Open Enrollment: Healthcare Considerations
With open enrollment season coming up, this post aims to provide an overview of healthcare plans and a framework for deciding which healthcare plan is right for you.
In this post, we review the main types of healthcare plans, define key terms in healthcare plans, and provide an example of comparing two healthcare plan options.
What are the different types of healthcare plans? HMO, PPO, EPO?
Healthcare plans come in various forms, each with their own features, benefits, and limitations. Three common types of healthcare plans are Health Maintenance Organizations (HMOs), Preferred Provider Organizations (PPOs), and Exclusive Provider Organizations (EPOs).
Health Maintenance Organization (HMO)
In an HMO, you typically need to choose a primary care physician (PCP) from a network of doctors. And you must get referrals from your PCP to see specialists.
HMOs have a strict network of healthcare providers, and they usually only cover services obtained from in-network providers. If you go out of network, you may have to pay the full cost.
Because of the strictness of HMOs and the requirement to see your primary healthcare physician, HMOs tend to have lower premiums and out-of-pocket costs compared to PPOs and EPOs.
Preferred Provider Organization (PPO)
PPOs offer far more flexibility when it comes to choosing healthcare providers. With a PPO, you may go straight to specialists without a referral. You may also visit out-of-network providers, although it's usually more expensive.
PPOs will have a preferred network of providers (in-network providers). You may see other providers (out-of-network providers), but visits to out-of-network providers are often subject to different out-of-pocket costs.
Due to their flexibility, PPOs often have higher premiums and out-of-pocket costs than HMOs.
Exclusive Provider Organization (EPO)
EPOs offer some features of HMOs and PPOs.
Like HMOs, EPOs have a network of providers and typically will not cover any out-of-network services. Like PPOs, EPOs usually do not require referrals to see specialists.
EPOs will often have moderate premiums but lower out-of-pocket costs compared to PPOs. They can be a cost-effective option if you're willing to stay within the network.
What are the key definitions of healthcare plans?
Within these healthcare plans, the following definitions are critical for understanding which plan best suits you.
Premium
The premium is the amount you pay for coverage. This amount is typically deducted from your paycheck, and your employer may subsidize your healthcare premium.
Regardless of whether you use your health insurance or not, your premium will be the same.
Deductible
The deductible is the amount you must pay out-of-pocket before your insurance company begins to pay for your healthcare costs. Your premiums do not count toward your deductible.
For example, if you have a $1,000 deductible, the first $1,000 in healthcare costs must be paid 100% out-of-pocket before your insurer will begin contributing towards your costs.
Coinsurance
Once you meet your deductible, you will often still be responsible for a portion of your healthcare expenses. But the insurer will begin covering a portion of additional expenses – and often a significant portion.
Coinsurance is the percentage of healthcare expenses above the deductible that you are responsible for, often quoted as a percentage.
For example, if your plan has a $1,000 deductible and 20% coinsurance and you incur $3,000 in medical expenses, your out-of-pocket costs would be $1,400. You would be responsible for 100% of the deductible ($1,000), and 20% of the $2,000 of expenses above your deductible ($400).
Out-of-Pocket Maximum (OOP Max)
As the term implies, out-of-pocket maximum is the maximum amount of money you will have to pay in a calendar year for covered medical expenses. Once you reach this limit, your insurance plan typically covers 100% of covered costs.
For example, if your plan has a $1,000 deductible, 20% coinsurance, and a $3,000 out-of-pocket max, it would take $11,000 in medical bills to reach the OOP Max. The first $1,000 meets your deductible and then you would pay 20% of the next $10,000 of medical expenses to reach your max. If you had covered expenses in excess of $11,000, your insurer would cover 100% of the costs above $11,000.
Copayment (Co-Pay)
Different from coinsurance, a copayment is a fixed, predetermined amount you pay for specific covered medical services or prescriptions. It is often a set dollar amount (e.g., $20 for a doctor's office visit).
Some plans will have both co-pay and coinsurance amounts to be aware of.
Network
A network is a group of healthcare providers, such as doctors, hospitals, and specialists, that have agreements or contracts with your insurance company to provide services at negotiated rates.
Healthcare plans will often have different deductibles, coinsurance, and out-of-pocket maximums for in-network vs. out-of-network providers, with lower values for in-network providers.
High-deductible healthcare plan (HDHP)
A high-deductible healthcare plan (HDHP) meets specific criteria (namely the size of the deductible) and allows participants to contribute to a health savings account (HSA).
These plans tend to have higher deductibles than other insurance plans and lower premiums. HDHPs may be HMOs, PPOs, or other types of healthcare plans.
How do I choose a healthcare plan?
Choosing a healthcare plan starts with estimating your healthcare needs in the coming year. After estimating your needs, you may evaluate the plans available to you and estimate your total cost.
The total medical cost will include premiums and out-of-pocket costs (deductible, co-pays, coinsurance).
Comparing Healthcare Plans and Total Costs
Your total healthcare costs can be broken down into your Net Premiums and Out-of-Pocket Costs.
Net Premiums
Net premiums are the premiums you pay (often deducted from your paycheck) less any employer contributions to your HSA. To incentivize enrolling in high-deductible healthcare plans, many employers will offer a contribution directly to your HSA. If so, this effectively offsets some of your healthcare costs.
Your premiums will often be quoted as a monthly amount. Annualize your insurance premium and deduct any employer contributions to understand your minimum net healthcare costs for the year.
Regardless of your healthcare needs and medical costs, you will pay this amount in the following year.
Out-of-Pocket Costs
The out-of-pocket costs are trickier to estimate.
If you expect the following year to be similar to the last, review your last year’s medical costs as a starting point. From there, add or subtract any anticipated changes to your health costs.
Do you have recurring prescriptions? Do you anticipate any procedures, imaging, or surgeries? Are you expecting a child?
After estimating the types of costs you expect to incur, you may review each plan’s deductible and co-pays and/or coinsurance to estimate your out-of-pocket costs.
Importantly, consider how your costs would change if you had lesser or greater medical costs. How would your costs change if you had another $1,000, $3,000, or $10,000 of healthcare costs?
Example of Comparing Two Healthcare Plans
Suppose you are comparing the following healthcare plans.
Plan 1 costs $410 per month in premiums and has a $750 deductible with 20% coinsurance up to a $3,000 out-of-pocket maximum. It is not a high-deductible healthcare plan.
Plans 2 costs $220 per month in premiums and has a $3,000 deductible with 20% coinsurance up to a $6,000 out-of-pocket maximum. Plan 2 is a HDHP and your employer contributes $1,000 towards your HSA if you enroll in this plan.
The annual net premium for Plan 1 is $4,920 ($410 * 12). The annual net premium for Plan 2 is $1,640 ($220 * 12 less $1,000 employer HSA contribution).
Although Plan 2 has a far lower net premium, it has a far higher deductible ($3,000 vs. $750). If one chooses Plan 2, they must be prepared to cover 100% of the first $3,000 of medical costs.
Now let’s add Out-of-Pocket costs if one were to incur $3,000, $5,000, or $20,000 of medical costs. Out-of-pocket costs include the deductible and coinsurance.
Plan 1 Total Costs
In each of these scenarios, the "net premium" of $4,920 ($410 monthly * 12) is the same. Regardless of your medical expenses, your premium is unchanged.
The out-of-pocket costs vary based on medical expenses incurred. In each of these scenarios, the deductible of $750 is met and that comes out-of-pocket first.
After meeting the deductible, the insured continues to pay 20% of covered medical expenses and the insurance company covers the other 80% until the out-of-pocket maximum is reached. The out-of-pocket maximum is only reached in the final example of $20,000 of medical expenses.
The total costs of premiums plus out-of-pocket costs range from $6,120 to $7,920 in these scenarios. The bulk of the costs are in the form of premiums ($4,920/yr) instead of out-of-pocket costs.
Plan 2 Total Costs
Plan 2's "net premium" includes $2,640 in premiums less the $1,000 employer contribution to the insured's HSA.
In each of these scenarios, the deductible of $3,000 is met. In the $5,000 and $20,000 of costs examples, coinsurance is also paid. And the out-of-pocket maximum is also met in the $20,000 example.
The total costs range from $4,640 to $7,640, with the bulk of costs through out-of-pocket costs rather than premiums.
Comparing Plans 1 & 2
What are your total costs (net premiums plus out-of-pocket costs) in each of these scenarios?
In each scenario, your costs are lower with Plan 2, although the gap narrows as costs climb.
The cost savings for Plan 2 is largely due to lower premiums and employer contributions to the HSA. Importantly, although total costs are lower for Plan 2, it requires very different budgeting than Plan 1.
With Plan 1, your costs are largely paid through premiums and the insurer picks up a greater share of costs during the year. With Plan 2, you have a low premium but must budget for greater out-of-pocket costs throughout the year. And if you have a big medical expense in January, you must be prepared to pay your $3,000 deductible and even up to your out-of-pocket maximum of $6,000.
Final Thoughts
The right health plan for you may very well change from year-to-year. As your circumstances, health, family, income, employer, etc. change, so will the best health plan.
As with all things in financial planning, the best you can do is make an informed decision with the information available to you. You will get a chance to reevaluate next year, and could even make changes mid-year in the event of job changes, family changes, or other qualifying events.