StreetTalk: Medicare Reform and Health Savings Accounts: A Trojan Horse for Industry?

A cynic once said that a camel is a horse designed by a committee.

Similarly, the cynic within some industry observers might wonder about a new government program designed to mitigate higher healthcare costs and provide consumers with more flexibility in managing their healthcare budgets.

The plan in question — the recently enacted Medicare Prescription Drug, Improvement, and Modernization Act of 2003 — looks to be, on the surface at least, a potential bonanza for makers of brand-name prescription drugs.

First, the good news.

At first glance the new Medicare reform bill looks to be a win-win situation for consumers, employers, and health services companies. With new prescription drug cards ready for use by 2006, government officials say that consumers can expect to save up to 25% in prescription drug costs. The theory behind the claim is that millions of cardholders, exercising the power of the purse, won't do business with drug companies that don't participate in prescription drug discount programs.

But drug companies that play can expect a windfall, experts say. "We believe passage of the Medicare bill is a decided positive for the drug industry as it is expected to drive a significant increase in volume, offset only partially by increased discounting," says a recently released Deutsche Bank report. "In addition, the legislation should help to remove a long-standing political thorn in the industry's side." The bank estimates that the new prescription drug cards may help boost drug company profits by up to $10 billion "despite the expected impact that price discounting will probably have." Lower drug prices would also help employers, too. Less money paid out for prescription drug costs should have chief financial officers dancing a conga line around the boardroom table.

A Trojan Horse?

But is Medicare reform a Trojan horse for prescription-drug companies? A closer look at the reform bill suggests this possibility.

First, the bill opens a new loophole for consumers and healthcare insurers to purchase ostensibly cheaper drugs from Canada where drug costs are, on average, about 50% lower than they are in the United States. If that loophole remains, look for consumers and healthcare insurers to bleed Canada dry of affordable prescription medications. The only barriers to taking off to the Great White North and buying cheaper prescription drugs are that the drugs must be safe and they must provide proven cost-savings.

But a potentially more significant provision of the Medicare reform act that could harm prescription drug companies is the health savings account (HSA) — a brand, spanking-new tax savings account that is a one of the act's centerpieces. With HSAs, Americans under age 65 with high-deductible health coverage can fund their own tax-free healthcare savings accounts. Unlike their flexible savings account (FSA) siblings or traditional health plans, HSAs roll over annually and remain with the plan participant whether they keep their job or not.

HSAs are, for a government program, fairly uncomplicated. Annual account investments are capped at $2,600 for individuals and $5,150 for families. The HSA's "catch up" clause enables Americans between 55 and 65 years old to contribute additional funds each year, starting at $500 in 2004 and reaching $1,000 by 2009. Like individual retirement accounts (IRAs), HSAs are managed by financial services firms. Unlike IRAs, however, HSAs are virtually tax-free and have no age restrictions on when money can be withdrawn.

HSAs differ from older healthcare spending plans, like FSAs or health reimbursement arrangements (HRAs). Like HSAs, FSAs enable users to pay for out-of-pocket health expenses (like prescription drugs) with pretax dollars. Process-wise, they differ. FSA contributions are subtracted from your paycheck on a pretax basis. With HSAs, you can contribute through deductions or through direct deposits to the managing financial institution. FSAs also don't allow employer contributions, and they don't allow plan participants to roll money over from year to year.

In the Raw

HSAs are so raw that companies are really just starting to get a good look at them.

Indeed, early plan investors are almost all individuals, drawn to HSAs by their relative liquidity, roll-over capabilities, long-term tax advantages, and “power of the purse” potential. It's the last benefit that should worry brand-name prescription-drug companies.

Why? Because the consumers who sign on for healthcare savings accounts will soon understand that, for them, healthcare is now a zero-sum game. Every dollar they pay for prescription drugs is a dollar removed from their own pocket. And every dollar they save on prescription drugs stays in their pocket. Compare that to the relative lack of transparency of traditional healthcare plans, where employers subsidize the costs of prescription drugs for employees and end users often don't know the actual prices of services rendered. Now, with HSAs, consumers have more power to shop and compare prices on their own — which could cut into pharmaceutical companies' profits.

Let's face it — Americans love value and love bargains, especially when it's their money on the line. Consequently, just like shopping for a can of soup or a roll of paper towels, the prescription-drug market is set to become a true commodity market where price is the top priority.

HSA participants may take a closer look at generic prescription drugs, which cost less and are readily available these days. The market research firm Theta Reports says that the generic drug market is worth roughly $22 billion and is growing at a rate of 12% annually. Add three million healthcare "value shoppers" to the mix (the number the White House says will be using health savings accounts by 2006) and generic drugs should become even more popular.

Am I acting too much like Chicken Little? Maybe. But the early evidence suggests that people like shopping for their own healthcare services — and keeping prescription-drug costs down are certainly in that mix.

Consider Pamela Wimbish, a 55-year-old furniture wholesale consultant from Aurora, IL who recently opened an HSA at Fortis Insurance. "I'm self-employed and in good health," says Wimbish. "I'd been a member of a health group plan for years, but, after medical savings accounts were introduced, found myself interested in high-deductibility healthcare programs."

When the Medicare reform bill was passed in late 2003, Wimbish was the first customer, according to Fortis, to sign up for its health savings account program (she appeared at the White House ceremony for the Medicare reform bill alongside President George W. Bush in late 2003).

"The fact that you could fund it with 100% of our deductible was great," Wimbish says. "I'm only paying for routine medical bills — check-ups, prescription drugs, and things like that — so I estimate I am only spending $1,000 on healthcare annually. And I shop very carefully for the best deal I can get on prescription drugs."

Economist Milton Friedman says that healthcare consumers like Wimbish will be the norm and not the exception. In a recent speech in New York, Friedman said that HSAs could make consumers smarter and savvier healthcare shoppers. If people have to pay the all-important "first dollar" for healthcare needs, he told the audience, consumers will shop around for the best deal they can get, just as if they were shopping for a new car or a new refrigerator.

If that transpires, brand-name prescription-drug companies could be in trouble. Industry executives have no doubt noticed how free-market consumers have driven down the prices of everyday items like DVD players and personal computers.

Who can blame them for wondering "are we next?"