By John C. Goodman
Originally posted at Forbes, May 2017
High deductible health insurance is an irritation for young, healthy families with modest incomes. In fact, health insurance with, say, a $10,000 deductible is almost like not having health insurance at all.
So, what can be done? One option is to buy down the deductible by paying a higher premium for less exposure. But people who try that often confront an unpleasant reality: the extra insurance you can obtain by buying down the deductible is the most expensive insurance there is. In fact, eventually you will reach a point where an extra dollar of coverage costs more than a dollar of premium.
There are two reasons for that. First, small dollar claims occur more often than large dollar claims. Second, there is an adverse selection effect. The people who are the most likely to want a lower deductible and who are the most willing to pay a steep price to get it are the ones who are the most likely to file claims. In other words, they are sicker than people who select high deductibles and bear the first-dollar risk themselves. Insurance companies know this and they price their policies accordingly.
A second option is to self-insure for the exposure under the deductible. For example, to protect yourself against the first $10,000 of medical expenses, you could put $10,000 in a dedicated account, such as a Health Savings Account. The problem is that families with modest means don’t have the money to do that. And if they make small monthly deposits to an HSA, it will take a long time to fill the deductible amount – even if they stay healthy and don’t have any medical bills.
For example, assume that the family deposits $140 a month to the account. It will take three years to accumulate just half the amount of the deductible.
A third possibility is for people with high deductible plans to get together as a group and insure each other for the expenses under the deductible. This would be a separate insurance arrangement – completely detached from their primary insurance plan.
But how can ordinary folks with no experience in the business pull that off? Fortunately, they don’t have to. A Houston based firm called Health Matching Account Services (HMA) is ready to do it for them with a brand-new insight: if you make monthly contributions to increase the amount of insurance you have, you can cover your deductible a lot faster than if you try to build up a cash account. What you get in return for your premiums is something akin to the Medigap insurance seniors buy to fill the gaps in Medicare. (Note: to avoid unwanted regulation, HMA doesn’t call its product “insurance.”)
To continue with the above example, instead of putting $140 a month into a bank account, suppose people instead gave that money to HMA in the form of a premium. After 12 months, they will have paid $1,680. For that amount, they will have insurance for the first $1,980 of medical expenses.
In other words, the buyers are getting $1.17 of insurance for every $1.00 they pay in premiums, on the average. You might regard that as not much better than putting the money in a bank account. But bear with me. This low payoff reflects the fact that first dollar coverage insurance is very expensive insurance – even for people who don’t expect to file a claim.
Things get better in year two (where you get more than $3 of insurance for every $1 of premium) and better still in year three (where you get almost $7 of insurance for every $1 of premium). After 35 months of premium payments, people with no medical bills will have insurance that completely fills the $10,000 deductible gap.
Would people have been better off putting those premium payments in an HSA? The company gives this example. After 35 months, the total amount contributed will equal $4,900. So, the person with the HSA will have that much in the bank, but face $5,100 of exposure – should an expensive illness occur. By contrast, the person who paid premiums will have nothing in the bank, but will have $10,000 of insurance coverage and no remaining exposure.
Now let’s suppose that a medical event occurs, costing $3,600. After the HSA holder pays this amount, she will have only $1,300 left in her HSA – according to the example the company provides. Since the HSA deposits are tax advantaged, we could top up that amount to $2,525 (assuming a 25% tax bracket). But remember, if she tries to withdraw the cash and spend on non-health consumption, she will pay taxes and penalties on the withdrawal.
The premium payer doesn’t get any tax relief, but she will still have $6,400 of insurance coverage. And, after one more year of premium payments she will have completely closed the $10,000 deducible gap again.
By the way, once an individual has achieved the $10,000 target level of coverage, she can maintain that level by making a modest payment of $40 per month. Going forward, she will have $10,000 of coverage for a price of roughly 5 cents on the dollar.
Is this a good deal? If you are a high-income individual with a lot more than $10,000 in the bank, this product may not be for you. But if you tend to live paycheck-to-paycheck and have trouble saving for medical expenses, insuring against your deductible may make more sense than trying to fund it with a savings account.
Health Matching Services is a very innovative firm, but it has to struggle with tax laws and regulatory regimes that look like they were designed with no thought at all. And of course, the ridiculously high deductibles offered by primary insurers are the perverse result of Obamacare.
In a rational world, the tax law would provide a level playing field for premium payments and deposits to medical savings accounts. Competition in a secondary insurance market would provide consumers with many choices. For example, some might prefer to self-insure for the first $3,000 and buy the kind of secondary insurance described above for the remaining $7,000 gap.
Who knows? But for the perverse incentives of Obamacare and other insurance regulations, primary insurers might offer these choices. A secondary market for health insurance might not even be necessary.