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It is a cliché to say that the American health-care system is broken. Errors, including fatal errors, are far too common; health-care professionals say they’re overburdened; and consumers feel powerless. Overall, U.S. health-care spending tripled between 1990 and 2005, from $655 billion to $1.9 trillion (projected). Annual health insurance premiums that might have cost a family of four (or their employers) $12,000 in 2000 would cost $17,000 today and could rise to $25,000 by 2010. But as troubling as this backdrop is, there is one bright spot often overlooked: During the next year or two, consumers will get a chance to reshape the health-care system through a form of insurance called consumer-directed health plans (CDHPs), which have been written about at length but not implemented until recently. They could well be the private sector’s last chance to avoid a government-controlled monopoly. If this solution fails, it is hard to see any alternative but a government-sponsored “universal” initiative, almost certainly involving price controls, supply constraints, and utilization mandates.

Consumers learn to spend their rolled-over health-care funds judiciously, balancing prevention with savings.

CDHPs empower consumers by letting them design and select their own health plans in an open market with a range of options at every stage for treatment and prevention, and turbocharged incentives for making economical, high-quality choices. Just as defined-contribution pension plans placed individuals at center stage in the 401(k) world, CDHPs establish individual choice as the core of health care's systemic improvement. Absent CDHPs, most people make few choices about health care beyond selecting their physician and their health plan — and even those selections are restricted by the paternalistic policies of the employers or membership groups through which most people obtain health-care coverage.

In a typical CDHP, an employer places a sum of money each year (perhaps $2,000 for an individual or $4,000 for a family) into a health savings account (HSA) that can be used only to pay medical expenses. The employer will also typically provide a high-deductible major medical policy for expenses over, say, $5,000 in any given year. To encourage proper preventive care, many such plans also cover screenings such as mammograms on a first-dollar basis. What sets CDHPs apart from traditional coverage is the rollover: The employee may carry over any unused cash balance, to which the employer will then typically add the following year’s contribution of $2,000/$4,000. This rollover feature is crucial to changing behavior. If unused funds disappear every year, consumers rationally view them as an evaporating asset they had better spend, thereby driving up costs. But if the unused funds accumulate, then consumers learn to spend the money judiciously, balancing the costs of preventive measures in the short run with long-term savings for possible crises. This also lowers the odds of incurring larger expenses in the long run.

Moreover, CDHPs are portable. Individuals can take their accumulated HSA balances with them when they change employers, withdraw from the work force, or retire. This feature transforms health benefits from an annually evaporating asset into a lifelong savings plan for almost any approved health-care expense.

And perhaps most attractive, health savings accounts are triple tax advantaged — tax-free when contributed; tax-free as they grow (they can be invested); and tax-free at withdrawal (whether one day after the money is deposited or 20 years later). These advantages will undoubtedly inspire financial-services providers to create new ways for individuals to maximize lifelong capital accumulation across categories (retirement, health care, life insurance, disability, higher education), as well as to mix and match these funds at different stages of life.

For instance, in the area that will likely see the most innovation over the next year or two, there could be a burst of borrowing products and services for people to leverage their assets during low-expense years to pay for the added costs of years with high health-care or education expenses. In addition, the increasingly high deductibles of health-care plans will create a need for mechanisms and products that bridge the gap between the funds that consumers have available for spending and the higher threshold costs of a catastrophic illness or accident. And investment products to manage longer-term savings will be increasingly necessary, especially when HSAs have been in place long enough to have generated a critical mass of rollover capital.