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IT’S OPEN SEASON for many of us—time to choose our health insurance for the year ahead. It’s a topic I got seriously interested in when I took over management of 500 mathematically astute engineers. They challenged me daily to understand how the various plans stacked up against each other. I spent a lot of time looking at various ways to assess the value of the different plan choices, and came up with a framework that worked for my family.
This is also the time of year when Chicago financial researchers Morningstar publishes its annual review of health savings accounts (HSAs). These are another favorite topic of mine because of their triple tax-deductibility. My wife and I were able to accumulate a decent sum that we’re now using in retirement to help pay medical costs while we wait to reach the Medicare eligibility age of 65.
I’ve spoken with dozens of people over the years about their benefit choices, and there always seems to be a group that wants the highest-priced plan, regardless of the underlying cost structure. They see plans with high deductibles and high out-of-pocket costs as unaffordable. They often pay so much more in premiums, however, that their total cost is greater.
My advice: As a first step when comparing plans, figure out each plan’s lowest possible cost and maximum possible cost. The lowest possible cost is the sum of your premiums for the year. The maximum possible cost is that premium total plus the maximum out-of-pocket cost.
Say you have two choices. The first is a top-notch health plan with monthly premiums of $700, maximum family deductible of $2,000, a 20% copay after meeting the deductible, and a maximum family out-of-pocket cost of $6,000. The lowest possible cost is 12 months of $700 premiums, or $8,400. The maximum possible cost is that $8,400 plus the $6,000 out-of-pocket maximum, or $14,400 total.
The other choice is a high-deductible health plan (HDHP). It has monthly premiums of $200, a maximum family deductible of $6,000, a 20% copay after meeting the deductible, and an out-of-pocket maximum of $12,000. This plan’s lowest possible cost is 12 months of $200 premiums, or $2,400. The maximum possible cost is that $2,400 plus the $12,000 out-of-pocket maximum, or $14,400.
With these two plans, the lowest possible cost is significantly different, but the maximum possible cost is the same. Most of us rarely reach the maximum possible cost. You’d have to have very significant medical issues. What if your family has a very healthy year and you never use any medical services? The HDHP will save you $6,000 in premiums.
The HDHP’s other advantage: You can fund a health savings account. Instead of paying the additional $500 per month in premiums, you could save that amount in your HSA. Both medical premiums and HSA contributions are deducted pretax from your paycheck. But the money you save in an HSA is yours forever. You can use it to pay medical expenses in the current year or in future years. By contrast, premium payments are gone, regardless of whether you incur medical expenses during the year.
The above examples are simplified versions of the choices my wife’s employer offered several years ago. There are certainly factors to consider other than total cost. For instance, does the plan include your current doctors and current health care systems? It’s also important to look carefully at the plans to make sure the coverage is similar.
Some employers offer incentives to stay healthy, which may include contributions to an HSA—and HSAs are only available with a high-deductible health plan. To be sure, employers want to steer you into the plan that minimizes their costs. But in my experience, this often aligns with the employees’ interests, because they end up with adequate medical insurance at the lowest price.
Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. He enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. Follow Rick on Twitter @RConnor609 and check out his earlier articles.
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We have been in an HDHP for many years. We are a relatively high-use family for several reasons, but the usage tends to be binary: a lot of expensive care or very little and inexpensive. Probably close to a third of the time we’ve been in the plan, we maxed out our family costs or came close to it. Most years someone at least hit their individual max. In the end, I think we’ve spent about the same or slightly less than we would have on the ‘cadillac’ plan, even with our relatively heavy usage.
However, the usage of the HSA also improved our cash flow considerably. Firstly, my employer contributes a nice sum each year to encourage us to use it. Who doesn’t like free money! Secondly, much as I want to use that contribution (and our own) for investment, the HSA has been a source of considerable immediate tax savings for us for near a decade. It’s an immediate 27% savings on our healthcare costs (Marginal Fed+State rates).
Of course investing that money would only increase the advantages, so at some point we may start investing some or all contributions. We got a big start recently, purchasing one share of VT inside the HSA (hah!) Regardless of how it’s used, the HSA is a valuable and flexible tool.
Thank you again for taking a very complicated subject and making it easier to understand!
You are 100% correct Richard. After fifty years trying to explain all this to employees my frustration in failing was a factor in my decision to retire.
People tend to overestimate their risk in a given year. Fact is most people incur little in health care costs each year. High costs are heavily concentrated in a small percentage of the population.
I used to show an employee with simple math that their selection made it impossible to come out ahead when considering OOP cost potential and premiums. The person would acknowledge the realty of their choice and then keep it anyway as their perception was they had the “Cadillac” plan and it was the best.
Fact is there are too many choices and it’s all too complicated and people don’t want to deal with the selection process. One of my sons called me yesterday asking me to review his choices and help him wade through the employer material.