Health Insurance: Fixed vs. Variable Costs

A lot of agents are good at analyzing a client’s options, doing the math, and then recommending a plan that will save the client the most money. After all, that is a big part of the agent’s job: to provide analysis and advice to the client.

Easier Said than Done

Unfortunately, explaining the recommendation in terms the client can understand is easier said than done. That’s because, insurance is complicated and some consumers 1) don’t always understand insurance ins and outs and 2) have been conditioned to believe that doctor visits should only cost $30 and that their prescription costs should be both low and predictable. Getting them to abandon the up-front copayments in favor of a policy that actually provides better catastrophic protection at a lower overall cost can be a challenge for brokers.

Fixed and Variable Costs

In reality, the total amount the consumer will pay for his or her health coverage consists of both fixed and variable costs. The fixed cost is the monthly premium that they pay for the plan, and that part’s pretty easy to understand.

The variable costs can be a little more confusing, though, because people tend to think in terms of their costs when they go to the doctor or pick up a prescription from the pharmacy—in other words, the more frequent expenses. They usually look at the deductible as well because they’re a little more familiar with how deductibles work; car insurance and homeowner’s policies also have deductibles, so this isn’t a completely new concept for them. What consumers tend to overlook, though, is the total out-of-pocket exposure on the health plan, the amount they will pay in the event of a serious illness or injury. People often buy a more expensive policy because of the low deductible and up-front copayments even though they could be out thousands of dollars if something major happens.

Step by Step

So how can brokers help clients select the right plan, the one that will provide the right balance of monthly premium and point-of-service expenses? Here are a few tips:

1. Start by explaining that, in your analysis, you will be looking at both the fixed and variable costs of the plan. The reason for stating this up front is because a lot of consumers are already familiar with these concepts, more familiar than they are with health insurance terminology. They probably study fixed and variable costs when preparing their household budget.
2. Second, since the plan has a calendar-year deductible and out-of-pocket limit, explain to the client that you will annualize the premiums on the plan so that you can add the fixed (premium) and variable (out-of-pocket) costs together to determine their total annual exposure.
3. Next, explain that you will be showing a best- and worst-case scenario for each plan. In doing so, you will temporarily disregard the deductibles and copayments and instead focus on the premium and out-of-pocket maximum.
4. Finally, do the math for various plan options so they can see how these dissimilar plans compare. In many markets, there won’t be that many options to compare in the individual market because some markets have a dominant carrier that only offers about a dozen HMO options. But other markets have a wide range of options available to consumers, so this sort of analysis will admittedly work better in those areas.

An Example

To help illustrate our point, we’re actually going to take a look at a group health plan because of the wide range of options it offers. Your analysis for an individual client will likely be a bit shorter than this.

Our example comes from a real-life small group client that currently offers a platinum plan to its employees. Some of those employees are covering their entire family on the plan, and the monthly premium is more than $3,000 per family.

Current Plan: PPO Copay Plan

Here’s a quick summary of the current plan:

On this plan, each individual member pays a calendar-year deductible of $1,250. There is no coinsurance after the deductible, so the total in-network exposure (the out-of-pocket maximum) is $1,250 for a single member, and the family out-of-pocket limit is three times that amount. The total monthly premium is $3,064; that means the annualized premium is $36,768. This represents our fixed costs. Sure, the employer is making a contribution to the employee’s portion of the premium, but on an individual plan this total fixed expense would be the client’s responsibility.

Now that we have the annualized premium, we can determine the best- and worst-case scenarios for the family. The best-case occurs if the family uses no benefits other than preventive care and therefore has no variable expenses. The worst-case occurs if three or more family members hit their out-of-pocket maximum. A more likely scenario is that one family member would have a big claim, so we’ll also include that in our analysis.

• Best Case: $36,768 fixed costs + $0 variable costs = $36,768 total costs
• More Likely: $36,768 fixed costs + $1,250 variable costs = $38,018 total costs
• Worst Case: $36,768 fixed costs + $3,750 variable costs = $40,518 total costs

So this is our starting point, the current plan. We’ll take a look at some of the other options available to this family and see if we can lower the overall exposure.

Alternative 1: PPO HSA Plan

The first alternative we’ll look at is an HSA-compatible PPO plan with a $3,000 deductible and no coinsurance after the deductible:

As you can see, the out-of-pocket exposure on this plan is higher for both the individual members and the entire family. This, combined with the fact that there are no up-front copayments on this plan, would be enough to scare a lot of people away from it.

However, it’s important to point out to the client that the monthly premium is $578 lower than the current plan, and that premium savings can be used to pay for a lot of doctor visits and prescriptions. This can even be done on a pre-tax basis if the client sets up a Health Savings Account and deposits at least a portion of the premium savings into the account.

The annualized premium for the HSA PPO plan is $29,832, which is significantly lower than the current plan, but the out-of-pocket exposure is higher, so we need to do the math to determine how the combination of both fixed and variable costs impact our best-case, worst-case, and most-likely scenarios.

• Best Case: $29,832 fixed costs + $0 variable costs = $29,832 total costs
• More Likely: $29,832 fixed costs + $3,000 variable costs = $32,832 total costs
• Worst Case: $29,832 fixed costs + $9,000 variable costs = $38,832 total costs

We don’t need to overanalyze this because it’s what is often called a “no brainer.” When comparing the best-case, worst-case, and most-likely-case scenarios, the HSA PPO plan beats the current PPO copay plan. The client is almost guaranteed to save money, and that’s before factoring in the tax savings that comes with depositing money into the Health Savings Account. Sure, we’ll want to take a look at some higher deductible HSA plans to see if they could save the client even more money, but it’s clear in this example that the client should consider switching from the current low-deductible copay plan to a higher-deductible HSA plan. Taking on more variable exposure lowers the family’s total costs.

Alternative 2: HMO HSA Plan

Before making our final recommendation to the client, though, we need to look at a second alternative: an HSA-compatible HMO plan. This plan’s in-network benefits are identical to Alternative 1, but the network is smaller, and the family members will need to get a referral from their primary care physician (PCP) to see a specialist.

While some people don’t like the HMO gatekeeper model, in this case it has to be considered because the premium difference is huge. This HMO HSA plan offers a monthly premium savings of $890 versus the comparable HSA PPO plan and $1,486 versus the current PPO copay plan! Yes, that sentence deserves an exclamation mark at the end, and you might consider adding one to any written analysis you provide to your clients—the savings is that big.

Let’s take a look at our three scenarios, though it’s already clear this plan will save the client a lot of money regardless of what the family’s claims look like.

• Best Case: $19,152 fixed costs + $0 variable costs = $19,152 total costs
• More Likely: $19,152 fixed costs + $3,000 variable costs = $22,152 total costs
• Worst Case: $19,152 fixed costs + $9,000 variable costs = $28,152 total costs

As you can see, the worst-case scenario on this plan would save the family more than $8,600 versus the best-case scenario on the current plan. When comparing worst-case scenarios, the family would save more than $12,300. Yes, it’s possible that the primary doctor does not participate in the HMO network. So what. The family could still go see their favorite doctor and just pay for the visit with their HSA card instead of using their health insurance. Again, the premium savings will pay for a lot of doctor visits.

Use this as a Template

It may seem like this sort of analysis would take a lot of work, especially if you do it for every client, but it really isn’t. You’re probably already doing the math now when making client recommendations, so all you need to do differently is plug the numbers into a pre-designed format to create a personalized report for each client. You can even use the above example as a template.

Again, not every individual client will have a wide range of network and out-of-pocket options, so you may need to modify the analysis based on what’s available in your area, but hopefully this gives you some ideas.