White Paper Report

The magic of “high deductible” plans

 by C. Dean Richard, JD, MSBA,
a leading HSA expert
and one of America's most trusted benefits brokers since 1980

(This is an article I wrote several years ago about the deductible under MSA-medical savings account-plans. It was designed to alleviate concerns some individuals have regarding larger deductibles.  Although HSA policies allow lower minimum deductibles than MSA's, the principles illustrated here remain as constant and powerful as ever. Indeed, it makes more sense than ever to go with even larger deductibles.)

Overriding theme:

Paying the extra money for a health plan with a low deductible makes about as much sense as paying extra money to have flat tires "insured" under an auto policy.

One of the most important lessons I ever learned about insurance I learned from -

. . . my torts professor in law school, who himself was a former insurance defense lawyer. Prof. Leity told us one day that the purpose behind buying insurance - of any kind - was to "equalize" your cash outflow.

I had never thought of it that way before and I've never thought of it the same way since. Insurance protects against catastrophic losses - not minimal ones.

Puting things back into the perspective of health insurance - if you carry no health insurance at all, you run the risk of incurring a large, catastrophic claim one of these days. For illustrative purposes, let's say $65,000 (a typical 5 to 7 day hospital stay, by the way).

If you go 20 years without any insurance before incurring that claim, then you can "flat line" your expenses for those 20 years as they are zero. But then, suddenly, in year 21, your $65,000 claim creates a sudden "spike" in your expenses (through the roof - quite literally).

Insurance eliminates those spikes. In those first 20 years, the prudent thing to do would have been to pay a little to reduce your risk, to say, $5,000 - which is much better than $65,000. Although there is a cost of doing that, the payoff comes years later when your outflow is limited to an additional $5,000 when that $65,000 bill hits out of nowhere.

How most people think about deductibles

One of the biggest sources of confusion people often have about health insurance centers around the “deductible.”  I hear this statement, or something similar to it, quite often: “Why would I want to switch to an health plan with a 5,000 deductible?  My deductible now is “only” $2,000.” I guess a politically correct response would be to ask whether the individual actually understands how much more in premiums they are paying for the luxury of carrying a lower deductible.

Assuming the individual making that statement is a “typical” self-employed person with a family, they may be paying around $600 to $700 per month in insurance premiums for that $2,000 deductible plan.  Let’s go small and call it $600 per month—that’s $7,200 per year.  Why didn’t that person just tell me this:  “I’m paying over SEVEN THOUSAND DOLLAR a year for health insurance—and we never meet our deductible!”? 

After being in this business almost 3 decades now, I think the answer to that question is this:  People “confuse” shopping for health insurance with shopping for car insurance--the other type of insurance most of us have to buy that utilizes deductibles.  With car insurance, the best way to buy your coverage is to compare deductibles and premiums. That's because the underlying coverage is virtually the same from company to company. That last sentence is worth re-reading--because it is easy to compare policies when all you have to do is compare deductibles, or perhaps co-pays. And while that is precisely the way it works with car insurance, and other property and casualty insurance lines, but not with health insurance!

With health insurance, the “deductible” is only the starting point 

After your deductible, you may also be responsible for these expenses:

  1. co-insurance, and
  2. co-pays, and
  3. numerous expenses not covered at all under the policy.

For example, lots of 80/20 plans have co-insurance to $10,000.  That means the insured person is responsible for 20% of $10,000 plus the deductible.  That adds up to $2,000 (deductible) plus $2,000 (co-insurance) for a total of $4,000, and that is per person! 

That being the case, why didn’t the individual tell me this:  “I’m paying over $7,000 a year in health insurance premiums for a plan with $4,000 out-of-pocket maxium per person—so if both my wife and I are in the hospital in one year, it could cost us $8,000 out of our pockets plus the $7,000 we pay in premiums!”?  On top of this, more and more plans are going to higher and higher “co-pays” per procedure.  And co-pays generally do NOT accumulate toward one’s deductible--it's just more money out of your pocket!

Moral of that story: The total out-of-pocket cost is more important than just the deductible, which is just the starting point.

A working definition of a deductible 

It's helpful if we find a more suitable workable definition of a deductible.  What is a deductible? What does that term actually mean?

Technically, it is the amount the insurance company deducts from what it owes you.  Notice the underlined terms. Many people mistakenly believe that the deductible is what they have to pay before the insurance starts to pay. While that is mostly correct, the problem with that definition is that it ignores the fact that the only bills you incur that the insurance company actually cares about are those that are actually covered expenses under the insurance contract.

The Statement of Benefits from an insurance company will only apply expenses to a deductible if the expenses are actually covered under the policy. Make sense? In other words, the insurance company first calculates what they owe you-legally, under the contract-then from that amount, they subtract, or deduct the amount you have agreed to be responsible for.

In reality, a deductible is simply a tool used by insurance actuaries to modify the premium. In the long run, in the big scheme of things, the insurance company is going to come out the same, regardless of the deductible size you opt to select. This is a very important concept for you to understand, because the reverse is also true-YOU will come out the same in the long run too, but you'll save a ton in the meantime by opting for higher deductibles, then saving the difference for a rainy day. And with an HSA plan, you are also able to reduce your taxes simply by stashing money into a "rainy day" fund.

The total "out-of-pocket" amount is more than just the deductible 

Instead of thinking solely in terms of deductibles, I’d like to suggest that you start thinking about the total amount of money you pay out of your pocket every year for all expenses related to medical care.  The total you pay, or could pay, includes all of the following:
  1. Gross insurance premiums paid, and
  2. Deductibles, co-insurance, and co-pays covered under an insurance policy, and
  3. Expenses incurred that are not covered by an insurance policy, and
  4. Taxes. Yes, taxes. Think about it. If you're eligible to reduce your taxes each year by carrying a certain type of health plan and opt not to do so, isn't it necessarily true that you are "voluntarily" paying more money in taxes than you are legally obligated to pay?

Notice that items number 1 (premiums) and number 4 (taxes) come into play every year.  You always pay premiums and you always pay taxes.  But, items 2 and 3 only come into play during years in which you actually incur medical bills.  With respect to that big policy deductible, it only applies if you are going into the hospital, or having a larger out-patient surgery in a particular year.  And just how many years in a row are people undergoing such procedures?  In fact, how long has it been since you or anyone in your family has been hospitalized?  On the average, it’s about 1 out of every 12 years for most Americans—and that’s just an “average” number. 

Food for thought.  If you’re not meeting your deductible every year, isn’t it actually irrelevant how large your deductible happens to be?  And what if you're actually carrying a "low" deductible? Does that cost more, or less, than a larger deductible? When you carry a lower deductible, you are necessarily increasing your cost on item #1 in our list above.  I’ll tell you one thing—the insurance companies LOVE people who pay extra for low deductibles and never meet them!

What's different about the deductible with an HSA plan? 

Here’s a different way of looking at the Health Savings Account plan that may help shed some light on the “true” deductible amount of an HSA.  Let’s assume we have a family plan with a 7,500 “deductible” and 100% coverage thereafter.  Let’s also assume the family funds the HSA savings account with $5,500 each year (a few hundred less than the maximum they could contribute).

7,500 family “deductible”

        less           5,500 health savings account contribution

        equals       2,000 “true deductible”

If this particular family has a “catastrophic” event and has to meet that “deductible” under their HSA insurance policy, they will have to come up with only $2,000 out of their pockets.  That’s it!  The $5,500 is money they have already earmarked for medical expenses—just in case.  It’s like insurance premiums with one notable exception—if they don’t have to use the full 5,500 in the first year, what’s left is theirs to keep!  Sure, the money will stay in their HSA account until needed—or withdrawn for retirement—but the point is huge—it is still their money!

Assuming this family pays $3,600 a year for their HSA insurance plan, this would be a correct statement:  “We only pay $3,600 a year for our insurance plan, and if anything major happens, we only have to come up with $2,000 out of our pockets.  It’s like we’re carrying a $2,000 “deductible” plan with 100% coverage for the whole family!” (By the way, if this hypothetical family could purchase a policy with a 2,000 deductible then 100% coverage, they would likely be paying $1,000/month or more in premiums.)

So far so good, but they still haven’t considered the impact of taxes-item #4 in our list.  By funding their HSA by $5,500, their tax bill is going to be about $1,500 a year lighter!  (5,500 contribution x 28% tax rate assumed = $1,540 tax savings-we're rounding to 1,500)  After considering the impact of tax savings, it would be correct to make this statement:  We’re only paying $3,600 in premiums and if something major happens we only have to come up with $500 out of our pockets! That's because our HSA plan reduced our "deductible" to 2,000 and then Uncle Same subsidizes another $1,500. How cool is that??

Why am I not characterizing the $5,500 HSA contribution as a “cost”?  Simple.  It’s not a “cost.” It's a contribution to a savings account. Key term: savings.   Have you ever heard anyone say that it “costs” them $3,000 a year to contribute $3,000 to their IRA (Individual Retirement Account)?  Of course not.  And for the same reason, a $5,500 tax-deductible contribution to one’s HSA (Health Savings Account) is not fairly characterized as an expense or cost—because you are literally saving money.  And in many cases, most or all of this money would have been paid to an insurance company in premiums, or to the Government in taxes!

One caveat about the forgoing example—it relates only to the first year of an HSA plan.  After the first year, ideally, you will continue to fund your HSA to the maximum amount allowable by law, so that your net cost actually gets lower and lower each year.  Bottom line:  It just keeps getting better and better, year after year, with an HSA. You are literally building equity in your health care plan!

Happy Savings!
C. Dean Richard, JD, MSBA

 

 

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