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Update Newsletter: Spring 2009

New Prospects for Payment Card Application in Health Care

Consumers' use of payment cards for making health-care payments has been relatively limited. According to McKinsey & Company, approximately 80 to 90 percent of health-care expenditures are paid by cash or check. In her paper "New Prospects for Payment Card Application in Health Care,"* Ann Kjos explores several reasons for the slow adoption of payment cards to date and discusses four specific trends and developments that may lead to increased growth in the future.

Health-care payments in the United States are overwhelmingly concentrated among government and business entities. Nevertheless, direct consumer payments — estimated at around $269 billion in 2007 — are substantial. While cash and check have been the traditional form of payment, credit and debit card terminals are becoming more common in doctors' offices and hospitals. At the same time, payment innovators are also focused on several specific health-care programs that appear to offer particular opportunities for payment card applications. These programs fall under the rapidly growing segment of consumer-directed health care: flexible spending accounts (FSAs), health reimbursement accounts (HRAs), and health savings accounts (HSAs). Individuals with an FSA or HRA can use a payment card to access funds set aside for health-care expenses, eliminating the need to submit receipts for reimbursement. The most recent program innovation, the HSA, was designed to incorporate a payment card application. With an HSA, individuals with health-care plans that have high deductibles can make tax-deductible contributions to their accounts, saving for qualified medical and retiree health expenses that can be accessed with a debit card.

Early expectations for card-based spending centered on these relatively new programs were extremely high. However, actual use of payment cards for these programs was estimated at only 3 percent of total consumer out-of-pocket expenses for 2007. More specifically, spending with FSA, HRA, and HSA cards accounted for $5 billion, $255 million, and $2.5 billion, respectively. In general, consumer adoption of these health-care options has been much slower than originally anticipated. According to Metavante Corporation, there were fewer than 20 million FSA, HRA, and HSA enrollees in 2005. As a result, a number of early payment card entrants into the market, including American Express and Discover, have cited limited market potential as a reason for cancelling or pulling back on their initiatives.

In addition to slow growth in these targeted programs, another impediment to card use has been the complex nature of health-care payments and the challenge of adapting traditional card payment processes to this different environment. Among the several examples discussed in the paper is the impact that the complexity of product pricing has on this payment card application. While the price of a good is readily established in a retail merchant environment, the price of a health-care service is often not available at the point-of-sale and is subject to different deductibles or co-payment structures. Moreover, transactions are often connected over time as part of an ongoing treatment, and payments are subject to complex adjudication rules. While payment card providers are developing solutions to these challenges, progress has been slower than anticipated.

Nevertheless, Kjos believes there is good reason to expect that these programs and associated payment card applications may soon experience more significant growth. She discusses four specific trends and developments: (1) a general shift away from employer-provided health care to card-friendly consumer-directed health-care plans (CDHPs), (2) an expansion of HSAs in particular, (3) a move toward using debit and prepaid card applications to address limitations in traditional paper-based FSA and HRA environments, and (4) new IRS regulations that address important impediments to expanding CDHPs and payment card applications.

Spending on health-care services is growing faster than the country's gross domestic product. Due to this rapid rise in overall health-care costs, many employers have been shifting away from employer-provided health-care plans and toward CDHPs. As this trend continues, and perhaps accelerates, the underlying payment patterns will shift toward a greater mix of consumer-directed payments. This, in turn, is expected to generate opportunities for payment card providers supporting FSA, HRA, and HSA programs.

Despite slow growth to date, many observers believe that as employers adopt or shift to CDHPs, HSAs stand especially to benefit. HSAs offer a number of attractive features to employees, and their card-based payment structure is expected to particularly attract the interest of payment providers.

The third factor that Kjos expects will spur increased card use in consumer-directed health-care payments is the special advantages that cards have in FSA and HRA programs. While these programs were originally structured on the basis of paper-based payment reimbursements, Kjos argues that the use of prepaid or debit cards can make such programs more attractive and increase adoption. An employee with an FSA that is not linked to a card encounters a "double payment" problem. First, the employee pays when money is taken from his or her paycheck to fund the FSA and, second, when making the health-care purchase. After the purchase, the employee needs to submit receipts to receive reimbursement. When an FSA is coupled with a debit or prepaid card, the employee makes only one "payment," which occurs when the account is funded. The health-care purchases made with an FSA card are deducted directly from the account, eliminating the second payment and the whole reimbursement process. Although an HRA does not involve the employee paying twice, since it is funded by the employer, the same cumbersome reimbursement process exists. Thus, the use of a debit or prepaid card addresses the limitations of the cash and check payments for both accounts.

The final factor discussed is a recent IRS ruling that is expected to greatly increase the attractiveness of card-based payments and by extension the adoption of related CDHPs generally. Although the IRS introduced the option of electronic substantiation of eligible purchases for CDHPs in 2003, many purchases still ended up requiring additional cumbersome manual processes, particularly at nonmedical merchants such as supermarkets, grocery stores, discount stores, and wholesale clubs. As a result of a follow-up ruling in 2006, a far simpler, card-friendly alternative was authorized. While it is too early to tell how effective the rule change will be, the intuition is that making payment card alternatives more attractive should expand their adoption by consumers.

Despite the fact that growth of card-based health-care payments has fallen considerably short of earlier expectations, Kjos argues that four specific developments and evolving trends may be expected to accelerate adoption rates. At the same time, there is reason to urge some caution in interpreting the potential impact of these developments. The four factors discussed generally address structural or process barriers that have limited program growth and payment card application. The role of consumer behavior in health-care choices, however, is not explicitly examined in this analysis. Based on the dramatic differences between historical growth forecasts and actual results highlighted in the paper, it is certainly possible that some of this disjunction may be due to undervaluing the role of consumer behavior in this area. While the paper argues that new product development and market trends all support more optimistic growth forecasts, it also suggests that more research into consumer behavior and attitudes is needed.