State of the Union: What's an HSA?

Health Savings Accounts? Sounds innocuous enough. But what is it really?

Previously, the tax code provided preferential treatment for health insurance paid by an employer, as well as a portion of other medical expenses for those who itemize. Insurance companies get to invest these funds in return for paying for the medical care of the insured.

Now, this transfer from the employer to the insurer of tax-free funds is being divided into two separate streams. The first stream replicates the old model, compensating the insurance companies for providing high-deductible plans. The second stream goes from the employer directly to the employee, or more specifically, to the employee's Health Savings Account maintained either at a bank or specialty financial institution.

As a result, the investment decision for a portion of the total funds earmarked for healthcare spending has shifted from the insurance companies to the individual. This raises several interesting problems.First, the consumer will bear the responsibility for making the decision to "allow" or "deny" any particular procedure. One could expect that on average, people as a whole will make the appropriate choices. However, in specific cases, individuals will make horrible choices, moreso than trained professionals making decisions on consumers' behalf. On one end, hypochondriacs will spend their entire savings on dubious cures and practices, while on the other end, the miserly will jeopardize their own health (and the health of others) by foregoing routine expenditures in order to bolster their rainy-day accounts.

Second, the transaction costs involved with moving a significant pool of investment funds from a concentrated handful of insurance companies to an entire population will be significant, making the economic justification for expanding HSAs even harder to justify.

Third, healthcare providers and pharmaceutical companies are going to benefit from the expansion of a direct-to-consumer market in a way that does not necessarily lead to a desirable outcome. If every working American has a pot of money in an account that can only be used for either (a) savings or (b) healthcare spending, then the aforementioned healthcare providers and pharmaceutical companies are going to direct their formidable energies toward separating fools and their money. Aside from the dubious media programs their marketing will support, this unchecked outpouring of the medical cornucopia will create an unhealthy tension between fear of today's illness and fear of tomorrow's financial ruin.

Fourth, the number and cost of items that may be classified as healthcare expenditures will do nothing but rise. For example, there's a bright future for bioengineered foods that have been modified to fit the genetic profile and the dietary requirements of the individual. Such innovations require not just the invention of the food itself, but also the distribution and communication infrastructure required to move it from farm to lab to plate. Will all of this effort, a mammoth yet worthwhile undertaking involving entire sectors of the economy, be given tax-advantaged status? And as the tax-advantaged sector expands, what's left to support, run and operate a viable government?

Banks are being given the chance to get in on the ground floor of the multi-billion-dollar HSA opportunity. But before boarding an elevator, it's always a good idea to check whether it's headed "up" or "down." ___

On the Web: U.S. Treasury F.A.Q. on HSAs