High deductible health plan

A High Deductible Health Plan (HDHP) is a health plan which pays nothing except for preventive care until the deductible is met. If your plan meets IRS requirements and you have no other health insurance, you are allowed to invest in a Health Savings Account (HSA), which allows you to deduct contributions to the account from your taxes, pay medical expenses from the account tax-free, and invest unused money for future medical expenses.

How the plan works
An HDHP makes insurance payments in the same way that most other insurance with a deductible works. If you have auto insurance with a $1,000 deductible, you pay the full repair bill if it is less than $1,000, but you have protection against catastrophic loss because you pay only $1,000 if your $20,000 car is totaled.

Most health insurance, even if it has a deductible, provides significant benefits before you have met the deductible. Typically, you pay a co-payment (a fixed dollar amount or percentage) for each doctor's visit or prescription; in a plan with a deductible, you might pay full price for other procedures such as X-rays and laboratory tests until you have met the deductible. The plan need not count prescription drugs towards the deductible.

An HDHP is not allowed to pay for anything except preventive care until you have paid the deductible out of pocket. If the plan has negotiated prices with providers (such as an HMO or PPO), you pay only the negotiated price. However, many employer-provided HDHPs make a contribution to your Health Savings Account, so you do not need to come up with the whole deductible out of pocket. (You can also contribute more to the HSA on your own, up to the IRS limit.)

Catastrophic coverage
The most important reason for having insurance is protection against catastrophe. An HDHP must have a catastrophic coverage limit; after you have paid that much out of pocket (or from your HSA), the plan must pay 100% of your covered expenses as long as you get your medical care within the network. Some conventional plans also have catastrophic limits, but they may have restrictions such as paying 100% for medical services but still requiring co-payments for prescription drugs.

IRS requirements
The IRS requirements change year by year, indexed for inflation. For 2010, the minimum deductible for an HDHP is $1,150 for an individual plan, $2,300 for a family plan, and the maximum catastrophic limit is $5,800 for an individual plan, $11,600 for a family plan. Regardless of the actual deductibles, you can contribute up to $3,050 to a Health Savings Account if you have an individual plan, $6,150 if you have a family plan, plus $1,000 catch-up contributions if you are at least 55.

Financial advantages and disadvantages
Since the payment structure of an HDHP is very different, you may owe significantly more or less with an HDHP than with a conventional plan. You will need to work out the costs yourself. Remember to count the value of the plan's contribution to the HSA, and the subsidy on your own contributions. For example, if the plan contributes $1,000 and you contribute another $2,000 in a 25% tax bracket, it costs you only $1,512 out of pocket to put $3,050 in your HSA, so you have a net gain of $1,512 before you pay any costs. (If your conventional plan allows you to use a flexible spending account, that provides a similar benefit, but only on the amount that you can be sure you will spend.)

You are most likely to benefit from an HDHP if you are either in good health or have very high prescription drug costs. If you are in good health, your expenses will usually be far less than the deductible, so the high deductible does not matter, and you have good coverage for the catastrophic insurance that you need. If you have very high prescription costs, the fact that prescriptions count toward the deductible and catastrophic limit may mean that you will pay less in total with an HDHP. If your medical costs are near the deductible, you may be better off with a conventional plan, as the HDHP will cover nothing but the conventional plan will cover some of the costs.

You may also benefit from the HDHP, regardless of the costs, if your employer gives a percentage subsidy on health insurance, because the insurer's contribution to the HSA benefits from the same subsidy. For example, if your employer pays 75% of your health insurance, it costs you only $250 to receive benefits which cost the insurer $1,000, even if that $1,000 benefit is a contribution to your HSA.

Even if your employer does not offer a direct subsidy, the tax laws may offer a subsidy on an employer policy; much employer-provided health insurance is paid by premium conversion, which means that the policy premium is not included in your income for purposes of income or Social Security tax. Your employer may also be able to contribute to your HSA by premium conversion.

Examples
These examples are not necessarily illustrative of any particular plans, but they show that an HDHP becomes more attractive if the insurance premiums are subsidized, either by the tax laws or by your employer. If you have to pay the full premium yourself, the HDHP is usually a better deal only if you are in good health. If you get a tax subsidy, the HDHP looks more attractive. And if you get an employer subsidy, the HDHP may be better regardless of your medical bills; work out the numbers even if you expect high expenses.

Individual plans or employer plans with no subsidy
Suppose that you can get an individual plan or an HDHP each for the same cost, the HDHP has a $2000 deductible, and you are in a 32% combined federal and state tax bracket. If you use the HDHP, you can contribute $3050 to your HSA, getting a $976 tax saving compared to putting the same money in a Roth IRA which would also grow tax-free. Therefore, you save $976 if you have no medical expenses.

If you have $1500 in medical expenses under the HDHP and pay the expenses from your HSA, and the conventional plan makes you pay $500 for the same expenses, the conventional plan is a better deal. And if you can deduct your medical expenses (because the insurance all by itself costs more than 7.5% of your income, and you itemize deductions), then the conventional plan looks still better; if you pay $500 out of pocket, you save $160 in taxes, a net savings of $184. Therefore, if you will be near the deductible, the HDHP will cost you money.

Employer plans with premium conversion
For these examples, suppose that your employer offers a standard plan for $4000, or an HDHP for $5000 with a $2000 deductible and a $1000 contribution to your HSA. Also suppose that your employer offers premium conversion, and that your combined federal, state, and Social Security tax rate is 40%.

If your employer does not subsidize the insurance, the day-one cost of the standard plan is $2400. If you use the HDHP and max out the HSA, you get an $820 tax saving on the $2050 you contribute, and the $1000 is free money, so your day-one cost is $3000-$1820=$1180, a savings of $1220 if you have no medical expenses. The savings is the same if you get a fixed-dollar subsidy.

If you have $1500 in medical expenses under the HDHP and the conventional plan makes you pay $500 for the same expenses, the conventional plan still costs $180 more. Even if the $500 in expenses is known so that you can use a flexible spending account, the tax savings is $200, which makes it a wash. If you use the whole deductible, the conventional plan comes out ahead unless it costs $820 after any tax savings from a flexible spending account.

Subsidized employer plan
Now suppose that your employer pays 75% of the health insurance cost. The conventional plan thus costs you $1000, which is $600 after tax. The HDHP costs you $1250, which is $750 after tax, plus you get $1000 free in the HSA and an $820 tax saving on the $2050 you contribute, which is a net profit of $1070 for you. The HSA savings is now $1670.

Even if you use the entire deductible of the HDHP, you are now likely to come out ahead; if you have $2000 in HDHP expenses, it is likely that your conventional plan will cost more than $330.

Non-financial concerns
Since the HDHP does not cover expenses until the deductible is met, it creates an incentive to avoid medical costs, even necessary ones. You should not use an HDHP if the potential of a $100 doctor's bill, or a $200 prescription, or a $1000 emergency-room bill, might discourage you from getting the care you need.