Can MSAs help reduce healthcare costs? - medical savings account

Healthcare Financial Management, April, 1996 by Michael T. Bond

COST MANAGEMENT

Medical savings accounts (MSAs) have been proposed as one possible solution to the problem of escalating healthcare costs. Because MSAs allow consumers to shop for healthcare services and negotiate the cost, MSAs have the potential to restrain the rise in medical costs.

This article compares MSAs to traditional insurance plans, highlighting the advantages and disadvantages of MSAs.

In 1960, 21 percent of national healthcare costs was paid by the Federal government, 23 percent by private insurers, and 56 percent by consumers. By 1991 those percentages had changed to 43 percent, 35 percent, and 22 percent, respectively.(a) These figures suggest that a direct correlation exists between increases in healthcare costs and increases in the percentage of these costs that are paid by insurers and group purchasers.

Some experts believe that any healthcare system reform must include reintroducing market forces to slow the rate of increase in healthcare costs. They believe that by applying the same free market forces that drive the sale and purchase of other goods and services, the rise in healthcare costs can be checked.

Research on market forces in healthcare

A RAND Corporation study of the relationship between the cost of medical treatment and the demand for it found that the elasticity factor (the percentage change in the amount of services purchased divided by the percentage change in price) for healthcare services was -2. This means that a 10 percent increase in healthcare costs will reduce utilization by 2 percent.(b)

Another study, by the National Bureau of Economic Research, indicated that the elasticity of healthcare services demand may be even higher. This study analyzed the potential effect on national healthcare costs of a change from traditional indemnity plans and HMOs, to a health insurance plan that featured a 50 percent copayment and an out-of-pocket limit of 10 percent of the insured's income. In other words, an individual who incurred healthcare costs of $3,000 and had an income of $30,000 would pay $1,500 out of pocket. If the individual had healthcare costs of $10,000 or more, the out-of-pocket payment would be $3,000, a maximum of 10 percent of the individual's total yearly income. The study indicated that if this scenario were implemented on a national level, a reduction in aggregate healthcare expenses of more than $100 billion annually would result.(c)

The problem with this scenario is that most individuals would balk at an insurance plan that made them responsible for potentially high out-of-pocket costs. What is needed, therefore, is a market-based plan that encourages healthcare consumers to shop carefully for healthcare services and thereby lower costs, but does not expose them to significant copayments.

Medical savings accounts (MSAs) are attracting interest as a means to reintroduce market forces into the healthcare payment system by allowing consumers to shop for the best price. Presumably, by allowing free market forces to function, overall healthcare costs would drop.

Essentially, MSAs combine a high-deductible major medical insurance policy (which almost always costs less than a low-deductible policy) with an employer-funded healthcare savings account. Employees can draw from the account to cover first-dollar healthcare expenses. The funds used to establish the account are derived from the savings realized by adopting the high-deductible insurance plan. These funds then are distributed among individual MSAs set up for each employee. The employer determines the deductible and can choose to make the corridor between the deductible and the funds in the MSA wide or narrow. About 1,500 companies nationwide offer MSAs.(d)

How MSAs work can be shown further by examining a Danville, Ohio, school's employee health plan; the plan offers employees the option of either a traditional health insurance plan or an MSA.(e)

The traditional insurance plan versus the MSA

The Danville school's traditional insurance option requires the insured employee to satisfy a deductible of $400 and pay a 20 percent co-payment on the next $4,000 of annual healthcare costs, for a total potential out-of-pocket cost of $1,200. An employee who incurs $1,000 in healthcare expenses has an out-of-pocket cost of $600 ($400 deductible plus 20 percent of $1,000). The total annual cost to the employer is $5,150.

Under the terms of the MSA, the employer buys high-deductible major medical insurance for the employee at a cost of $3,350. With the savings that result from buying a high-deductible policy rather than a low one, the employer sets up an MSA for the employee with $1,500. The insured employee must satisfy a deductible of $2,000. An individual who incurs $1,000 in healthcare expenses pays for them out of the MSA, leaving $500 in pretax funds available for future use. This is not "use-it-or-lose-it" money. Unused MSA funds either can be withdrawn by the employee at the end of the year or can be rolled over for use in future years.