Health Insurance is a Misnomer

Happy Health Insurance Open Enrollment! This seems like an appropriate time to think about the peculiarities of healthcare markets in the U.S.

Most “health insurance” as presently sold in the U.S. is not entirely insurance. Health “plans” (not “policies”) combine insurance (i.e., protection against unusual or unexpected costs) with a service contract. The service part of the plan can reduce or reimburse at least part of every dollar you spend on healthcare, even before you hit a plan’s “annual out-of-pocket maximum” (which is when the component that meets the traditional definition of “insurance” kicks in).

Normally I recommend against buying bundled financial products. Health plans are an exception for two reasons. The first is that the tax code allows you to pay “health insurance premiums” with pre-tax dollars, but you have to use post-tax dollars for “out-of-pocket” healthcare costs. So it can be more tax-efficient to buy “health insurance” with a low deductible so that more of your medical spending is done with pre-tax dollars. (Yes, if you spend enough out-of-pocket then that’s an itemized deduction, but I’ll explain in a future post why that’s still not as efficient as using pre-tax dollars.)

There’s a bigger reason to buy a health plan together with insurance: An individual consumer can’t easily pay a market rate for healthcare. Medical service providers list and bill outrageous prices that are many multiples of the fair market rate. Large buyers – health insurers and government programs like Medicare – negotiate market (a.k.a. “reasonable and customary”) rates that they will actually pay for covered medical services. If you’re not covered by one of those large buyers you (1) can’t easily learn what the “reasonable & customary” rate is, and (2) could be subject to collection efforts for the full (and absurd) list rate. As an individual you can negotiate a “cash” rate that is close to the reasonable & customary rate, especially if you are shopping in advance. But that’s much harder to do when you need emergency medical care. When you buy a health plan you’re buying access to fair market rates for medical services in addition to insurance against unexpectedly large medical expenses.