Healthcare companies can be challenging investments. They are highly regulated, and must navigate complex and opaque relationships with hospitals, insurance companies, and end customers. That said, within healthcare, there are many promising areas of growth. One of them is the health savings account, or HSA for short. These accounts let participants set aside money on a pre-tax basis to pay for qualified medical expenses.

As one of the largest providers of HSA accounts, HealthEquity (HQY 1.03%) is capitalizing on the growth in their popularity. And there are several reasons to believe the company will continue to prosper.

Hand flip wooden cube with word wealth to health

Image Source: Getty Images.

1. HSAs are more cost-effective than alternatives

HSAs help people save for medical expenses by allowing them to deposit money from their paychecks pre-tax. Additionally, assets in an HSA account can be invested, and gains accumulate tax-free as long as the account is used for qualified medical expenses. In other words, HSAs are similar to retirement accounts like IRAs and 401(k)s, except they are targeted toward saving for healthcare expenses.

In order to qualify for an HSA account, a person must be enrolled in a high-deductible health plan that supports HSA accounts. A person with a high-deductible plan generally pays lower monthly premiums to maintain their health coverage, but has to meet an annual deductible each year before medical costs are fully covered by an insurance company.

High-deductible health plans can do a good job of aligning patient medical usage with expenses, because they offer a financial incentive for patients to only visit a doctor when they really need to (compared with lower-deductible health plans). This makes high-deductible health plans more cost-effective for employers, and they can also be more cost-effective for patients if they do not have high medical needs. As a result, high-deductible plans are growing in popularity.

The growth in high-deductible health plans directly benefits HSA companies like HealthEquity; as more people become eligible to open HSA accounts, HealthEquity is able to collect fees for administering each account. From 2017 through 2019, HealthEquity was able to grow its HSA member count from 2.7 million to 3.9 million, or 45%. At the start of 2020, the company reported 5.3 million HSA members, or 35% growth, though some of that growth was thanks to the acquisition of benefits administrator WageWorks.

What's more, most employed people in the United States still do not have HSA accounts, which means the industry has space to continue to grow.

2. Rising HSA account balances

In addition to getting paid a small fee for each HSA account it administers, HealthEquity generates revenue from the assets held in each account by collecting interest and administering investment programs.

For example, if an HSA account has $10,000 in cash, the company sweeps those funds into an investment program that invests in bonds, and HealthEquity keeps the interest. If an HSA account holder invests their HSA account into a mutual fund, HealthEquity gets a cut of the investment advisory fees collected by the investment advisor.

Metrics 2017 2018 2019
HSA assets held $5.0 billion $6.8 billion $8.1 billion
Custodial revenue $59.6 million $87.2 million $126.2 million

Data Source: HealthEquity financial reports.

In HealthEquity's fiscal 2019, the company oversaw more than $8 billion in HSA assets, which accounted for both cash and investments held in HSA accounts. The company was able to generate $126 million in revenue from these assets. This stream of revenue has grown at a rapid rate as HSA assets have continued to stockpile higher each year.

3. More HSA transactions

As well as to making money from account administration and the assets in the HSA accounts, HealthEquity collects a portion of transaction revenue from its HSA debit cards. In fiscal 2019, the company generated $60.5 million in transaction revenue, a rise of 19% over the prior year.

As the company grows its account base, it will naturally see its transaction revenue rise. Aging demographics should also help spur transaction revenue, as older account holders will likely make more medical purchases than their younger counterparts. These are two fairly dependable sources of HSA transaction growth for the coming years.

Putting it all together

Putting the pieces together tells a story of continued growth for HealthEquity within the healthcare industry. The total number of HSA accounts is expected to continue growing, the average HSA balance should do the same, and as both of those metrics increase, HSA transactions are expected to rise as well.

Historically, HealthEquity has been able to grow its top line well in excess of 20% per year, and it has done so profitably. The company will see growth slow due to the law of large numbers, but its overall growth outlook is still rosy.