Decision Time

Richard Connor

FALL IS MY FAVORITE time of year, but there used to be one thing I dreaded: picking a health plan for the year ahead.

Many folks don’t know how to evaluate their health insurance options. I used to be in that group—until I adopted a fairly straightforward process. Bear with me while I walk you through the sort of choice you might face as an employee. The same analysis can be used if you’re buying insurance on your own.

Health insurance costs have four components: premiums, deductibles, copays and out-of-pocket (OOP) maximums. Your company should provide these values for each of the plans on offer. It’s important to distinguish between employee costs—the money you actually pay—and medical costs, which are the costs that medical providers charge and which may be covered by insurance. My four-step process is as follows:

  1. Calculate the total annual premium. This is the minimum amount you’ll pay during the year. Think of it as the best-case scenario. This is the cost if you’re perfectly healthy and never use medical care.
  2. To the results from step No. 1, add the deductible for each plan. Taken together, this is the maximum amount you’ll pay before copays come into play.
  3. Subtract the deductible from the OOP maximum. Let’s say that number is $4,000. Divide that $4,000 by the copay percentage, which might be 25%. You’ll need to turn the 25% into a decimal by dividing it by 100, so it becomes 0.25. If you divide $4,000 by 0.25, you get your answer: $16,000. To that $16,000, add the deductible. Result? This is the total medical costs—much of which would be paid by the insurance company—that you’d need to incur to hit the out-of-pocket maximum. That OOP would be your share of these costs.
  4. Add the premium amount from step No. 1 to the OOP maximum. This is the maximum employee cost you can incur in a year. Think of it as the worst-case scenario.

Confused? With any luck, an example will help. Check out the table below. This is a real-life example from a midsize company in 2018. The company offered three plans with different premiums and deductibles. Note that the copay and OOP maximum is the same for each plan.

Next, let’s turn to our second table, which shows the results of the four-step process.

That brings us to the graph below. The horizontal axis shows the total medical costs incurred, while the vertical axis is the cost an employee pays at any given total medical costs.

When you have zero medical costs, your total cost as an employee is equal to the total annual premium you pay. You hit the first bend in the line when your medical costs for the year equal your deductible. Until you hit that deductible, all medical costs come out of your pocket.

Once you reach your deductible, you go into a copay situation—the line beyond the first bend. The copay for our three plans was 20%. In other words, for every $5 of medical costs you incur after meeting the deductible, you have to pay $1. The three lines in the chart keep rising until you’ve accumulated enough medical costs so that the combination of your deductible and 20% copays add up to your OOP maximum. Once you reach this point, the line flattens, because you’ve reached the maximum in medical costs you’ll owe for the year.

If you knew exactly how much medical costs you would incur over the next year, it would be easy to look at the graph and pick the best option. But unfortunately, it’s impossible to know. What to do? After looking at these types of choices for many years, I’ve developed a rule of thumb: Pick the plan that does the best job of minimizing both the low end and the high end.

Plan C has the lowest minimum cost—because it has the lowest premium—and also the lowest maximum cost, as reflected in the premium plus OOP maximum. Result? If you had a very healthy year with no medical care, you’d have the lowest cost. And if you had a very unlucky year, with high medical costs, you’d still have the lowest employee cost. In between those two extremes, it’s a mixed bag. Still, I would pick plan C. I know my best- and worst-case costs, and anything in between is acceptable to me.

The values shown here are for an employee only. Most plans I’ve seen have higher costs for different family sizes. You can use the same process, but the conclusions may be different once additional family members are considered. For many years, my wife and I both had access to good medical insurance. We would do the analysis on both sets of plans, and then pick the best plan for our family.

Another consideration: Medical premiums are usually paid out of pretax income, effectively reducing an employee’s cost. You may also be able to pay out-of-pocket costs using pretax income if, say, you can fund a flexible spending account or you have a high-deductible health plan with a health savings account attached. Sometimes, employers contribute to a health savings account, and that can tip the balance in favor of a high-deductible plan.

Finally, in addition to costs, you’ll want to look closely at which doctors are considered in-network by each plan. Got doctors you’ve used for years? To continue seeing them, you may need to favor a plan that’s less financially attractive.

Richard Connor is a semi-retired aerospace engineer with a keen interest in finance. Rick enjoys a wide variety of other interests, including chasing grandkids, space, sports, travel, winemaking and reading. His previous articles include Our CharitySolo Effort and What Number. Follow Rick on Twitter @RConnor609.

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