MSA's Can Be a Windfall for All

Policy Backgrounders | Health

No. 157
Friday, November 02, 2001
by Greg Scandlen

Will MSAs Attract "the Healthy And the Wealthy" at the Expense of Everybody Else?

The complaint that MSAs will benefit the healthy and wealthy at the expense of the rest of us is a catchy sound bite well suited for Washington spinmeisters. Unfortunately, it is no more true for having been so frequently repeated. Whether or not one chooses an MSA depends in part on available alternatives. But it is impossible to examine the likelihood of a selection simply by looking at a single choice. Side-by-side comparisons must be made.

Traditional Indemnity vs. MSAs: Comparing Plans.

A "traditional indemnity" plan is also known as a "fee-for-service" (FFS) or "major medical" plan. It is characterized by a small deductible (usually $250 to $500) and "coinsurance" (typically 20 percent of claims). Both are paid by the insured up to some "stop-loss" level ($1,500 or so).

As the name implies, a fee-for-service plan pays providers a fee for providing a service. The payment may be based on a fixed fee schedule or may be a "usual and customary" fee. "Managed care" efforts are minimal and patients are free to choose their own providers, although utilization review programs are increasingly common in FFS plans.

In contrast, a typical MSA program, as enabled by Congress in 1996,31 starts with a deductible of approximately $2,000 for an individual or $4,000 for a family. In this case, the individual (or the employer) may deposit as much as $1,300 into the MSA. A family may deposit as much as $3,000.32 These deposits are excluded from taxable income if made by the employer (thus avoiding income and payroll taxes) and are deductible if made by the account holder (avoiding income tax alone).

"The money in an MSA may be invested and build up tax free over time."

Consider an individual with a $1,300 MSA deposit and a $2,000 deductible. When this individual enters the medical marketplace, the first $1,300 of expenses are paid from the MSA. The next $700 is paid out of pocket. And beyond $2,000, all expenses are paid by the health plan.33 Thus in this example, the patient's out-of-pocket risk is limited to $700. However, if not all of the $1,300 MSA deposit is spent, the remainder stays in the account and is added to the next year's MSA balance.34 So after a few years, most people's MSAs will exceed $2,000 and there will be no out-of-pocket risk.

The money in the MSA may be invested and build up tax-free over time. Money in the MSA may be used to pay for health care expenses at any time without penalty. It may also be withdrawn to pay for other needs, but the account holder has to pay taxes plus a 15 percent penalty on any amount withdrawn.

The essential idea behind the MSA is that the money saved on premiums can be deposited in the savings account. By going from a $250 deductible FFS plan to a $2,000 deductible MSA plan, an individual might save enough to cover the maximum $1,300 contribution. Whether that happens depends on local market conditions, the attitude of the insurance company, risk factors associated with the insured and a lot of other factors. But the idea of saving $1,300 in premiums by raising the deductible by $1,750 is not unrealistic.35

Most MSA programs use a "Preferred Provider Organization" (PPO) for the insured portion of the coverage, thereby gaining the benefit of whatever cost savings may be available for higher-cost claims. Although PPOs are customarily considered to be part of managed care, they are more like traditional FFS plans than Health Maintenance Organizations (HMOs). They use deductibles and coinsurance and pay providers on a fee-for-service basis, although they usually negotiate discounted rates from their "preferred" network of providers. PPOs direct their patients to the preferred providers by charging a higher coinsurance rate for going "out of network."

Table II - Total Spending and Out-of-Pocket Costs under Four Scenarios

"The typical MSA plan benefits both the sick and the healthy."

Most people will spend less money out-of-pocket with an MSA than they would with a traditional FFS, including high and low utilizers and high- and low-income earners. Because plan design may vary, we will look at four different scenarios to illustrate this point.

  • Plan A is a $250 deductible FFS plan with a 20 percent coinsurance on the next $7,500 of claims.
  • Plan B is a $500 deductible with a 20 percent coinsurance on the next $5,000 in claims.
  • Plan C is an MSA with a $2,000 deductible and a $1,000 contribution in the account.
  • Plan D is an MSA with a $2,500 deductible and a $1,500 contribution to the account.

As Table II shows, in these hypothetical scenarios there is only a small range of expenses for which the MSA out-of-pocket exposure is greater than the traditional FFS program - claims between $2,000 and $3,500. But because out-of-pocket expenses are usually paid with after-tax dollars,36 if MSA deposits are tax-preferred, the range is even smaller than the amount reflected and depends on the marginal tax rate of the insured.

The notion that the unhealthy and the unwealthy do better in a traditional FFS indemnity plan than they would in an MSA is false. People with few expenses do better under the MSA regardless of their income, and people with very high expenses do better with the MSA, again regardless of their income.

The Urban Institute Study.

"Sick people gain from MSA plans because their out-of-pocket expenses are typically lower."

An early Urban Institute (UI) study supports these conclusions. The study estimated "winners and losers" if everyone switched to an MSA program. It concluded that 80 percent of the population would be financial winners. That number of financial winners would be much higher but UI included the highest utilizers among the losers, though just barely.37 The UI study concluded that the primary losers in an MSA scenario would be those with annual expenses ranging from $2,000 to $5,250. It also found that, "on average, lower wage workers would benefit from switching to MSA/catastrophic plans."

HMO vs. MSA.

If an MSA is better for the unhealthy and unwealthy when compared to a traditional FFS or PPO plan, what about when compared to an HMO? An HMO environment presents an entirely different dynamic and set of choices than an FFS plan. As a rule, HMO premiums are lower than the MSA/high deductible insurance plan combination and involve lower cost-sharing. A lower-income person would probably prefer the HMO, all other things being equal. As it turns out, however, all other things are not always equal.

When we consider that a person with few expenses will actually have money left over at the end of the year to be included in the next year's MSA, the "wealthy" charge looks absurd. A person with $250 in expenses in the first year may have $750 left over at the end of the year. This $750 is far more meaningful to someone earning $10,000 per year than it is to someone earning $100,000 per year. It amounts to a bonus of 7.5 percent of the former person's income, but less than 1 percent of the latter's.

"The savings in an MSA are far more meaningful to a low-income employee than to high-income employees."

Low-income workers might prefer to pay the added cost of the MSA program because, if they are careful in their health care spending, they will have money left over at the end of the year. As with the example above, the opportunity to save several hundred dollars in a personal account means a lot more to a lower-income worker than it does to "the wealthy." The value the working poor put on extra cash may be much higher than the value they put on extra doctors' visits.

This opportunity is admittedly a matter of personal choice. Not everyone places more value on cash than they do on doctors' visits, and there are a large number of other factors that enter into the perceived value of one or the other. The proximity of services is one such factor. It is a lot easier for a low-income family with children to make use of an HMO's services if it has facilities or participating providers close by. If the closest facility is across town or out in the deep suburbs, the value of the benefit to an inner city, low-income family is greatly diminished, and the prospect of money in the bank looks more attractive.

So, for lower-income workers, the appeal of an MSA may be a toss-up when compared to an HMO. Some will prefer one, some the other. But what about the unhealthy? Would they prefer an HMO or an MSA? Again, it is hard to say, but there is evidence in that in the Medicare program healthy beneficiaries tend to select HMO coverage and then revert to traditional Medicare when they become sick.38

As we have seen with the "managed care backlash," many people fiercely resist the idea of having a limited choice of doctors, or of having the health plan second-guess recommended services. The "unhealthy" (people with chronic or acute medical conditions) are far more sensitive to the problems of managed care than are people of average risk who encounter the health care system only rarely. Very often these "high utilizers" will have a personal network of doctors they know and trust. If one of those doctors does not participate with an HMO, or is dropped from the HMO's network, that patient will be a good candidate for an MSA. High-utilizers are also far more likely to experience the other problems associated with managed care - trouble getting through on the phone, long waits to get an appointment and in the doctor's office, being assigned to an inappropriate specialist, having prescribed treatments questioned and so on.39

The RAND Study.

Table III - Health Care Spending and Family Income by Type of Plan Chosen

A recent study by researchers at the RAND Corporation confirms this analysis.40 The study, funded by the Department of Labor, constructed a simulation of multiple choices of health plans in a small group environment. As Table III shows, it found that those who chose an MSA were on the average the highest-risk people and considerably less wealthy than those who chose HMO coverage.

"The RAND study found that those who choose an MSA were on the average the highest-risk people and considerably less wealthy than those who chose HMO coverage."

The RAND researchers concluded, "HMOs are attractive to wealthier workers," and "higher-income employees prefer to stay with the HMO." They went on to debunk the myth about the healthy flocking to MSAs when they wrote, "We see that the MSA is not attractive to exceptionally good risks, as some critics have hypothesized. Instead, these healthy people prefer to decline coverage."

In other words, the wealthiest workers prefer HMO coverage and the healthiest workers choose no coverage at all. MSAs are chosen by the least healthy and the third least wealthy of all the groups. The RAND researchers add, "We find that MSAs could be desirable to workers in firms that already offer HMO coverage or standard FFS plans. As a result, expanding MSA availability could make it a major form of insurance for covered workers in small business."41

NBER Study.

Another problem with the "healthy and wealthy" argument is it assumes there are two kinds of people, the healthy and the unhealthy, and never the twain shall meet. For instance, Catholic University law professor Regina Jefferson states in an article about MSAs: "Approximately 70 percent of Americans account for only 15 percent of national medical expenditures. Nearly 75 cents of every dollar spent on health care in the United States is attributed to only 10 percent of the population."42 She implies that this small minority of people will be disadvantaged by an MSA because they will never be able to build up or replenish their funds.

"The vast majority of people will be able to build up funds in the MSA before an illness hits, and replenish them after it is over."

These numbers may be approximately right - in a single given year. But this year's 10 percent of high-utilizers are not the same people as last year's 10 percent or next year's 10 percent. In fact, most acute health care expenses involve either end-of-life care or an episodic illness that may appear for a year or two and then disappear. The vast majority of consumers will be able to build up funds in the MSA before an illness hits, and replenish those funds after it is over.

One study published by the National Bureau of Economic Research (NBER) found "that high expenditure levels typically do not last for many years."43 This study modeled an MSA-type program44 based on the experience of a large Midwestern manufacturing firm, and found that by projecting actual claims experience over the entire worklives of the employees, even without considering any behavioral response to increased cost-sharing, 95 percent of the population would have retained at least 20 percent of their MSA contribution and 80 percent would still have at least half of what had been contributed.45

"People with MSAs have a source of funds for preventive care."

In other words, almost everybody has some health care expenses in the course of their lives, but few if any are sick all the time. If behavioral responses (i.e., the tendency to consume fewer services when paying for them directly) were accounted for, the authors say the results would have been more equal with fewer people spending most of their MSA funds."46

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