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Like Vanguard for Healthcare Costs: An Interview With HealthEquity CEO John Kessler

Shannon Jones, The Motley Fool

HealthEquity (NASDAQ: HQY) is changing the way Americans save and pay for healthcare. On this week's episode of Industry Focus: Healthcare, host Shannon Jones and Motley Fool co-founder Tom Gardner interview HealthEquity CEO John Kessler. Find out why Tom likens this business to a Vanguard for healthcare, how HealthEquity empowers consumers to save for medical expenses, how investors can gauge HealthEquity's long-term growth runway, the rationale behind the WageWorks (NYSE: WAGE) tie-up, and much more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

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This video was recorded on July 17, 2019.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every single day. Today is Wednesday, July the 17th. I'm your host, Shannon Jones. Today's Industry Focus: Healthcare show is all about a company called HealthEquity, a company truly transforming the way we save and pay for healthcare expenses. This company has truly taken the world by storm. We've covered it a few times on the show. Now, it's even garnered the attention of Motley Fool co-founder and CEO Tom Gardner.

Tom and I recently had the chance to sit down with HealthEquity CEO John Kessler to talk about the company, how they're positioned to help fix our broken healthcare system, and the rationale of that WageWorks acquisition. So sit back, take a listen, and hope you enjoy!

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Tom Gardner: John Kessler from HealthEquity, thanks so much for joining us! I think I'd just like to start at a very high level by hearing from you what you think of our healthcare system overall. This is a very unfair question to start with. What you think is wrong with it, and what HealthEquity is doing to try and fix an aspect of a system that a lot of people think needs repair?

John Kessler: Let's take the unusual tactic starting and saying what's right with it. I think it's important to understand what we're trying to protect in the healthcare system. And what we're trying to protect is the level of innovation that's generated by the U.S. healthcare system and the miracles that it does, in fact, perform. If you are anywhere in the world and you are truly sick, then this is the place you want to be. What our system doesn't deliver well for is the average consumer. It doesn't deliver well in a number of respects. The costs of material, obviously. Consumers are not empowered to understand the costs or what's actually happening. The evidence is that an individual that's not empowered as a consumer is also typically not empowered as a patient -- that is to say, they are less likely to follow their doctor's instructions, they're less likely to do the difficult things that are often required to heal, and less likely to do the things that we all know are out there to stay healthy. So, fundamentally, what we're trying to do as a company, and our vision as an organization, is that planning around healthcare and the consumer aspects of healthcare should be as important to American families as is their retirement planning. We think if that's true, you really get two advantages. For individuals, of course, it puts them in a better position, greater security, likely more effective care. But then secondly, it has benefits for the system as a whole, because consumers with knowledge and power that prepared to use it can do very good things for any economic system, and certainly for our healthcare system.

Gardner: Could you speak almost like a sales pitch to our listeners, who perhaps could be customers of HealthEquity? How would they become a customer? What would they get for it?

Kessler: That's a funny way to ask the question. It shouldn't be, but it is. At HealthEquity, we are about connecting your health and your wealth. The way we do that, the mechanism through which we do that, is a health savings account. A health savings account paired with an HSA-compatible insurance policy is going to be, first of all, typically your lowest cost in terms of premium, and it is going to be the highest return to you in terms of your ultimate ability to pay for healthcare today, and what you pay for healthcare today, and ultimately what you pay for healthcare for life. If you want to get control of healthcare and feel like this is something that, in the same way that I suspect many of your readers like the fact that they are in control of their financial plan, this is the way to do it.

Gardner: One of the great innovations, maybe the greatest innovation in the last 50 years in the financial markets, was the creation of the index fund. What is the index fund equivalent in the world of healthcare?

Kessler: Boy, I wish we could do that well, in the sense that the index fund has largely wiped out, for the average consumer, a lot of unnecessary costs and complexity in investing, and I think made investing accessible. But if I look at the health savings account, it has a lot of the same attributes. First, it eliminates middlemen. It creates more connectivity between the consumer and the ultimate product that they're trying to consume, which is a healthy lifestyle, etc. It provides the consumer with more information, but most importantly, the information is actually relevant. Lastly, it does this in a way that doesn't leave the consumer without expertise. An index fund, as you well know, is not, "do it yourself, have fun, here's 1,000 choices." An index fund is basically, "We know diversification is right for you. We're going to make that part easy so you can focus on what's most important to you, which is understanding what your asset class allocation is and matching that to your risk appetite." An HSA is somewhat similar. What an HSA and a qualified policy provide, they provide protection from real insurable events that allow you to focus on the things you can control, which is your health, the cost of your care, where you get care, and how you heal when you get sick. That's a pretty valuable thing. 

And then, where I think the real commonality is, is that ultimately, both of these products within their respective industries have the potential to significantly reduce the inefficiencies in the overall system. Index funds do that by exposing circumstances where the cost of active management is not worth the benefit. There's nothing wrong with active management as long you're getting benefit for it. What an HSA does is, it exposes the circumstance where the cost of price fixed insurance, that is to say, I'll just write you a check and see what happens, isn't worth the benefit. And the result in both cases is lower total costs. And you see that every day. We see it every day, in the results that our partners on the employer side get, that are ultimately passed onto consumers in the forms of lower premiums in their paychecks and so forth.

Jones: Shannon Jones here. We have member questions that I want to make sure we can have addressed and answered. Of course, as you know, we're in the throes of a presidential election cycle. You have a lot of candidates right now campaigning on platforms with a single-payer system like Medicare for All. One of our members, Brock, asked about this. He specifically wants to know, do you see Medicare for All or some sort of single-payer system having a detrimental impact to HealthEquity? And, how do you adapt if you see that on the horizon as well?

Kessler: Yeah, it's a really important question. Let me start by talking a little bit about the history of the health savings account and the health savings account concept, because it is relevant to answering this question. Health savings accounts began as a pilot program called medical savings accounts, yet another acronym, which came into being as the result of bipartisan legislation sponsored principally by Tom Daschle. As a pure coincidence, it happens to be the case that Tom Daschle is the one and only politician for whom I have ever phone banked as a college student back at the time, or, I guess, graduate student. This started as an idea that was very bipartisan. The basic idea was that by giving consumers the tools to have skin in the game, and a reason to do so, you could create an environment where consumers would take the long-term view of their health, and where they would be a valuable input into what else you were doing as part of the healthcare system. 

That idea exists today, and it exists whether the system as a whole is a private system, a multiplayer private system, or a single-payer public system. That is to say, in whatever system we operate, what's been proven to both Democrats and Republicans is that the consumer plays a valuable role in making that system work. I would say an essential role in making that system work. 

As an example, if I look at the policies that are coming into being under the ACA exchanges, many of these policies are HSA-qualified plans. Even those that are not contain significant amount of consumer responsibility. Why is that? One, it keeps premiums themselves low, and two, it allows consumers to play a role in helping control costs, which is essential. So, that's a case where, notwithstanding the fact that the ACA marketplaces are obviously heavily government-oriented, that the consumer plays a significant role, and products like this do play a significant role. 

If you extend that point to a single-payer environment and look internationally, there are a number of very successful single-payer systems internationally in which products identical to our health savings accounts exist. That's, again, because of, I think, ultimately, the same recognition that for a system to work, the consumer has to be part of the equation of providing signals to the marketplace about what care is needed, what care isn't needed, etc. The consumer never will be the entire system because you get, very quickly, frankly, into circumstances where at an acute level, where the consumer is no longer able or willing to make decisions. But for day-to-day care, and the regular things that happen, as well as for accumulating the funds that help determine what care will be included in retirement, the consumer's role is essential, and I think that's true in any system.

Our job as a company, and we take this role very seriously, we've talked about it, including in our earnings calls, is to help make sure that policymakers on all sides of the aisle really understand the role that the consumer does play, where the consumer is challenged, and where the consumer really can be effective. For example, right now, one of the few areas of bipartisan cooperation that you're seeing is around surprise medical bills. Surprise medical bills are an area where the consumer is genuinely challenged. It's not the financial component of the surprise bill, it's the fact that it's that the consumer's interface with the system is such that the consumer could have no way to have known that the bill would be incurred. That's a great example where, whether you're in a public system or private system, if you want the consumer to be involved, you have to think about how to eliminate those kinds of situations. It's not the financial responsibility, it's that you don't get consumer empowerment if it's all a surprise after the decisions have been made. 

I'm fairly confident, at some level, that wherever our healthcare system goes over the course of the next two, five, 10, 20 years, that policymakers on both sides, while they obviously have different objectives and so forth, are of the view that consumers with the financial acumen and ability to play a role and add value to the system will be allowed to do so. And our job as a company is to be part of that and to continue to adapt our product set, and at some level to prove that consumers can do this, because they can.

Gardner: I want to go back to the comparison to the HSA to the index fund. Having gotten to know Jack Bogle over the years, he would tell me things like, "Tom, I've been saying the same thing, just in different ways, for the last couple of decades." And looking at Vanguard and the tipping points that caused the marketplace to realize this is a very elegant solution that simplifies, lowers costs. He was trying to knock that door down for a very, very long time. And I think some of it surrounds the arrival of the internet, the opportunity to popularize these ideas and get the conversations out from just with a potentially conflicted financial professional who wouldn't want to sell such a low-cost, effective, tax-efficient vehicle, to getting that message and concept socialized and popularized on the platform of the internet. So, today, Vanguard has more than $5 trillion under management. It's one of the largest money management companies in the world, way larger than Jack envisioned when he started the company. Where are you in the progression of that? And what do you think are some of the tipping point moments that you've maybe already hit, and that might be out on the horizon that are indicators that you're breaking through?

Kessler: I think we're frankly still with Jack knocking on doors and trying to explain to people why he would abandon the cushy job at Wellington and so forth, and in the following ways. It is fair to say that the large economic forces, whether they be government-oriented or in private industry, in healthcare, are still largely aligned in a way that at best is tolerant of the consumer, and at worst is fearful of the consumer. I think you're still at a place, if I look at the broad system, where if most actors in the system had their druthers, their view would be, "No, no, consumers really won't get this. Look, it would all be better if they would just behave and do what we told them to." And I believe that most people involved in healthcare have a social mission, but nonetheless, they all have to pay the bills, and sometimes more than that, and so implicit in that is, "And we should be paid to do that." So, I suppose the analog would be, we're still at the place where, "You're nuts. They need our advice. It's impossible to imagine a world where markets could sort out all the complexities that we experts understand." 

I think you see that most clearly, frankly, at some level, even down into the HR departments of employers themselves. Almost 200 million of us will get insurance through work. We rely on people departments to be our guides and in many respects to act in our best interest. And they genuinely try to do that. But they, too, look at it and say, "Hey, I need to plan for the consumer who's least prepared, so I'm going to treat everyone that way." And the result of treating everyone that way is that people aren't always given the information they need, or the flexibility they need, to make the right decisions. 

I want to get to your question about tipping points. I think that one tipping point that we have reached that's very important is, we've gotten to a place where now, roughly speaking, more than a quarter of Americans are in these products. So, they are big enough that they cannot be ignored. In other words, you have a circumstance where it's not dissimilar to that, you go to a place where Fidelity was going to offer index funds. Whether they were the best index funds, whether they were the lowest-priced or what have you, they had to be on the menu. I think we have reached that point, where employers recognize, health plans recognize, that there's enough demand out there for these products that they must be on the menu. We're now at a place where more than 50% of large employers offer HSA plans as one choice. That number is still a little lower among smaller groups, but it grows every year. I think it will not be long before the vast majority of employers are offering these products, and the vast majority, if not all, insurance carriers are offering them in the individual markets. 

That's the first step, and not dissimilar to the journey that Jack and the team went through. It's a genuinely humbling comparison because, obviously, Vanguard is a close partner of ours, and we are of like mind, and every time I drive up to the facility, I'm reminded that there are people who have saved thousands and thousands of their hard earned dollars, that will never know these people exist, but this is how it happens. I don't want to be in any way arrogant about embracing the comparison, but it certainly makes me smile, in the sense that it is the journey that we're on. And it is, as you said, back to your initial comment about the long-term nature of what the company is doing in the investment -- this is why we came public. We came public because we recognized that this was a 10, 20, 30 year problem, not a problem that was going to be solved in two years. We needed to be operating in a structure that would allow us to do that. We felt like that was our decision. It's a different one than the one that Jack Bogle made, obviously, but our decision was, this was the essential structure for us to be able to walk this path over the course of a long period of time. And that's what we're doing.

Jones: Great! I'd love to ask more about this proposal for WageWorks. This is a pretty large acquisition, right now about half the size of HealthEquity's market cap. Can you talk a little bit about a cultural fit, but also scale across more accounts, and maybe some of the integration opportunities and challenges that you see should this go through?

Kessler: I do want to be thoughtful in the sense that I don't want to comment further on our proposal or on their response or what have you. I will comment briefly on our rationale. Is that fair enough? 

Gardner: Definitely!

Kessler: Let me say this. This transaction, from our perspective, is all about the journey that I described in the answer to the last question. We came to the conclusion that one way in which we can help individuals as well as employers who are also on this journey was by being able to offer, beyond HSAs, incremental products that have a lot of the same attributes, and that are often viewed as transitional products into the HSA. WageWorks is a leading provider of what are referred to as consumer-directed benefits or CDBs. The one that people probably know the best is a healthcare flexible spending account, or FSA. An FSA is, in some sense, like an HSA. It's like a starter HSA, let's call it that, in that it has training wheels that can be very frustrating to consumers. You have to submit the receipts to make sure that it's a medical expense. It's really only a one-year product, not a lifetime savings product. There isn't an investment component, etc. But it's the same in that it is ultimately about paying for your healthcare as tax efficiently as possible, and hopefully providing you the incentive and tools to pay attention to those health bills, and as you do so, not only learn more about what it costs, but also, that translates back into paying attention to what your doctor's asking you to do, asking your doctor questions about procedures, that kind of thing. 

We felt like we could get farther, faster, deeper along this journey by having an upgraded suite of products along those lines. And that's really what WageWorks is about. So, our rationale ultimately is to get farther faster in the HSA journey. And we feel like being able to touch more consumers who are earlier in that journey is helpful in that regard, and also work with employers who are earlier in that journey is helpful in that regard. 

The second -- well, I guess I'll stop there and say that's really our rationale for the proposal, and I'll see what else you'd like to ask.

Gardner: Thank you, thank you for sharing that! I know that there's a lot of constraints to what you can talk about now at this stage. So, thanks for sharing that! I think, in the interest of time, because we're right at the end, I'd love to hear your personal journey --

Kessler: Since we lost a few minutes, I'm happy to take a few extra if you need them.

Gardner: That's great! I'd love to hear about your personal journey, and in this category, what's driving you? What's your time horizon as a leader? And, a little bit about the leadership culture at HealthEquity?

Kessler: I'll start with the last part of the question since it's a lot more interesting than me. This company has a very, I think, unusual and valuable approach to culture. It starts from the company's founder, Stephen Neeleman, who remains my partner in leading the business. Steve is an unusual guy. He was a physician, actually an ER doctor, trauma surgeon. He's also in the tradition of very entrepreneurial Utah-based families. He was involved with his brother David in starting a couple of airlines. You don't see that combination very much, of someone who on the one hand is in healthcare and on the other is in an extremely consumer-oriented business, one that lives and dies by pennies, and whether the consumer's experience is slightly better than it is on the next airline. That's really what Steve brought into the company, was a view that, just as the consumer's role in the airline industry is to push the industry toward lower costs and higher value, that we could be in the same place in healthcare. And he concluded very early on, notwithstanding being a surgeon and a good-looking guy and all that, a very humble guy, and he concluded very early on that the culture he wanted to build was one with two pillars. The first being what Jim Collins in Good to Great called service leadership, or Level Five leadership, where we as leaders are about helping our team members succeed. The second is what we internally call purple, which is borrowed from Seth Godin's Purple Cow. And that's about being remarkable, not only to our customers, but to each other. Those are the pillars on which this culture has been built over time.

And you can get arrogant about your own culture, but it is a great place to work and a great place to be part of the team in that people care about each other, they care about customer outcomes, they are able to celebrate success in modest ways, and they understand that, given that it is a long-term journey, that a huge part of the success and stability of that journey is underpromising and then overdelivering. That is, it is very difficult to run a stable organization when you set goals that are difficult to meet, and then you don't meet them. There's a place for that, but the marathon isn't it. All marathons are about setting reasonable goals, achieving them, setting the next goal, achieving them. "I'm going to make this mile. I'm going to do that. I'm going to make the next mile, I'm going to do that. I'm going to make the next mile, I'm going to do that." And pretty soon, you've won the race. And that's the way this business operates and, we think of it as a community, that this community operates. 

It's a pretty special culture. I've been pleased to be a part of it over these years. We're in 10 years now. I don't know that it's for everybody, but certainly it works for us.

Gardner: In my historical research, or some of our historical research on our investment team here, we've found that over the very long term, let's say 20 years, one of the best indicators of great long-term investment returns is simply the sales growth rate. It is the engine for all the opportunities that flow financially for that organization. A company that has 6% top line growth over a 20-year period is unlikely to have a stock that performs much above that rate of growth. If you look at a business like Starbucks' compound annual growth rate since coming public in 1982, sales growth around 22% a year, investment return around 24% a year. Obviously, one of the greatest-performing businesses for all stakeholders that's ever existed in the U.S. How do you think about sales growth and the opportunity long-term for organic sales growth, if the acquisition goes through, the unified group and any other adjacent markets that are available to you? How do you think about top-line growth over the next 10 to 20 years?

Kessler: Well, I'll say the good news is, we don't have to think about adjacent markets and all of that. I'll start by saying, I find that these banker-driven discussions of, "Well, your core market will eventually slow down, so you'd better do something else," the question that any manager should ask themselves is, have investors asked them to play private equity? Or are they supposed to be running a business that they truly understand and letting shareholders decide on those kinds of investments? That's the way we think about it. 

The good news is, we have the luxury of thinking about it that way because of where our core market is. Let me break it down for you. Today, there are about 25 million health savings accounts. Those accounts have roughly $55 billion in assets, give or take. I think it's $54 billion, according to Devenir, the scorekeeper in our industry. Our view is that at market maturity, the number of accounts will a little more than double, somewhere between 50 and 60 million. And that's good, but if, let's say, that were a 10-year process, and we can all do the math, so that implies, give or take, an 8% growth rate. That would be great, but it's not as exciting. What's really exciting is that our view is also at market maturity, that that $50 billion in assets will be somewhere between $600 billion and a trillion dollars. Put differently, the average balance of an HSA, instead of today being in the $2,000 range, will be closer to $15,000 to $20,000. We believe that because that's what we see with our accounts that have reached maturity and with our members who truly understand how to use this product. That implies a compound growth rate on the asset side in the mid-20s over a 10, 15-year period. 

As you know, since you've studied the company, our ultimate revenue, or sales growth, is driven in part by accounts, but ultimately largely by the volume of assets in those accounts. In some ways, we're asset managers, just like every reader of The Motley Fool. So, more assets is good. 

Our basic view is that there is a long runway of growth available to us in a market that will ultimately consolidate into a smaller number of players. Everything we do is about capturing as much of that growth as we can and about moving forward on that journey and promoting that journey for our own benefit and that of the entire industry, and ultimately, we think, the entire healthcare system. We're in a very fortunate position in that we don't feel that we need to talk or think that much about product adjacency. We think of everything we do in terms of feeding that HSA core that we see as being a source of growth for years to come.

Gardner: Let's end it there, John. Thank you so much! I really loved hearing your perspective. I, also, for your business, love the comparison to the index fund and the super long-term journey. I view what you're doing as every bit as important or more important than what the index fund created, and I don't say that lightly. Obviously, the index fund is an unbelievable gift to the world in the world of finance. In the world of health management and the financial side of our lives, I noted in the conversation you had with Brian Feroldi, you were saying, this is killing the opportunity for people to save money if we don't get this right. It's a crucially important goal that you all are working toward. Thank you very much for sharing your thoughts! If you're ever in the D.C. area, please come by Fool headquarters. We'd love to have lunch and have you meet our analysts! 

Kessler: I'd love to! Thank you!

Gardner: Right on!

Kessler: They only let me into D.C. every now and again because I cause trouble, but I do sit on a board that meets twice a year in D.C. I'll make a point of that.

Gardner: That'd be great!

Jones: Excellent!

Gardner: Thank you to the whole team there! Enjoy the rest of the week!

Kessler: Thank you!

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Jones: Thanks to John Kessler for joining Tom and I to learn more about the business! We hope you enjoyed the interview and access to an incredible company and an incredible CEO. 

That'll do it for this week's Industry Focus: Healthcare show! Thanks much for tuning in! As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is being mixed by Austin Morgan. For Tom Gardner, I'm Shannon Jones. Thanks for listening and Fool on!

Shannon Jones has no position in any of the stocks mentioned. Tom Gardner owns shares of SBUX. The Motley Fool owns shares of and recommends HealthEquity and SBUX. The Motley Fool has a disclosure policy.