How Does Health Insurance Work?

Why America Relies on a Private Health Insurance Model

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Health insurance pays for the high cost of healthcare in America. Photo: Ariel Skelley/Getty Images

Health insurance is very complicated, and many people are overwhelmed and annoyed with the process. Here's an explanation of health insurance, and how it got to be the dominant delivery vehicle for health care in America.

The Real Purpose of Health Insurance

Since health insurance is the primary delivery vehicle for U.S. health care, people have lost sight of its underlying purpose. It's just like insurance for your car, home or apartment.

It's supposed to protect your life savings from the devastating costs of a major accident, medical emergency or a chronic disease.

But, unlike other insurance, health insurance makes it possible for you to get that health care when you need it. If you don't have car insurance, you can take the bus until you can afford to get your car fixed. If you break your leg, you can’t splint it yourself until you save up enough to go to the doctor. 

Therefore, health insurance has two goals: 1) protect your assets and 2) make sure you can get health care when you need it. That's why most discussions about health care reform in the United States are really about making health care insurance available to more people.

Choosing Health Insurance Is Very Complicated

Health insurance companies provide lots of choices. But before you select a plan, you've got to wade through the various combinations of deductibles, copayments, coinsurance and premiums.

 

  1. Monthly premiums. Just like auto or homeowners insurance, you pay this even if you never make a claim. That provides the cash flow so insurance companies can pay their day-to-day expenses.
  2. The deductible. That's what you pay before the insurance company contributes a dime. Deductibles can range anywhere from $500 a year (usually only available from company-sponsored plans) to $10,000 a year or more. They are annual, which means you start over on January 1 of each year. 
  1. A copayment for each visit. A typical copay is $20 for a doctor visit, $50 for a hospital visit and $10 to $40 for each prescription. You pay 100 percent for the visit until the deductible is met.
  2. Coinsurance. That’s a percent you pay for procedures, like surgeries, or hospital stays. If your doctor visits you in the hospital, you might pay a copayment for the visit and coinsurance for the hospitalization. 

Insurance companies charge deductibles, copays and coinsurance to keep you from running to the doctor for every sniffle. They were worried that, if health care were 100 percent free, their costs would skyrocket. The Affordable Care Act mandated that your costs (deductible, copay and coinsurance) can't exceed an out-of-pocket maximum of $6,600 for individuals, or $13,200 for a family. After that, the insurance company pays 100 percent. 

All these choices make picking health care insurance very complicated. You’ve got to be an odds-maker on your own health.

For example, you might be willing to pay a higher monthly premium for a lower coinsurance percent and/or deductible. That would make sense if you have a chronic disease, like diabetes, and know you’ll be in to see the doctor frequently.

On the other hand, people who are usually healthy might want the lowest premium possible and a higher deductible. They are willing to take the chance of paying more for health care because they believe that chance is small. Usually, the lower the deductible, the higher the premium, co-pay or co-insurance. As health care costs have grown, more people have opted for higher-deductible plans just to keep their monthly premiums affordable. Obamacare has not been able to correct this underlying flaw of the health insurance system.

Why America Relies on Health Insurance to Pay for Medical Care

Health insurance is necessary for Americans to pay for the high cost of health care. Without it, your entire life savings could be wiped out by a $300,000 medical bill. For more, see Why Health Care Costs Are the No. 1 Cause of Bankruptcies.

Before World War II, hardly anyone had insurance, and those that did were only covered for the cost of the hospital room and board. After the War, the federal government instituted a wage freeze to curb inflation. But that meant companies couldn’t give raises to get the best employees. Instead, they offered benefits including health insurance.

In 1954, the IRS made health insurance premiums non-taxable. That made an additional dollar of health insurance more valuable than a dollar of taxable salary. This tax break alone increases the U.S. deficit by $250 billion a year. Nevertheless, politicians aren’t likely to get re-elected if they suggest removing this popular tax break.

That’s especially true because this tax break is like providing a government insurance subsidy for the upper-middle classes and the wealthy. The Tax Policy Center estimated that the average benefit of the health insurance tax break was about $800 for a household in the middle 20 percent of earners. That’s great for the middle class. But the benefit is four times that, or $3,400, for people in the top 20 percent of the income range. (Source: "Treasury Modifies Use-or-Lose Rule for Health Spending Accounts,” U.S. Treasury, October 31, 2013.)

Alternatives to Health Insurance

Many countries have adopted universal health care. That's where the government pays for health care, just like it pays for education and defense. It's like expanding Medicare or Medicaid to everyone. When you go to the doctor or the hospital, the government picks up most or all of the bill. Sometimes it takes a long time to see a specialist or receive a non-emergency operation. On the other hand, no one has to worry about dying from a disease because they can't afford treatment. Here's one reason universal health care failed in America.

Another alternative is self-pay. If people paid for their own health care, they'd bargain on price to get the best deal. That would lower the cost of health care overall. They could take out loans for expensive procedures, like they do a car or a house. They would take better care of their health to avoid preventable diseases like diabetes. On other hand, it might force low-income people to choose between food and medicine. Access to health care has become part of today's American Dream.

More on Health Insurance

For a step-by-step guide in picking the right insurance for you, see my book The Ultimate Obamacare Handbook (2015 - 2016).