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 will pay full price for doctor visits, lab tests, prescription drugs, hospital visits up to the deductible, and then possibly co-insurance or co-payments up to the policy maximum.

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 (including prescription drugs) 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 $1,200 for an individual plan, $2,400 for a family plan, and the maximum catastrophic limit is $5,950 for an individual plan, and $11,900 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. If the family plan has individual deductibles, they can't be lower than the $2,400 family plan minimum deductible. Family plans can also have a shared deductible in which any one member of the family can meet the deductible requirement.

Qualifying HDHP Plan Statement
It is important to note that not all plans with a deductible high enough to meet the limits will qualify for a Health Savings Account, due to other specific requirements of the IRS such as prescription drug coverage. Each individual HDHP insurance policy must include a statement that it is a "Qualifying High Deductible Health Plan" or a reference to "IRC Section 223" in order to be a qualifying plan to allow contributions to an HSA. (See HSA for America 2009 Special Report page 7). The insurance policy must also agree to report the list of policyholders to the IRS, so the IRS can cross-check HSA account holders to HDHP insurance policy holders and audit accordingly.

Other Health Coverage
The IRS has specific rules about outside health coverage you can have while covered by an HDHP in order to be eligible for a Health Savings Account. You can have insurance for worker's compensation, a specific/disease or illness, a fixed amount per day for hospitalization, accident, disability, dental care, vision care, and long-term care. No other first-dollar medical insurance is allowed. A common strategy for those than have an HDHP is to have an alternate accident policy to lower their deductible substantially in the case of accidents. You are also not allowed to enroll in a Flexible Spending Arrangement - FSA unless it is limited to covering dental and vision expenses only. Use a Health Savings Account instead. See [http://www.irs.gov/pub/irs-pdf/p969.pdf IRS Pub. 969] page 4 for details of all of these requirements.

Prescription Drug Coverage
Since January 1, 2006, HDHPs have been required to count the full price of prescription drugs up to the annual deductible, exceptions can be made if the prescription is preventative. (See HSA Insider Road Rules page 5, section 2g). If a plan provides any prescription drug benefit before the annual deductible is met (except in the case of preventative prescription drugs) it is not a qualifying HDHP for a Health Savings Account.

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 $1,538 before you pay any costs. (If your conventional plan allows you to use a Flexible Spending Arrangement - FSA, 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, rather than alternative coverage with no out-of-pocket maximum for prescription drugs. 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. Compare the lower premium of the HDHP with the deductible to the alternative plan's higher premium, smaller deductible, and co-payments. It may be good to graph a visual representation using excel to chart out of pocket costs including premium vs. actual medical expenses to help with this comparison.

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.

At some employers, the premium + out of pocket maximum of the HDHP are lower cost than the premium alone of the conventional co-payment plan. It is also not unreasonable for the HDHP premium to be $0 and/or have employer contributions to your HSA. In this case, choosing the HDHP is an easy decision, even if you have high medical expenses.

Consider that in some states, state income tax is owed on Health Savings Account contributions, which may factor in this calculation. See the Health Savings Account page for more information.

Examples
These examples are not necessarily illustrative of any particular plans, but they show how the subsidy makes the HDHP more attractive, and may make it a better option for anyone with a percentage subsidy.

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 $2,000 deductible, and you are in a 32% combined federal and state tax bracket. If you use the HDHP, you can contribute $3,050 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, or if your expenses are the same under either plan.

If you have $1,500 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.

If your employer offers a plan with no subsidy, or with a fixed-dollar subsidy (say $3000 towards any plan), the numbers work out essentially the same. If the employer's HDHP costs an extra $1,000 and contributes $1,000 to your HSA, that is break-even for you (as long as you either deduct the premium or pay with premium conversion).

Employer plans with subsidy
Now suppose that your employer offers a standard plan for $4,000, or an HDHP for $5,000 with a $2,000 deductible and a $1,000 contribution to your HSA. Also suppose that your employer pays 75% of your premium for any policy, offers premium conversion, and that your combined federal, state, and Social Security tax rate is 40%.

The conventional plan thus costs you $1,000, which is $600 after tax. The HDHP costs you $1,250, which is $750 after tax, plus you get $1,000 free in the HSA and an $820 tax saving on the $2,050 you contribute, which is a net profit of $1,070 for you. The HSA savings is now $1,670.

Even if you use the entire deductible of the HDHP, you are now likely to come out ahead; if you have $2,000 in HDHP expenses, it is likely that your conventional plan will cost more than $330. And if you have more than $2,000 in medical expenses so that the HDHP pays something, it is likely to be even better because of the catastrophic coverage rules.

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.

Links

 * IRS Publication 969, Health Savings Accounts and Other Tax-Favored Health Plans
 * HSA Insider 2009 Road Rules Guide
 * HSA for America 2009 Special Report