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Why High Deductibles Make Sense

Intro:
This is an article I wrote several years ago while attending graduate school at San Diego State, where I was working on Master's in Financial & Tax Planning. At that time, the HSA was still called the MSA (medical savings account). The article was written as a class project designed to help people understand that there are many factors that should be considered besides the deductible when purchasing a health plan. 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 carry higher deductibles. In fact, healthcare reform
will "encourage" more and more people to consider high deductible plans.

Article:
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 HSA with a 5,000 deductible? My deductible now is “only” $1,000.” I guess if I were going to be brutally frank, my response would be: “So what?” Perhaps a more 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 $1,000 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 features 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 could also be responsible for co-insurance, co-pays, and numerous expenses not covered under the policy.  For example, lots of 80/20 plans have co-insurance to $10,000.  That means the insureds are responsible for 20% of $10,000 plus the deductible.  That adds up to $2,000 plus $1,000, for a total of $3,000, 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 $3,000 out-of-pocket maxium per person—so if both me and my wife are in the hospital in one year, it could cost us $6,000 out of our pockets plus the $7,000 or so we are paying 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!

A working definition of a deductible 

For starters, let’s use a more 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 part highlighted in red. 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 you pay 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 3,750 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 $850 to $1,000/month 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!

C. Dean Richard, JD, MSBA
"the HSA king"™
Independent Licensed Agent/Broker since 1980