Every fall, during open-enrollment period, over 100 million families can choose a health plan. Anyone who receives health insurance through their employer, Medicare, Veterans Affairs, the exchanges—including members of Congress, CEOs, teachers—is invited to participate in this national ritual.
The decision, which has enormous implications for our health and finances, is horrendously complex. And we are universally terrible at it.
People choose plans that don’t fit their situation based on bad assumptions and predictions, or they don’t choose at all, blindly staying with what they have done in the past. No matter what the mistake, they end up paying a lot more than they should, potentially costing themselves thousands of unnecessary dollars a year. In the end, in fact, for most people one simple type of plan makes the most sense, with some important caveats.
Why do we make mistakes?
It isn’t entirely our fault that we make unwise choices. Healthcare providers don’t make it easy to figure out what they are offering us, whether it’s the breadth of coverage—what hospitals, physicians and treatments they cover—or the quality of those hospitals and doctors. What’s more, open-enrollment materials are punctuated with misleading expressions that suggest value, such as “platinum plan” and “enhanced benefits,” which nudge us to pick more expensive options than we need.
We’re also confronted by language that we’re unfamiliar with. Plan materials are littered with jargon like actuarial value, specialty tiers, coinsurance, out-of-pocket maximums, as well as a word salad of acronyms—HMO, PPO, POS, PDP and HSA. Only 14% of us are able to correctly answer simple questions about these concepts, and they are central to choosing wisely.
Then there are the subtleties we’re supposed to understand. For instance, oral medicines for cancer or multiple sclerosis are covered by a prescription-drug plan, but infused medicines for the same diseases are by a medical benefit. Most doctors, other than the ones treating multiple sclerosis or that particular cancer, wouldn’t know the distinction. How would we?
Go with the flow
All of this complexity and obfuscation leads to the first basic mistake many of us make when choosing a plan: We don’t actually choose one.
When faced with open enrollment, many of us succumb to inertia and keep the plan we already have. Inertia costs us money because there is often a more generous plan that is also cheaper than the one we’re in. One study estimates that employees are paying 40% more for their premiums as a result of inertia (this amounts to $2,400 a year for a family).
The other big mistake we make doesn’t have to do with the opacity of health plans. We’re simply not good at predicting what we need.
To choose the right plan, we need to forecast what our healthcare needs will be for the following year. This is relatively easy for persistent healthcare needs, like medicines for chronic diseases such as hypertension, and one-off events like the birth of a child. But our ability to predict the unexpected is, frankly, terrible. It is all too easy to rely on a mental shortcut where we visualize a nasty medical condition—a rare cancer or a birth that requires a Level 4 NICU—that would require expensive coverage. Maybe we saw something similar in a movie, read about it in a story or heard it from somebody else.
These emotional choices are known as the availability heuristic in economics. Most of us believe that the likelihood of being bitten by a shark is more likely than being hit by a falling airplane part, but the risk of the latter is about 30 times greater.
The result is that we often choose a pricey, low-deductible plan that seems to cover every contingency. Such a plan may be worth the extra spending—often about $800 a year more for a family—if you need broad access, but most of us don’t.
It is also important to remember that a less-expensive, high-deductible plan will cover contingencies that we fear, like shark bites, being hit by falling airplane parts, level 4 NICUs and rare cancer treatments. What it won’t cover is every provider in your city, and that isn’t a bad thing if some of these providers are expensive without being better.
Sometimes we don’t even get the benefits we assume we will with an expensive plan. In one famous study, economists studied how consumers chose between one of those pricey plans and a lower-cost option. Enrollees thought that the expensive plan had broader access to providers than the lower-cost one—when in reality the latter option offered the same providers and treatments.
And remember that the $800 mentioned above is just an average. Those who selected one particular employer plan paid over $3,000 more than the less-expensive option (in current dollars) for an imaginary benefit.
Avoiding the mistakes
There is a very simple strategy for getting around these errors. The first step is obvious: Choose a plan instead of succumbing to inertia. The second step is to realize that for most people, there is one type of plan that will work just fine.
Say you are covered by your employer and are relatively healthy—you have no chronic conditions and don’t anticipate needing a medical procedure that exposes you to high out-of-pocket spending, like a joint replacement in the next year. In this case, the best choice is a high-deductible health plan (HDHP) paired with a health savings account (HSA).
Let me explain why.
High-deductible plans come with, obviously, high deductibles—typically around $4,500 for a family. But as we have seen, the premiums might run $3,000 lower for a family than a preferred-provider organization (PPO) plan, which carries lower deductibles.
The high deductible often scares people away, as does the prospect of shopping for in-network healthcare. But the number to focus on isn’t the deductible—it’s the premiums. Remember, an HDHP might well save a family as much as $3,000 a year in premiums relative to a PPO plan, so that is $3,000 toward our $4,500 deductible right there.
Then there is the health savings account, a fund that lets you contribute pretax money that can be used for healthcare costs and then withdraw it without a tax penalty. Employees and employers can contribute up to $7,750 to an account annually.
That employer contribution is crucial. Many employers give over $1,000 for families, with employers who have fewer than 200 employees often contributing twice as much as larger firms. All that money can go toward meeting the deductible. We have already gotten $3,000 closer by reducing our premiums, so our employer’s donation will give us another $1,000. All of a sudden, the effective deductible is down to $500.
What’s more, money in an HSA carries over indefinitely, even after we change jobs, or stop being in an HDHP, allowing us to have cash on hand when we do have a large medical bill or need nursing care. It can also be used for any purpose, not just health expenses, after the age of 65 (but you will pay taxes if you use HSA money for nonhealth spending).
Given the large medical needs we have as we get older, and the growing likelihood that we will need high-quality nursing care, this seems like a wise investment in our well-being and our family’s well-being. In contrast, with a low-deductible plan, we have no financial reserve for when you really need money for healthcare, which is the same as having less coverage.
Triple tax benefits
All of this adds up—especially because you can put HSAs into mutual funds. If your family invests $5,000 a year via an HSA for the next 25 years, and earns the historical stock-market average over the past 25 years, you would have $550,000 to spend on your family’s care.
But isn’t it better to put savings into a 401(k)? The HSA offers triple tax benefits—the money that you put in isn’t taxed, the money grows tax-free, and you don’t pay taxes on it when you finally use it. The last two aren’t true for 401(k) savings.
Don’t forget the tax savings from putting money in the HSA. If you’re in the 30% bracket, and you put away $5,000, you have saved $1,600 that would otherwise have gone to taxes. Once again, this money would get you a long way toward your annual deductible.
Remember one important caveat, however: If you’re sure to spend over the deductible, other plans may be more appropriate for you, such as the PPO plan that will cost you an additional $800. (You forgo the ability to save, but you also face a lower out-of-pocket maximum.) For instance, if you know with reasonable certainty that you need access to a more-expensive provider for a one-time procedure, then you should pick a plan that gives you this access, such as a PPO plan, and switch back to an HMO plan with an HDHP-and-HSA option during next year’s open-enrollment period.
If you do end up choosing an HDHP, please remember: Do not cut back on care haphazardly, as many people do. Following a doctor’s recommendations is much more important than saving a bit of money.
This article was originally published in The Wall Street Journal on May 23, 2023, and written by Amitabh Chandra. Image courtesy of Matt Chase/WSJ.
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