How Health Insurance Works

Why America Relies on a Private Health Insurance Model

Things to Consider When Choosing Health Insurance: Monthly premiums, the deductible, co-payment, and co-insurance.

Image by Britney Willson © The Balance 2020

Health insurance protects your assets from the high cost of medical care. But how it works can be complicated if you don't understand health insurance basics like what a deductible is, when copays apply, and how coinsurance works. Below we tackle these considerations and why health insurance is essential no matter how complicated it might seem.

Key Takeaways

  • Health insurance is a necessity for most Americans who cannot afford to pay medical bills out of pocket.
  • The cost of your health insurance premium is based on a combination of your co-pay, co-insurance, deductible, and maximum out-of-pocket costs.
  • The current health insurance system doesn't allow equal access to healthcare for all Americans.
  • Other countries use universal health care, but the Affordable Care Act only incorporates some aspects of that kind of system.

Why You Need Health Insurance

Health insurance is necessary for Americans to pay for the high cost of healthcare. You generally need it unless you can afford to pay for healthcare on your own or receive government assistance. The very wealthy can afford the cost of even extraordinary emergency or chronic medical care. Those over age 65 usually qualify for Medicare. Lower-income individuals and families may qualify for Medicaid.

Everyone else must either purchase health insurance or risk medical bankruptcy. Since it is so common, many 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.

Unlike other insurance, health insurance makes it possible for you to get healthcare 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.

How to Choose Health Insurance

Health insurance companies provide lots of choices, options, but before you select a plan, you've got to wade through various combinations of deductibles, co-pays, co-insurance, and premiums. 

  1. Monthly premiums. 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. It is an annual amount, which means you start over on January 1 of each year.
  3. A co-pay for each visit. A typical co-pay might be $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.
  4. Co-insurance. 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 co-payment for the visit and co-insurance for the hospitalization. 

Why do insurance companies charge deductibles, co-pays, and co-insurance? They want to keep you from running to the doctor for every sniffle. If health care were 100% free, their costs would skyrocket. The Affordable Care Act provided that these out-of-pocket costs can't exceed a maximum amount that is adjusted each year. For 2020, it was $8,150 for individuals and $16,300 for a family. After that, the insurance company pays 100%. 

All of these details make picking health 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 co-insurance percentage 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 healthy might want the lowest premium possible and a higher deductible. They are willing to take the chance of paying more for healthcare, because they believe their risk is small. The lower the deductible, the higher the premium, co-pay, or co-insurance. As healthcare 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

Before World War II, most Americans had no health insurance. The policies that existed only covered 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 Internal Revenue Service made health insurance premiums non-taxable. That made an additional dollar of health insurance more valuable than a dollar of taxable salary. The Tax Policy Center estimates that this tax break alone increased the federal deficit by $273 billion in 2019, but politicians aren’t likely to get re-elected if they suggest removing it.

This tax break is like providing a government insurance subsidy for the upper-middle classes and the wealthy. The Tax Policy Center found that the average benefit of the health insurance tax break was about $254 for a household in the 12% tax bracket but $347 for those in the 22% tax bracket. 

Alternatives to Health Insurance

Many countries have adopted universal healthcare. 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 Canadians go to the doctor or the hospital, the government picks up most or all of the bill. The downside is that it may take 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.

When Hillarycare tried to implement universal healthcare in America, the medical profession and health insurance companies defeated it. Obamacare was initially presented as universal healthcare, but different interest groups and politicians led to that goal being changed. 

Access to healthcare has become part of today's American Dream. Research has found that the higher your income, the better your health, on average. As a result, income inequality has led to healthcare inequality.

In DepthPros and Cons of the ACA | Trump and Health Care | The Truth About Obamacare

For a step-by-step guide to picking the right insurance for you, see "The Ultimate Obamacare Handbook."