Nongroup Buyer? Why Choose Anything but an HSA Plan?

Millions of Americans buy their medical coverage from a source other than an employer. Most are missing an important option to reduce their net financial responsibility.

About 17 million Americans are covered by medical plans bought in the nongroup (sometimes called individual) market, either through federal- or state-facilitated marketplaces (often called public exchanges), private marketplaces, or directly from insurers. Sadly, many aren't aware of one type of coverage that can save them money on both their premiums and out-of-pocket financial responsibility. They are either unaware of these plans or don't understand how to evaluate their options. That's unfortunate. They may be losing several thousand dollars annually because they just don't know.

Who Buys Nongroup Coverage?

The universe of people who purchase nongroup coverage is composed of four primary groups:

Temporarily unemployed. Workers between jobs often can exercise COBRA rights to continue their group coverage by paying 102% of the group premium. This option may make sense for older workers (group premiums are blended, so younger workers subsidize older ones) and those who've met most or all of their deductible (and are receiving reimbursements from the insurer). But for others, particularly the young (who can find lower premiums in the nongroup market) with few claims incurred that plan year, buying nongroup coverage as a bridge between employer-sponsored plans often makes sense.

Early retirees. These people need a bridge between the end of their group coverage (including their period of COBRA coverage, which usually is no more than 18 months) and their eligibility to enroll in Medicare. Nongroup coverage may be their only option if they're not covered on a spouse's plan (or, in California, an adult child's nongroup plan) or Medicaid (the federal program primarily for low-income Americans).

Nontraditional workers. With the advent of new technology and apps, more workers than ever are opting to become contract workers, consultants, and gig workers. They may work as structural engineers consulting on a project, free-lance writers, Uber drivers, office cleaners, paralegals, photographers, and a number of other roles, trading the security and benefits of traditional employment for the power to determine when and how they work. If they're not eligible for group benefits (most aren't), they must find coverage on a spouse's plan or through the nongroup market.

ICHRA recipients. Some employers don't sponsor group medical coverage but instead offer employees an Individual-Coverage Health Reimbursement Arrangement through which the company delivers a tax-free stipend. The company can adjust the amount that it gives to each employee based on age and family size - the two variables that determine nongroup premium differences.

Reimbursement Accounts

The federal tax code includes three common medical reimbursement accounts:

Integrated Health Reimbursement Arrangement. An HRA is an employer-sponsored, -designed, and -funded account that is integrated with a group medical plan with high cost-sharing. The HRA reimburses a portion of out-of-pocket expenses - for example, the first half or second half of the deductible. Because it's owned by the employer and works with a specific medical plan that the employer chooses, an HRA isn't available to nongroup buyers.

Health FSA. This account allows employees to receive a portion of their compensation in the form of pre-tax payroll deductions that they can then spend on qualified medical, dental, vision, and over-the-counter expenses. It too is an employer-sponsored plan in which only benefits-eligible employees can participate.

Health Savings Account. Although most of the 34.5 million accounts were established through employers, Health Savings Accounts are not a group plan. Rather, anyone who meets eligibility requirements - which don't include traditional employment or earned income - can open and fund an account. The IRS - not the employer - designs the account. And the account is owned by the individual - not by the employer, as in the case of HRAs and Health FSAs.

Among the reimbursement accounts listed above, only the Health Savings Account is an option for individuals covered by nongroup plans. The exception is ICHRA recipients, who maintain the employer-employee relationship. If their employer offers a Health FSA to benefits-eligible workers, they can participate in that account.

Why Consider an HSA-qualified Nongroup Plan?

Only a small portion - single digits as a percentage of all buyers - of nongroup enrollees choose an HSA-qualified plan. That's unfortunate, because many can save money by buying this form of coverage. How?

Lower premiums. In most cases, HSA-qualified plans have lower premiums than comparable traditional plans. That's because more services are applied to the deductible. All services except select-preventive care are applied to the deductible on an HSA-qualified plan. In contrast, a traditional plan with the same deductible level may cover some services - like physician visits and prescription drugs - in full after a copay or coinsurance. Because the insurer pays more for these services, the premium is generally higher. The lower premiums benefit especially healthy people, who enjoy the premium savings and have fewer claims applied to the deductible.

Lower out-of-pocket ceilings. HSA-qualified plans have an out-of-pocket maximum (the combination of deductibles, coinsurance, and copays) of no more than $7,500 for self-only coverage or $15,000 for a family plan (with a maximum of $9,100 per family member). In contrast, other plans can impose cost-sharing of up to $9,100 for self-only coverage and $18,200 for a family plan. The out-of-pocket ceiling are often much lower on employer-sponsored plans. But insurers can't underwrite (assess and price for the risk of each policy owner) in the nongroup market, as they can in the life, auto, and homeowner's insurance markets, for example. As a result, insurers often try to discourage sick enrollees from choosing their plan by increasing the out-of-pocket exposure, narrowing the network (often excluding hospitals that specialize in the treatment of certain chronic diseases), and narrowing the drug formulary. Lower out-of-pocket responsibility benefits high claimants (those with chronic conditions or acute episodes of expensive care).

Net savings when paying out-of-pocket costs. Health Savings Account owners can pay their cost-sharing and other qualified medical, dental, vision, and over-the-counter expenses with pre-tax dollars. This tax benefit can easily save $1,000 or more annually.

Example 1: Estelle chooses a family medical plan with a $4,000 deductible per person ($8,000 per family) and 20% coinsurance up to $8,000. She breaks her leg and incurs bills with her orthopedic surgeon, imaging center, anesthesiologist, hospital, and outpatient physical therapy provider. She is responsible for $4,000 in deductible expenses and another $2,400 of coinsurance. If her plan isn't HSA-qualified, she must pay $6,400 with post-tax dollars. If her plan is HSA-qualified and she's eligible to fund a Health Savings Account, she can fund her account and pay the $6,400 from it. If her marginal tax rate is 34.65% (22% federal, 5% state, and 7.65% FICA), her tax savings on a $6,400 contribution are $2,218. Thus, her net cost for the $6,400 of medical expenses is only $4,182.

She receives that $2,218 savings only if she's enrolled in an HSA-qualified plan and is eligible to fund her Health Savings Account. If she chooses another type of medical plan, she can't access another tax-advantaged reimbursement account (unless she's a traditional employee buying in the nongroup market, and her company offers an ICHRA and a Health FSA - which is unusual).

But these benefits don't accrue to the Health Savings Account owner only if she has high medical expenses that year.

Example 2: Same situation as Example 1, but Estelle doesn't break her leg. In fact, she and her family incur only $500 of out-of-pocket financial responsibility that year. She contributes $250 monthly ($3,000 annually) to her Health Savings Account through automatic electronic distributions from her checking account. She saves $1,040 in taxes and has a $2,500 balance to spend tax-free on future qualified expenses.

The Bottom Line

Too many nongroup buyers are unaware of the benefits of choosing an HSA-qualified and opening and funding a Health Savings Account. That's too bad. They may be costing themselves thousands of dollars annually in higher premiums and the loss of tax savings to pay qualified expenses.

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The content of this column is informational only. They are not intended, nor should the reader construe the content, as legal advice. Please consult your personal legal, tax, or financial counsel for information about how this information applies to you or your entity.