Many people assume that if some health insurance is good, more health insurance is better. That’s not always true.
Sometimes, having a little LESS coverage is the smarter move.
Don’t let sticker-shock fool you: high monthly premiums, over time, can be worse.
To understand why, keep in mind that the purpose of health insurance is to safeguard you against risk. The purpose is NOT to pay your medical bills, it’s to keep you out of bankruptcy.
Health insurance should be used ONLY as a safeguard against calamity. It should never be used as a way to cover reachable costs.
It’s Not “Health” Insurance, It’s Bankruptcy Protection
“Health” insurance is a misnomer. Don’t think of this as insurace that covers the cost of your healthcare — think of this as insurance that protects you from going bankrupt.
Example: Suzy thinks that health insurance should pay for all of her health-care bills. She’s 28 and in good health. She pays $350 per month for individual coverage, which allows her a $500 deductible and pays 100 percent of her health-care expenses after the deductible.
Total cost per year = $4,200 + $500 deductible = $4,700 per year out-of-pocket, every year.
John thinks that health insurance is protection from bankruptcy. He doesn’t expect it to cover the health-related bills he can afford out-of-pocket, like eyeglasses, an annual physical, prescription allergy medication, and a yearly dental exam. He’s also 28 and in good health, and he pays $105 per month for individual coverage, which allows him a $1,500 deductible and covers 80 percent of his health-care costs after the deductible until he reaches his out-of-pocket maximum of $5,000, at which point it covers 100 percent of costs.
John understands that this means that, in any given year, the most he’ll have to pay is $1,500 (the deductible) + $5,000 (the out-of-pocket maximum) + $1,260 (his premium). This means that if the worse-case scenario unfolds, he’ll have to cough up a maximum of $7,760. This is the worst-case scenario.
But most years, while he’s healthy, he pays only $1,260 (his premium) + $700 of his deductible, which he uses for an eye exam ($150), new eyeglasses ($100), allergy medication ($150), and miscellaneous other costs ($300). This means that most years, John pays $1,960.
Who Saves More?
Suzy pays $4,700 per year, while John pays $1,960 per year. Both are protected against the worst-case scenarios: if they break a bone, need emergency surgery, or get diagnosed with a disease, their expenses will be covered.
John knows he needs some padding in his bank account to cover any extra out-of-pocket expenses, so each month he stashes away the difference between Suzy’s monthly premium ($350) and his own monthly premium ($105). This means each month, he saves $245, which he can tap whenever the worst-case scenario unfolds.
John saves this $245 per month in an Health Savings Account, a tax-deferred account that is only available to people with high-deductible insurance plans like his. The $245 he saves each month is tax-free income, and as long as he spends it on medical expenses, he’ll never pay a penny in taxes on that money. Since he normally pays 28% in taxes, this means each month he gets $69 in “free money” (money he’d otherwise have to pay the tax man).
Suzy, meanwhile, is paying her after-tax money as a monthly premium.
Both John and Suzy Break Their Leg.
Two years into their health-care plans, both John and Suzy break their leg. Cost: $10,000. Suzy pays her normal yearly rate: $4,200 premium plus $500 deductible. She doesn’t see any difference in her bills; she paid the same amount last year, when she had no major medical expenses.
John is faced with a total bill of $3,200 for the broken leg. He has been saving $245 per month in a tax-free Health Savings Account for the last two years, so he has $5,880 in the bank. He uses the balance in his Health Savings Account to pay in full.
Add the $3,200 bill to his $1,260 normal premium, and he’s spent a total of $4,460 that year.
How Much Did They Each Pay?
Over the span of two years and one broken leg, Suzy paid a total of $8,400 while John paid $6,420.** Suzy paid after-tax money while John paid mostly tax-free money from his HSA.
In that same span of time, Suzy has $0 saved, while John has several thousand in the bank.
**(John’s payments = $1,960 from Year 1 and $4,460 from Year 2.)
What Should I Do?
Don’t assume – as most people do – that more is better. If you’re in good health, sometimes less health insurance is better, as long as you can pay for costs once they skyrocket.
Afford Anything’s Golden Rule of Buying Insurance is to never pay insurance for something you can cover out-of-pocket. It may stink to have to pay such a big bill out-of-pocket; there’s a large sticker-shock at receiving a $6,500 hospital bill, or shelling out $1,500 for an out-of-warranty refrigerator. But paying high premiums for high coverage does not make sense for most people. (Add up those premiums over 2-3 years, and you’ll get an even worse sticker shock.)
If you’re in poor health or elderly, and you’re likely to run up high medical bills every year, it might make sense to get the higher coverage. But if you’re healthy, then stick to the Insurance Golden Rule.
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Mike
Hi Paula,
Sorry to write on such an old post but it’s open enrollment time and I was reading thru this as I make my elections.
If John were hit with a bill for $10,000, under his plan, wouldnt he only have to pay $3,200 out of pocket? ($1,500 deductible + 20% on anything above that, which in this case would be 20% of $8,500)
Afford Anything
Hi Mike —
Wow, I’d forgotten about this old post! Yes, you’re correct. If John were hit with a $10,000 bill, he’d pay $1,500 (deductible) + $1,700 (co-pay) + $1,260 (normal premium), for a total of $4,460. I’ve changed the blog post to reflect that. Thanks!
Kyle
Paula,
Which bank do you have your HSA in? Which one’s wound you recommend?
I have heard HSA bank and HSA administrators are best because they offer low cost Vanguard funds. I was leaning towards HSA bank since they seem to have commission free trades and lower annual costs. What would you suggest?
Afford Anything
@Kyle — I use HSABank.com and have a linked account with TD Ameritrade, and within that brokerage account, I keep most of my money in the iShares S&P 500 Index Fund, which has a 0.07 percent expense ratio.
Unfortunately, HSA Bank doesn’t have any association with Vanguard or Schwab (my two favorite brokerages), but Ameritrade is also a decent brokerage and I’m happy with the ability to buy low-cost index funds.
My biggest pet peeve is that HSA Bank charges $2.25 per month as an account administration fee if your balance is lower than some $X amount (which mine always is, since I invest the funds through Ameritrade), but I looked through all of the other HSA banking options and they all seem to have some type of associated fees. 😛
Ameritrade also charges a $3 monthly fee if you invest less than $4,925 through your linked HSA account — fortunately I’m beyond that amount, but that’s something else you’d need to watch for.
Kit
Hey Paula,
Just starting to become more active in the FIRE community. I have another edit for you in the same vein as Mike.
I think you calculated John’s worst case scenario too high. My understand of Out of Pocket max includes the amount you paid which counted for the deductible. So for a worst-case scenario for John it would be $5,000 (the out-of-pocket maximum) + $1,260 (his premium) = $6,260. I just saved John $1,500 for his worst year.
For reference: https://www.healthcare.gov/glossary/out-of-pocket-maximum-limit/
Natalie
Hi Paula,
I’d like to re ask the question from Kyle “Which bank do you have your HSA in? Which one’s wound you recommend?” Im looking into a health plan that is HSA eligible and curious if your answer has changed over time. Did you find an option/administrator that would allow you to invest in Vanguard?
jennifer
Hi Natalie, Optumbank is where I have my HSA and I have all of my investments in Vanguard funds.