to select high-deductible health insurance and place the premium savings in a personal health account to pay for small medical expenses,4 and a follow up study contrasting MSAs and managed care.5

Of particular importance in the academic world was a Health Affairs article by Goodman and Wharton School economist Mark Pauly showing how the tax system could encourage healthinsurance without distorting health care choices through the use of Roth type medical savings accounts.6

Patient Power. In 1990, the NCPA organized a task force of researchers from 40 thinks tanks, universities and research organizations, including the American Enterprise Institute, the Cato Institute and the Hoover Institution.7 The report advocated self-insurance for small medical bills through "medisave" accounts - a concept soon after referred to as medical savings accounts (MSAs). Goodman and Musgrave expanded the work of this Task Force into a classic book, Patient Power, published by the Cato Institute in 1992.8

Capitol Hill responded quickly. In 1992, 150 members of Congress cosponsored at least one of 12 different bills designed to create medical savings accounts. These included Democrats and Republicans, conservatives and liberals. For instance, S. 2873 was introduced in June 1992 by Sen. John Breaux and 12 cosponsors, including Democratic Senators Thomas Daschle, David Boren and Sam Nunn.9

More then 300,000 copies of the abridged version of Patient Power were published and distributed. Many people regard the book as the driving force that derailed Hillary Clinton's plan to reform the U.S. health care system. The Clinton plan is not mentioned in the book, however. The plan was essentially sidetracked when about 40 or so Republican senators signed on to a rival reform plan whose central focus was the Patient Power concept of MSAs.

Representative HSA Plan

Trial and Error. The idea of MSAs began to catch on like wildfire in the private sector as well:

  • NCPA Board member Pat Rooney tried the idea out with his own employees at Golden Rule Insurance Company and the company then began selling MSA plans in the marketplace.10
  • Forbes magazine publisher Steve Forbes created a variant of the idea for his employees.11
  • Versions of the idea were implemented by Quaker Oats and Dominion Resources.12
  • In yet another twist, the United Mine Workers accepted a $1,000 deductible as an alternative to first-dollar coverage in return for a $1,000 check from management each year for each employee.13

Pilot Project for MSAs. These early attempts to implement MSA plans were at a disadvantage under the tax law. Unlike employer-paid premiums, MSA deposits were subject to income and payroll taxes, and unspent funds could not be rolled over to accumulate and earn tax free interest. In 1996, however, Congress created a pilot project allowing tax free MSAs for the self-employed and small businesses. The total number of MSA policies allowed was capped at 750,000, but only about one-tenth that number were purchased due to the numerous restrictions imposed.

One of those restrictions was the design of MSA plans. In the early 1990s, Goodman drew a diagram of a possible MSA plan for Ways and Means Chairman Bill Archer. [See the figure.] Subsequently, this design was codified - both in the pilot program and the current HSA law. A similar approach initially was taken in South Africa. But in that country, the market was free to innovate and experiment.

MSAs in South Africa. In 1993, Goodman helped Discovery Health launch an MSA plan in South Africa.14 The plan was hugely successful and rival insurers quickly copied it. Today, MSA plans have captured about two-thirds of the private insurance market in that country. However, the most popular South Africa plans today would not be allowed under the rigid parameters that currently govern the U.S. market.

Currently, the health insurance policy that accompanies an HSA must have an across-the-board deductible of at least $1,000 for an individual or $2,000 for a family, with exceptions for preventive care. [See the figure.]

In a typical South African plan, however, there is no deductible for hospital care, on the theory that patients typically exercise very little discretion in a hospital setting. By contrast, there is a deductible of roughly $1,200 for out-patient care on the theory that patients exercise a lot of discretion with respect to those services. Most drugs also face a high deductible; but when the insurer wants to encourage drug therapies, the deductible may drop back to zero. This flexible approach encourages patients to make prudent choices where patient discretion is appropriate, but not where discretion is inappropriate.15

There are also other interesting innovations. For example, diabetics can enroll in a center of excellence for diabetic care. They pay one-third of the cost from their MSA, while the employer (or insurer) pays the other two-thirds.

Health Reimbursement Arrangements. In June 2002, with encouragement from the NCPA and the Wye Group on Health, the U.S. Treasury Department issued a Revenue Ruling clarifying that unused funds in Health Reimbursement Arrangements (HRAs) - employer-funded accounts similar to HSAs - could be rolled over from year to year tax free. Like MSAs in South Africa, HRAs are very flexible. Employers, for example, can alter copayments and deductibles to encourage employees to buy medications for chronic conditions or to encourage preventive care.

The account can never be cashed out and taken as compensation by the employee, however.16 They are also generally not portable. Thus, HRAs are essentially expense accounts with use-it-or-lose-it incentives.17 Nonetheless, they have been very important politically in building large employer support for consumer directed health care.

Health Savings Accounts. In contrast to HRAs, HSAs create an actual savings account that belongs to the worker, can travel from job to job, and be passed on to heirs. To a large extent, they allow people to choose between health care and other uses of money. Funds can be withdrawn and spent for nonhealth purposes after age 65, after paying normal income taxes. Prior to age 65, a 10 percent penalty also applies.

The Role of the NCPA. The National Center for Policy Analysis provided the intellectual justification and rationale for individual self-insurance. Between the time the NCPA task force was formed in 1990 and Health Savings Accounts became a reality in 2004, NCPA scholars made more than 250 presentations, including speeches, briefings, testimony, etc. in virtually every state.

The NCPA produced more than 40 studies, backgrounders, brief analyses and articles and other publications in addition to scores of newspaper editorials in such places as the Wall Street Journal, Washington Times, and Investors Business Daily.The NCPA also sponsored nationally televised debates including a Firing Line debate with Bill Buckley and a debate on the PBS program Debates Debates.

Conclusion. Health Savings accounts is truly an idea whose time has come. These accounts promise to revolutionize the American medical marketplace. However, they need to be more flexible in order to allow the market rather than Congress to discover what works best.

Notes:

  1. John Goodman, Peter Ferrara, Gerald Musgrave and Richard Rahn, "Solving the Problem of Medicare," National Center for Policy Analysis, NCPA Policy Report No. 109, January 1984.
  2. John Goodman and Richard Rahn, "Salvaging Medicare With An IRA," WallStreet Journal, March 20, 1984.
  3. In 1984 Singapore introduced a program under which all workers are required to contribute 6 percent of salary to individual Medisave accounts - a program that has been highly successful and eliminates the need for most third-party health insurance. See John Goodman and Peter Ferrara, "Private Alternatives to Social Security in Other Countries," National Center for Policy Analysis, NCPA Policy Report No. 132, April 1988; Mukul G. Asher, "Compulsory Savings in Singapore: An Alternative to the Welfare State," National Center for Policy Analysis, NCPA Policy Report No. 198, September 1995; and Thomas A. Massaro, and Yu-Ning Wong, "Medical Savings Accounts: The Singapore Experience," National Center for Policy Analysis, NCPA Policy Report No. 203, April 1996.
  4. John Goodman and Gerald Musgrave, "Controlling Health Care Costs with Medical Savings Accounts," National Center for Policy Analysis, NCPA Policy Report No. 168, January 1992.
  5. John Goodman and Gerald Musgrave, "Personal Medical Savings Accounts (Medical IRAs): An Idea Whose Time Has Come," National Center for Policy Analysis, NCPA Backgrounder No. 128, July 22, 1993.
  6. John Goodman and Mark Pauly, "Tax Credits for Health Insurance and Medical Savings Accounts," Health Affairs Vol. 14, No. 1, Spring 1995, pp 126-139.
  7. National Center for Policy Analysis, "Health Task Force," June 9, 1991.
  8. John Goodman and Gerald Musgrave, Patient Power: Solving America's Health Care Crisis (Washington: Cato Institute, 1992).
  9. John Goodman and Gerald Musgrave, "Personal Medical Savings Accounts."
  10. Golden Rule Insurance Company health plan deposited $2,000 a year into a medical savings account (MSA) for employees who chose a $3,000 family deductible. The result: In 1993, the first year of the plan, health costs were 40 percent lower than they otherwise would have been. See Peter Ferrara, "Medical Savings Accounts: The Private Sector Already Has Them," National Center for Policy Analysis, Brief Analysis No. 105, April 20, 1994.
  11. Forbes magazine paid each employee $2 for every $1 of medical claims they did not incur up to a maximum of $1,000; the result: Forbes' health costs fell 17 percent in 1992 and 12 percent in 1993. See Ferrara, "Medical Savings Accounts: The Private Sector Already Has Them."
  12. In the first 10 years that Quaker Oats utilized personal health accounts, its costs grew at an annual rate of 6.3 percent, which was well below the average. In the first four years that Dominion Resources had voluntary medical Savings Accounts, their health costs went up less than one percent. See Goodman and Musgrave, "Personal Medical Savings Accounts."
  13. In 1994 the United Mine Workers started a health plan with $1000 deductible. At the start of each year workers received a bonus of $1,000 to cover the gap. The result is they still had first dollar coverage, but they had an incentive to be wise medical consumers. See Peter Ferrara, "Medical Savings Accounts: The Private Sector Already Has Them."
  14. For more information how these plans work, see Shaun Matisonn, "Medical Savings Accounts in South Africa," National Center for Policy Analysis, NCPA Policy Report No. 437, June 2000; and Shaun Matisonn, "Medical Savings Accounts and Prescription Drugs: Evidence from South Africa," National Center for Policy Analysis, NCPA Policy Report No. 254, August 2002.
  15. John Goodman, "Two Cheers for the Bush Health Plan," National Center for Policy Analysis, NCPA Brief Analysis No. 465, January 30, 2004.
  16. Devon Herrick, "Health Reimbursement Arrangements: Making a Good Deal Better," National Center for Policy Analysis, NCPA Brief Analysis No. 438, May 8, 2003.
  17. Michael Cannon, "Flexible Spending Accounts: The Case for Reform," National Center for Policy Analysis, NCPA Brief Analysis No. 439, May 13, 2003.