How Does Health Insurance Work?
HR pros know better than anyone how confusing healthcare can be. In many organizations, employees see you as the insurance expert in the office even though your experience may only go so far as open enrollment or special enrollment periods.
So, here's a primer on how health insurance works, including key terms.
How Does Health Insurance Work?
At its most basic, health insurance is an agreement—called a plan—between an insurer and an individual—sometimes referred to as a participant or beneficiary. This plan requires the insurer to partially or fully cover the cost of the individual’s medical expenses in exchange for a regularly recurring payment. Medical expenses include doctor visits, prescription drugs, medical devices, and surgeries.
Insurers also negotiate contracts with particular medical providers so that plan participants pay a lower price for the services of those providers. This arrangement is called a network, and plan participants may pay significantly more for the services of providers outside their insurance network. In some cases, insurers may deny coverage for some in-network services—say, for obtaining them without preauthorization.
In the US, most individuals and their families have health insurance coverage through an employer-sponsored plan, but many purchase it through the Healthcare.gov Marketplace or directly from insurers instead. Employers can obtain a lower regular insurance payment for their employees by grouping them together into the same health plan. Most employers also cover some of the cost of an employee’s regular payment—or premium.
What is a Premium?
An insurance premium is the regular amount paid by an individual and/or their employer to keep their health coverage active. Premiums are usually charged monthly, but employees with employer-sponsored coverage may have a portion of that amount deducted from their paycheck and paid monthly on their behalf instead.
Like a subscription or membership fee, health insurance premiums must be paid every month regardless of how much the participant actually uses the plan’s services.
Three Stages of Health Coverage
Premiums are the easiest expense to budget for, but they’re not the only expense that participants need to understand about their insurance plans. In fact, it might help to think of insurance coverage in three stages:
- First, the individual pays for medical expenses.
- Then, once their deductible amount is met, insurance shares the cost of medical expenses with the individual.
- Finally, once their out-of-pocket maximum amount is met, insurance pays for medical expenses.
There are some exceptions to this general progression, but overall, the framework is a helpful one.
It’s also important to note that premium, deductible, and out-of-pocket maximum amounts are lower for policies covering an individual than policies covering a family. And of course, all of these amounts vary by insurer and policy.
What is a Deductible?
A deductible is the amount an individual must pay each year for medical expenses before their health insurance will contribute to the cost of covered services. Deductibles can be anywhere from $0 to $10,000. Typically, deductibles reset each calendar year.
This means that an individual’s medical expenses would need to exceed their deductible before the insurer would start paying anything. Premiums do not count toward an individual’s deductible.
Once the deductible is met, coverage moves to the second stage, in which the insurer shares the cost of medical expenses with the individual.
What is Coinsurance?
Coinsurance is the percentage of medical expenses that insurance will cover after the deductible has been met. Coinsurance is usually represented as the individual’s share plus the insurer’s share—which, together, add up to 100%.
For example, an 80/20 policy means insurance will pay 80% of a medical expense while the individual is responsible for paying the remaining 20%.
Once the out-of-pocket maximum is met, however, coverage moves to the third stage, in which the insurer pays for medical expenses entirely. But first, let’s look at copayments.
What is a Copayment?
Some plans include copayments—often called copays. Copayments refer to exact dollar amounts that individuals pay for each medical service that their policy covers.
Within the same plan, copays can vary depending on the medical service. For instance, they depend on whether a service is essential or routine as opposed to others that are less routine. Additionally, copays tend to be lower for standard doctor visits versus specialist visits.
In most cases, copays do not count toward the deductible. But since 2014, copays must count toward the out-of-pocket maximum for all new health plans.
What is an Out-of-Pocket Maximum?
An out-of-pocket maximum is the total amount an insured individual will spend on their medical expenses in a calendar year. An out-of-pocket maximum is designed to be a stop loss for the policyholder.
In other words—once an individual hits their out-of-pocket max—the insurance company will pay the rest of their covered medical expenses. Keep mind, though, that premiums do not count toward an individual’s out-of-pocket max.
So, you can think of the three stages as a gradual transition from full individual responsibility to full insurance responsibility. Generally, an individual pays for all medical expenses until they reach their deductible, then they share a percentage of the cost with the insurer until they reach their out-of-pocket maximum, at which point insurance should pay for all covered medical expenses.
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