Health Insurance: How it works, why you need it, and how to make the best of it.
Insurance is a useful financial tool to offset risk. By paying a fee (known as a premium), we get coverage for certain risks. With health insurance, we get coverage for ailments, procedures, medication, and preventative measures. With car insurance, we get coverage to repair damage from accidents, weather events, and even theft. With homeowners’ insurance, we hope to protect our homes from fire, weather, and even from theft of the stuff inside. And with life insurance, we insure against the loss of the life of a loved one.
Note here that none of these are used as investments or to protect against small risks – insurance should be used solely to offset rare, but potentially costly events.
At the most basic level, insurance works like this: Everyone who is insured by a certain carrier pays into a pool. Some people end up having a lot of insurance claims, while some have few. Ultimately, these premiums balance out to make it affordable for all those insured. When a claim is made, the insurance company provides reimbursement or pays for some or all the claim, with some exceptions.
Health insurance is expensive, so how can we best utilize it in our own financial planning? This post is here to answer all your questions about health insurance, why you need it, and how you can get the most bang for your buck.
Disclaimer: I’m aware that this post does not discuss the flaws in the system – the cost of health insurance has risen disproportionately with inflation, cost of care is inconsistent at best, fraud is plentiful, and there exists a myriad of other problems. It is the system we have, and this post aims to provide guidance for doing the best we can within the system. If you want a deeper dive on issues with healthcare, health insurance, and more about what we can do to better the system, I highly recommend “Never Pay the First Bill” by Marshall Allen.
Back to health insurance, in the U.S. System.
Even if you are a low utilizer of insurance, that is, you don’t see doctors often and don’t have ongoing medical conditions, health insurance provides a way to offset any potential risk which can cause serious financial harm. My husband and I are both typically very low health insurance utilizers. I don’t think he’s gone to a doctor since we’ve been together (7 years!). However, when our son was born, our family suddenly became very high utilizers – and I was very glad to offset that risk. What could have been hundreds of thousands of dollars to us, was a mere few thousand dollars in premiums and copays. This is why we have insurance – to offset potentially large financial risks (not small ones).
When choosing health insurance, we want to be mindful of our needs before they become needs. Planning to have a child? Insurance that has good prenatal and birth coverage would be important. Know you will need a major operation soon? Check to see that the insurance covers the physician you want to see in-network. Do you have an ailment that requires regular visits and care? Consider these types of questions when choosing an insurance plan.
You should review your coverage at least annually to make sure it is meeting your needs. We tend to fall victim to the “set it and forget it” mentality with a lot of things, and this is one of them. We chose our plan once and don’t often revisit it, even when our needs change.
Common Terms
Here are the common terms to understand when choosing a plan or reviewing your own coverage.
Premiums are the amount you pay every month for the health coverage. If your employer provides health insurance, you can see what you pay each month by checking your pay stub. If you get paid twice monthly, it is likely that your health insurance will be deducted from each paycheck.
Deductible is an amount of money specified in your insurance plan that you will have to pay before your insurance will pay. For example, if you have a $1000 deductible, you will pay $1000 in medical costs before your insurance will pay.
Co-Pay is a flat fee you pay for certain covered treatments every time you receive the treatment or have a visit. For example, if I see a physical therapist under my plan, I pay a $40 co-pay for the visit and the insurance company pays the rest of the bill. I am co-paying with the insurance company. Typically, co-pays do not count towards the deductible.
Co-Insurance is in some health plans and for certain medical procedures. Co-insurance requires you pay a certain portion of a claim, after the deductible has been met. Oftentimes, co-insurance is 80/20, which means that you will pay 20% of a claim. If you have a $1,000 claim and 20% coinsurance, you will pay 20% and the insurance company will pay 80%.
Out-of-Pocket Maximum is the largest amount of money you will pay towards your covered healthcare each year. This includes deductibles, co-pays, and co-insurance, but does not include premiums. Once you have reached your out-of-pocket maximum, your insurance will pay the rest of your covered healthcare costs for the year.
In Network v. Out of Network – When a physician or provider is in-network, it means that they have negotiated with your insurance company for more favorable rates. When they are out of network, it often means higher prices for you.
How do all these terms actually work in your policy? Here’s an example:
Mark suddenly falls ill with stomach pain and vomiting. He goes to the ER and needs to have an emergency appendectomy. He stays in the hospital for two days. He gets a bill for $50,000. His co-pay is $500, his co-insurance is 20%, his deductible is $3,000, and his out-of-pocket maximum is $6,000. Since Mark hasn’t had any medical expenses yet this year, he will pay the $3,000 deductible, and then coinsurance of 20%. Because his out-of-pocket maximum is $6,000, he will pay an additional $3,000 after his deductible. While this is a lot of money, Mark is thrilled he had the money set aside in a savings account and had insurance! It is far less than the full $50,000 bill. If mark has any additional covered medical expenses during this same calendar year, he will not have to pay out of pocket, since he has paid the out-of-pocket maximum already.
Get the most bang for your buck
If you are a low utilizer, a way to offset medical costs is to choose a plan that has a low premium and a high deductible. By doing this, you’re utilizing insurance for the unlikely chance something serious emerges. The lower the monthly premium, the higher deductible. The higher the monthly premium, the lower the deductible. The reality is, most people can choose a low premium, high deductible plan. One study of homeowners’ insurance policies found that only 5% of people made a claim in any year, which means that it is likely anyone would have a claim only once every twenty years! It would be wise to choose a higher deductible and lower premium plan and set aside the difference in premium cost in a savings account, so that you can cover the higher deductible if you do have a claim. You will likely see this account grow before you have a claim.
Another way to ensure your health insurance helps you mitigate risk is to always have the amount of the annual out-of-pocket maximum in your savings account. If one has a $7,000 out of pocket maximum, this is likely the most they would be saddled with in a given calendar year if they had very serious medical expenses.
Finally, if your employer offers a health savings account (HSA), it is an excellent tool to maximize your health insurance choices. An HSA is a savings account to which you can contribute pre-tax income. Whatever money you don’t spend in the HSA rolls over to the next year and eventually becomes a retirement account. You can use the funds contributed to your HSA to pay for medical expenses. Even better, the funds in your HSA can be invested and grow, just like a 401k or IRA.
Major takeaways
Revisit your plan annually to make sure it covers your needs; know your annual out-of-pocket maximum and make sure you have at least that much set aside in a savings account; choose a high deductible plan if you don’t utilize your health insurance much; and use an HSA if you have one available to you.
Have more health insurance questions? Send ‘em my way and I’ll do a final wrap up post to newsletter subscribers with any questions that come up this month!