How Health Insurance Works

Why America Relies on a Private Health Insurance Model

African American medical professional holding baby
••• Photo by ERproductions Ltd/Blend Images/Getty Images

Health insurance works by protecting your assets from the high cost of medical care. Without it, your entire life savings could be wiped out by a $300,000 medical bill. In fact, health care costs are the No. 1 cause of bankruptcies.

It's 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.

Why You Need Health Insurance

Health insurance is necessary for Americans to pay for the high cost of health care. You need it unless you are very wealthy, over 65, or very poor. The very wealthy can afford the cost of even extraordinary emergency or chronic medical care. Those over 65 have paid into Medicare. The very poor can 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.

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.

How to Choose Health Insurance

Health insurance companies provide lots of choices. But before you select a plan, you've got to wade through various combinations of deductibles, copayments, coinsurance, 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. Deductibles can range anywhere from $500 a year to $10,000 a year or more. The lower deductibles are only available from company-sponsored plans. They are annual, which means you start over on January 1 of each year. 
  3. 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.
  1. 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. 

Why do insurance companies charge deductibles, copays, and coinsurance? They want 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 said these out-of-pocket costs can't exceed a 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 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. 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

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 that this tax break alone increases the U.S. deficit by $250 billion a year. But politicians aren’t likely to get re-elected if they suggest removing it.

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 found that the average benefit of the health insurance tax break was about $281 for a household in the 15 percent tax bracket. But the benefit is $374 for those in the 25 percent tax bracket. 

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 the French or Germans go to the doctor or the hospital, the government picks up most or all of the bill. The downside is that 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.

When Hillarycare tried to implement universal health care in America, the medical profession and health insurance companies defeated it. Obamacare was initially presented as universal health care. But the insurance companies changed it to one that relied on their products. 

An alternative to health insurance 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 the 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. Research has found that . As a result, income inequality has led to health care inequality.

For a step-by-step guide in picking the right insurance for you, see my book, "."