Financial Makeover: Health Insurance Costs

— Q U E S T I O N: I am a self-employed consultant and so I have to purchase my own health insurance. My business has suffered some setbacks recently and I'm not bringing in as much income as I did in the past. But health insurance rates keep rising and I'm getting killed with premiums that are nearly $600 each month and rising fast. My wife talks about getting a job that offers health insurance so that we can stop paying premiums out of our own pocket. We'd prefer that she not have to go back to work, but it may be the only way since if insurance costs keep going up we'll be forced to drop our current coverage. We also sometimes think about just going without health insurance because we rarely see the doctor anyway, but we know that's not a good idea.

— Michael

A N S W E R:

Michael and his wife are feeling the pinch of rapidly rising health insurance premiums, which run nearly $600 each month and consume a significant portion of Michael's consulting income. Millions of Americans face similar concerns as rising insurance premiums are forcing many companies, especially smaller ones, to ask employees to accept a larger portion of health insurance costs. Self-employed people like Michael are especially vulnerable since they bear the entire cost of health insurance rate increases.

Unfortunately, some people faced with this dilemma simply drop their health insurance coverage entirely, which creates an enormous financial exposure in the event that a person becomes seriously ill. Congress recognizes this problem and responded late last year with a solution that, while definitely not perfect for all people, begins to address the issue of skyrocketing insurance costs.

High-Deductible Health Insurance

Many economists believe that one of the main reasons behind rapidly rising health care expenses is that most consumers are not connected with the true cost of the care they receive. Why should consumers care about how much health care they use, or from whom, or at what cost, if an insurance company pays almost the entire bill? If consumers cover a material portion of their own routine medical care, these economists say, they'll have a financial incentive to economize their own health care spending by seeking lower-cost options, avoiding unnecessary treatment, and maintaining a healthy lifestyle.

This theory led to the creation of high-deductible health insurance policies. Unlike traditional insurance, where the insured pays a small office visit co-pay and perhaps a $500 annual deductible, high-deductible insurance features a high annual deductible of between $1,000 and $2,600 for individuals, or $2,000 to $5,150 for families.

The tradeoff is that high-deductible insurance is much less expensive than low-deductible insurance. For example, Michael and his wife are paying $600 each month for a low-deductible health insurance plan. They could replace this costly coverage with a $5,150-deductible family insurance policy that costs about $300 each month, for a premium savings of $300 each month, or $3,600 annually!

Health Savings Accounts

As an incentive to adopt high-deductible health insurance, Congress created tax-free Health Savings Accounts (HSAs) late last year as part of the Medicare reform legislation. Michael and his wife can contribute up to 100 percent of their insurance deductible ($5,150 in this example) to an HSA account. Participants over 55 years old can make additional "catch-up" contributions of $500 in 2004, increasing in $100 increments annually until reaching $1,000 in 2009.

The contribution to the HSA account is tax-deductible, so if Michael and his wife contribute $3,600 annually (their premium savings by maintaining a high-deductible policy) they'll also realize perhaps $700 of tax savings in addition to their premium savings. They can generate additional tax savings by contributing even more than their premium savings (up to $5,150 annually) to the HSA.

Many high-deductible policies cover the cost of one annual preventive care visit to the physician without cost to the insured. Beyond that, Michael and his wife will have to pay out-of-pocket a large portion of any other medical expenses incurred each year, which shouldn't be a problem because by depositing their $300 monthly premium savings into the HSA they'll quickly accumulate assets for just this purpose. (Unlike the common flexible spending arrangements maintained by many employers, HSA account balances roll over from year to year if not used.)

After reaching the deductible, the insurance company shares expenses with the consumer. In the event of a truly catastrophic medical expense, the insurance policy caps out-of-pocket expenses at $10,000 for family policies and $5,000 for individual policies.

A high-deductible policy, combined with an HSA account, would accomplish Michael's goal of reducing health insurance premiums. And because Michael and his wife are quite healthy they'll quickly accumulate a large balance in their HSA account with the premium savings. However, high-deductible health insurance is not appropriate for everyone. People who frequently need health care, especially due to a chronic health condition (e.g., diabetes, heart disease), are less likely to find HSAs advantageous because they incur significant medical expenses every year.

Likewise, young people who expect to have children soon may want to stick with traditional insurance to avoid having to fund costly delivery expenses out of pocket. Further, high-deductible health insurance works only if the insured is disciplined enough to deposit premium savings into an HSA account to accumulate money for future medical expenses.

While this article focused on a self-employed person, many companies are now making these policies available to employees, and some companies even encourage employees to participate by making deposits into an HSA account for the employee.

HSAs are relatively new, so few banks and brokerage firms offer them yet. One early leader is MSA Bank. Their Web site (www.msabank.com) has more information on HSAs and forms to establish an account.

Health savings accounts aren't perfect for everyone, and they certainly don't solve this nation's serious problem of having too many people without health insurance. HSAs do, however, provide an opportunity for many people to finally take some control over their health care spending.

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Guest columnist Greg Schick, CFP is a financial planner at Kochis Fitz, a wealth management firm in San Francisco.