Demystifying Annual Healthcare Enrollment

Earlier this week I received a panicked email from a friend last week who wanted help choosing between about 20 healthcare plans during open enrollment. To the uninitiated, this indeed is a confusing process. However, this needn’t be confusing. But you first need to be informed.

Important Definitions

Here are some definitions that will help you navigate the process:

  • Health insurance premiums
    • The monthly cost of purchasing healthcare insurance. Usually your employer will subsidize this cost. If you’re curious to see how much of your healthcare premiums that your employer is subsidizing, check your monthly paystub. In my case, I pay $134 per month for healthcare and my employer pays $1,329. In other words, the employer pays 91% (=$1,329/$1,463) of my total monthly premiums of $1,463 (=$134+$1,329).
      • Most people vastly underestimate the true cost of health insurance because they fail to consider the employer portion of healthcare premiums.
    • Health insurance premiums paid for through payroll deduction are not subject to federal or state income taxes.
      • For a fascinating history of how the US arrived at this equilibrium, listen to this Planet Money episode from a decade ago (link).
        • Spoiler alert: it’s the result of unintended consequences of government-imposed wage controls during WWII that continue today.
          • Moral of the story: Seemingly harmless government interventions often distort incentives and create unintended consequences that persist for decades and centuries.
      • This creates a weird system where the after-tax costs of healthcare are cheapest for high earners.
        • Why? They have the highest marginal tax rate, and thus benefit the most from the tax-deductions that healthcare offers.
        • Further, high income earners are the most likely to receive generous healthcare benefits from their employers.
        • To state the obvious, the poor on Medicaid are well taken care of as well, since they get free access to unlimited healthcare.
          • I state this from a position of experience from my prolonged experience living below the poverty line while in grad school.
        • In other words, the current system favors the rich and the poor, leaving those in the middle substantially less coddled.
  • Deductible
    • Prior to hitting your deductible, you are responsible for paying 100% of your healthcare expenses.
      • These healthcare expenses can be paid for with cash (after-tax) or with FSAs or HSAs (pre-federal, pre-state, pre-social security, pre-medicare taxes).
    • After your deductible, your insurance company begins to pay for stuff.
      • Until you hit your annual deductible, you’re on your own.
  • Co-Insurance
    • After you hit your deductible, this is the portion of any extra expense that you’re on the hook for. At my employer, the coinsurance amount can range from 20% to 30% depending on the plan.
      • If my coinsurance percentage is 30%, this means that my insurer is picking up 70% when I’m past my deductible and in the “co-insurance” region.
      • These healthcare expenses can be paid for with cash (after-tax) or with FSAs or HSAs (pre-federal, pre-state, pre-social security, pre-medicare taxes).
  • Annual Stop-Loss (aka Out of Pocket Maximum)
    • This number represents the max that you are on the hook for after the deductible is met. If my deductible is $3,100 and my annual stop loss is $5,000 (without deductible) or $8,100 (with deductible), the most that I could possibly be on the hook for is $8,100 (=$3,100+$5,000).
  • Health Savings Account (HSA)
    • If you have a qualified high deductible healthcare plan (QHDHP), your employer may offer a Health Savings Account to allow you to save for medical expenses.
    • The annual contribution limit in 2019 is $7k.
    • These savings can be invested in stocks/bonds.
    • Unused HSA funds carry over to the next year, saving you the hassle of purchasing $7k of band-aids on Dec 31 at Walmart.
    • This is the most tax-advantaged savings vehicle available within the US. You fund it with pre-tax money similar to a Traditional 401k, but unlike a Traditional 401k, you don’t have to pay Social Security or Medicare taxes on these contributions.
      • As a result, many will find it prudent to use the HSA as a “stealth” retirement account. See these resources for a great discussion:
        • Mad Fientist article (link).
        • Bogleheads forum on receipt saving strategy (link).
  • Flexible Savings Account (FSA)
    • This is a savings vehicle that your employer will offer to allow you for healthcare expenses even if you don’t have a high deductible plan.
    • The annual contribution limit for 2019 is $2,650.
    • The FSA cannot be invested.
    • Unused FSA funds are lost on Jan 1 of following year, creating an incentive to purchase $2,650 of band-aids on Dec 31 at Walmart if you haven’t used your funds.
    • In general, you cannot simultaneously fund a HSA + FSA, but you may do so only if the FSA is designated as a “limited purpose” FSA.
      • The “limited purpose” FSA is specifically designed to be used exclusively for eyeballs and teeth.
      • If you have access to both a HSA and a limited purpose FSA, the utilization of both is a no-brainer. Max out the HSA and fund the limited purpose FSA up to what you expect to spend on eyeballs and teeth for the given year.
        • I don’t have access to a “limited purpose” FSA through my employer, but I’ve been pleading the case to add one to HR.

 

Important Strategies

The healthcare system, as it currently stands, is bizarre. Prior to Obamacare, the “existing condition” issue with many insurers handcuffed employees with pre-existing medical conditions to their employers. Luckily, this problem has been resolved. Yet many other distortions remain.

One distortion that remains is the incentive to have lumpy medical expenditures. It is way more prudent to spend $250k in healthcare in a given year then $0/year for 9 years than it is to spend $25k/year on healthcare every year. I realize that this isn’t always actionable, but the incentive is to go buck wild with medical expenditures the moment you hit your deductible (and thus get a 70%-80% discount on subsequent treatment for the rest of the year) or your stop loss (and thus get a 100% discount on subsequent treatment for the rest of the year). I know from personal experience that appendectomies are hard to time perfectly, but non-life-threatening trips to the ophthalmologist, allergist, and dermatologist are discretionary and easily accelerated (or delayed) a year or two depending on how your healthcare expenditures evolve over a particular year.

Once you hit your deductible (and especially your annual stop loss / out of pocket maximum), go buck wild with healthcare and strive to spend zero the following year(s).

 

How to Choose the “Right” Plan

Step 1: Extract relevant parameters from employer

I have 4 choices through my employer.

High Deduct Med Deduct Low Deduct QHDHP
Annual Premium $1,572 $3,684 $6,384 $1,572
Deductible $3,100 $900 $600 $5,400
Co-Insurance 30% 30% 20% 20%
Additional Stop Loss $5,000 $3,200 $2,800 $1,800
Total Out of Pocket Max $8,100 $4,100 $3,400 $7,200

 

Step 2: Gather  individual parameters

Federal Marginal Tax Rate 22% (don’t know what this is? then I have failed you)
State Marginal Tax Rate 7%
Medicare Marginal Tax Rate 2.35% (will be 1.45% for most people)
Social Security Marginal Tax Rate 0% (will be 6.2% for most people)

 

Step 3: Model healthcare choices in Excel (or on graph paper)

Y axis is total cost to employee

X axis is the healthcare expenses (Doctor visits, etc)

Start by Ignoring Taxes:

  • Y-intercept is annual healthcare premiums (This is a sunk cost. You pay it regardless of whether you go to 0 doctor visits or 200 in a year).
  • Once you incur non-zero expenses (i.e. go to the right of zero on the X-axis), the slope of the line is now 1 until you hit your deductible, at which point you arrive at the first kink point in the chart.
  • As you continue to incur more medical expenses through the year, the slope of the line changes from 1 to your coinsurance responsibility. This continues until you hit your annual stop loss at the second kink point, at which you are no longer responsible for any subsequent medical expenditure and the slope of this line flattens to zero.

Note the obvious wacky perverse incentives induced by the current healthcare system. The second plot illustrates the marginal cost of healthcare as a function of total annual medical expenses incurred. Until you hit the deductible, you’re bearing 100% of the cost. Once you hit the deductible, you’re responsible for the coinsurance. Once you hit the annual stop loss, you’re responsible for 0%.

Given the many surgeries this year, my family is currently in that wacky 0% region and we are predictably consuming a large amount of healthcare before Jan 1, 2019 hits. Weird behaviors emerge (excessive, price indiscriminate demand) when the price of something becomes zero. Suddenly it isn’t financially prohibitive to go to the ER if you have a headache or a sore throat.

Want to solve the entirety of the US healthcare problem? Look no further than by mandatory and widespread adoption of high deductible health plans. Let people bear 100% of the cost of their non-preventative healthcare expenses up to a high deductible (and continue to subsidize preventive healthcare expenses like crazy because these ward off huge downstream problems through early detection and behavioral modification). If you’re worried about this being too punitive to the poor, then compensate with cash transfers to these people.

 

Adjustments to the Above Chart by Incorporating Taxes:

Health insurance premiums reduce your tax liability by your Annual Premium * (federal marginal rate + state marginal rate). This results in a downward shift in the above Cost vs Expenditure chart across all expenditure levels.

Contributions to FSA / HSA shift the Cost vs Expenditure chart down by the FSA/HSA contribution amount * (federal marginal rate + state marginal rate + social security marginal rate + medicare marginal rate).

In the above chart, I treat the tax benefits of the HSA as “sunk”, and therefore don’t adjust the marginal cost of healthcare on the QHDHP downwards. I think this is an economically accurate way of viewing these transactions.

Step 4: Estimate how much you’ll spend next calendar year

We had a gallbladder removal & appendectomy this year. But on an ongoing basis, we consume relatively little non-preventative healthcare. We usually have around 5-10 sick visits (strep, etc) per year, each one costing $90/pop at the walk-in-clinic in a grocery store. If we were instead to go to our primary care physician, these strep visits cost $150.

$150 strep test at primary care physician. This was prior to hitting deductible, so our responsibility was 100% after “discounts” were applied.


$94 strep test at quickie mart. This was prior to hitting deductible, so our responsibility was 100%.

Barring catastrophe (knock on wood), we should spend around $1k on dr visits next year which is pretty typical for us.

Step 5: Choose Plan With Lowest after-Tax Cost Given your Expected Healthcare Expenses

Choose plan with lowest after-tax cost given your expected healthcare expenses. In my case, the QHDHP with max HSA provides the lowest after-tax expected healthcare costs. In other words, the purple line in the after-tax chart a few pictures above has the lowest after-tax expenses for our expected level of expenditures next year (~1k).

 

After You’ve Chosen the “Right” Plan

Be a Savvy Consumer of Healthcare 

When the inevitable strep throat or broken arm comes your way, consume healthcare responsibly. Utilize lowest cost providers when appropriate. Always price shop, particularly before you hit your annual deductible (see the finance buff’s great post here). Many insurers will have price comparison tools to allow you to scope out the best price for a procedure. We used such a tool for my wife’s gallbladder removal surgery and were extremely pleased with the accuracy of the price quote through our insurer’s website. Her surgery cost $6k, which was around 70% lower than other providers charging $18k for the same procedure.

Review your explanation of benefits (EOB) provided by your insurer after every medical transaction, hopefully on their website. Understand the true cost of healthcare and how this cost is divided among you and your insurer (and how this division of financial responsibility changes before/after hitting your deductible/stop loss).

Wash Your Hands and Eat your Broccoli

The US has great health care but abysmal health outcomes compared to much of the world. Why? We eat too much bad food, eat too little good food, and move our bodies too little. No amount of healthcare spending can compensate for failure to take care of our own bodies.

 

 

**** UPDATE ****

Reader Tabitha asked for my spreadsheet. Please download it here (link).

13 thoughts on “Demystifying Annual Healthcare Enrollment”

  1. “I know from personal experience that appendectomies are hard to time perfectly”. Me too! I was admitted a couple hours before midnight on 31-DEC and had surgery shortly after midnight. My out-of-pocket costs ended up spread across two high deductibles… xD

    Reply
    • As an eternal optimizer, this pains my soul to no end. I’m sorry for your loss….of two high deductibles! Your tragedy rivals that of Romeo and Juliet.

      Reply
  2. My employer only offers one plan. A QHDHP with an HSA. My wife stays home with our kids, so I don’t even have anything to comparison shop with 🙁

    My employer implemented a spouse surcharge of $100/month if your spouse is employed at a position offering health benefits but they elect to be insured with our company’s benefits. I thought it was an interesting way to potentially decrease the pool of costs.

    Reply
    • Very interesting about the $100/month surcharge. I’ve seen this at other employers as well (perhaps old engineering gig?).

      QDHDP with HSA isn’t a bad “only” option to be in, particularly if you can be frugal with your healthcare expenditures and invest the HSA wisely. I’ve been really pleased with Saturna’s HSA, costing only $15/year in administrative fees. I’m not sure if you have access to investments in your HSA, but if not, you could always transfer out your HSA (just as you would a IRA) for a nominal fee after you’ve harvested the payroll tax benefits from contributing directly to your in-house HSA.

      Reply
  3. It might be specific to my employer, but our limited purpose FSA allows $500 to be rolled over to the next year. It can also fund healthcare expenses beyond “eyes and teeth” once the deductible has been met. Good luck with talking to your HR team about an LPFSA and hopefully you can get some other good options included.

    Reply
    • Thanks for the input. Sounds like your limited purpose FSA is better than most I’ve heard of, but maybe I have a poor understanding of most plans.

      Reply
  4. This article/calculator does not mention or consider a HDHP’s pass-through. Should it? Or should that just be deducted from the premium?

    Reply

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