How Does Health Insurance Work: Here’s What You Need to Know

Nearly 10% of the US population doesn’t have health insurance.

This may sound like a low number until you consider that it represents almost 30 million people and that without coverage a single accident or injury can result in medical expenses that can cause years of financial hardship.

Without coverage, routine exams and basic medical needs are often overlooked as well, potentially contributing to larger health issues later.

If you’re in the market for health insurance coverage, here’s what you’ll need to know.

how does health insurance work
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What is covered by health insurance?

Health insurance plans vary in what they cover, often depending on whether the plan is sponsored by your employer.

For example, many employer-sponsored health insurance plans cover vision care, such as glasses and contacts, whereas plans purchased independently often do not offer vision care for adults.

The Affordable Care Act (ACA), better known as Obamacare, introduced the requirement of Minimum Essential Care (MEC), which refers to 10 essential health benefits that ACA compliant health plans must have.

Essential benefits

These essential benefits include hospitalization, prescription coverage, lab services, pediatric services, and emergency care, as well as preventive and wellness services, which would include periodic checkups.

Preventive services

Covered preventive services are broken out into three groups: all adults, women, and children, and cover several categories of preventive screening distinct to each group.

ACA-compliant plans also cover ambulatory services, which refer to medical services provided even if not admitted to a hospital.

Cosmetic medical services

Notably, cosmetic medical services, weight loss surgery, and alternative medical treatments are not considered essential services.

However, some plans may offer limited coverage for services not required by the Affordable Care Act.

Vision and oral care for children

ACA-compliant plans must provide vision and oral care for children, although it is not a requirement to provide these services for adults.

Consequently, some plans offer bundled adult coverage for vision and dental while others do not.

Out-of-pocket costs

While the list of coverages offered by ACA-compliant health insurance plans is extensive, it’s important to be aware that there may still be some out-of-pocket costs even for covered services.

Most plans adhere to the Minimum Essential Care requirements but there are some types of plans that do not, including short term health insurance.

ACA-compliant plans are grouped by “metals categories”, including Bronze, Silver, Gold, and Platinum, with each category corresponding to increasing levels of coverage as you move up in the metal tiers.

Catastrophic health insurance with reduced coverage areas is also available for those under 30 or those with financial hardship exemptions.

Open enrollment and the marketplace

One of the many changes brought by the Affordable Care Act when it was passed in 2010 was the formation of a centralized healthcare marketplace.

The marketplace serves as a hub where people can shop for plans and find out if they qualify for financial assistance, called subsidies.

As a technical matter, insurance is governed at the state level, which led to the creation of several independent marketplaces for specific states, like Covered California, or New York State of Health.

Whether using the Marketplace at Healthcare.gov or a state-specific marketplace, you’ll find that you can only buy ACA-compliant health insurance at certain times, called open enrollment.

However, there are several exceptions to the rule, like getting married, having children, or if you lose your health insurance through an employer.

If you qualify for Medicaid or Children’s Health Insurance Program (CHIP), you can also enroll at any time.

Short-term health insurance plans are a common option for those who need coverage between open enrollment periods.

Individual coverage mandates

Prior to 2019 and following the passage of Obamacare, health insurance became mandatory and was enforced by a tax penalty for those who didn’t have coverage.

The federal mandate has been lifted, but you may still find state-level mandates that require residents to purchase health insurance if they don’t have qualifying coverage. 

A handful of states still have their own health care mandate and others are considering legislation.

Even in cases where health insurance is no longer mandatory, seeking coverage is beneficial in regard to routine and preventive care and can offer long-term financial security by protecting you against larger medical expenses due to illness or accidents.

Health insurance costs

While health insurance can help prevent financial catastrophe due to medical expenses, it isn’t without cost.

These are the primary terms you’ll need to understand when purchasing coverage.

  • Health insurance premium: The premium is the payment for the insurance coverage itself and premium amounts are driven by age, location, tobacco use, plan category (metal tier), and individual vs. family enrollment. For ACA-compliant plans, neither pre-existing conditions nor gender may be used to establish premiums or determine eligibility.
  • Copayment: A copayment is paid by the insured and is usually a fixed dollar amount paid directly to the service provider.
  • Coinsurance: Similar to a copayment, coinsurance is an amount paid by the insured and is typically a percentage of the total cost of service.
  • Deductible: Most plans have a deductible in addition to copayments or coinsurance. A deductible is an annual amount you’ll need to satisfy before your coverage begins to pay for medical expenses. Preventive services are usually not subject to a deductible.
  • Out-of-pocket (annual) maximum: Between copayments, coinsurance, and deductibles, out of pocket costs can add up. An out-of-pocket-maximum sets a limit to how much you pay out-of-pocket, with the insurer paying for all qualified expenses once the annual out-of-pocket limit is reached.
  • Lifetime maximum: A lifetime maximum refers to the maximum amount an insurer will pay for a certain medical service or category during the entire course of your coverage. Lifetime maximums may apply to orthodontics, for example.
  • Annual limit: Similar to lifetime maximums, insurers may limit the annual amount they will pay for certain services. Again, it’s more common for this to apply to add-on coverage, like dental or vision care.

Example of how health insurance coverage works

Here’s an example of how coverage might look for a common procedure.

Let’s say you’re a 50-year-old single male in NJ and after visiting your doctor for stomach pain, you learn you have gallstones.

The condition is extremely common, with nearly half a million US residents undergoing gallbladder surgery each year.

The cost of this surgery can vary, but a laparoscopic procedure is less expensive, ranging from a negotiated rate for uninsured patients of about $17,000 up to $24,000 on average for surgery covered by insurance.

Without insurance, the cost is easy to understand. You pay $17,000. With coverage, there’s some math involved — and it can vary case by case.

Deductible

The first consideration is the deductible. On a bronze plan, which has the highest annual deductible of $3,000, expect to pay at least $3,000 unless some of the deductible was already paid earlier in the year.

For most plans, you can also expect to pay copayments or coinsurance, or both.

Copayment

Copayment are generally smaller payments, like $30 for a routine doctor visit. Coinsurance will be a major factor in this case, however.

In our example, which is based on a real plan, the coinsurance for outpatient surgery like laparoscopic gallbladder removal is 30% after the deductible.

30% of $24,000 is $7,200 but a deductible of $3,000 has to be applied first. The math would be $24,000 -$3,000 = $21,000. The 30% coinsurance would then be applied against $21,000, which is $21,000 x .30 = $6,300.

Bronze tier plans currently have an annual out-of-pocket limit of $6,750 for individual coverage. Because the $3,000 deductible was already paid, the most you would pay for the $24,000 surgery is $3,750.

If you had other qualified out-of-pocket expenses earlier in the year, your cost may be lower due to the out-of-pocket cap.

Higher tier plans, covered in a later section, can reduce the out-of-pocket cost for this procedure. However, the trade-off is a higher monthly premium.

Health insurance plan options

You’ll also need a basic understanding of the network types available, the metal tiers, and high-deductible health plans, which are a popular option to save on overall healthcare costs by using tax advantages.

Health insurance network types refer to how the network is structured and how much freedom you have to choose your doctors or providers.

  • HMO: A Health Management Organization uses a controlled structure to help reduce the cost of healthcare, often making HMO the least expensive coverage in regard to premiums. Your primary care physician acts as a central point for in-network care and can approve a specialist or special procedure if needed. Non-emergency care outside of your network typically is not covered by an HMO. An HMO is a regional network.
  • PPO: A Preferred Provider Organization provides more flexibility because you don’t need to choose a primary care physician nor do you need a referral to see a specialist. Non-emergency out-of-network coverage is provided. However, out-of-network services are typically covered for a lesser amount as a percentage. PPOs may include out-of-state providers that are still considered to be in-network providers.
  • POS: A Point of Service plan functions like a hybrid of an HMO and a PPO. Your primary care physician still acts as a central point for care and referrals, but you have the option to choose out-of-network providers, albeit with a higher out-of-pocket cost.
  • EPO: An Exclusive Provider Network is another type of hybrid between an HMO and a PPO. In this case, you don’t need a primary care physician for referrals but you are limited to in-network providers for coverage. Non-emergency out-of-network services must be paid out-of-pocket.

Where network types speak to your freedom to choose providers and care, metal tiers for ACA-compliant plans speak to the level of coverage, meaning what percentage of your care is covered by the insurance plan compared to how much you pay out-of-pocket.

Metal tiers coverage percentages

Below are estimates of coverage percentages as provided by Healthcare.gov.

Plan categoryInsurer shareInsured share
Bronze60%40%
Silver70%30%
Gold80%20%
Platinum90%10%

Premiums for metal tier plans increase with plan level, but higher tier plans offer more robust coverage, reducing the risk of high out-of-pocket medical expenses.

When shopping for health insurance, you’ll often find the metal tier in the name of the plan.

Using the Marketplace or a state exchange, you can also filter results based on metal tier, with bronze plans having the lowest premiums and platinum plans the highest.

High Deductible Health Plans (HDHP) are another variation that can save money on premiums and which can be combined with a Health Savings Account (HSA) to provide a tax-free way to pay for qualified medical expenses.

As the name suggests, a high deductible health plan has a higher-than-average deductible, with current IRS guidelines requiring a minimum annual deductible of $1,350 for individuals and $2,700 for families to qualify for a tax-advantaged health savings account.

Health insurance programs administered by the government

Several government-sponsored health insurance plans are available as well. Eligibility is based on age, income, or both.

  • Medicare: Most people are familiar with Medicare, which is a healthcare program for seniors age 65 and up. Medicare is split into 4 parts, with part A & B providing hospitalization (Part A) and medical insurance (Part B) coverage. Based on income, there may be a monthly premium for Part B. Medicare Part C (Medicare Advantage) is private market coverage that can replace Part A & B and which requires separate premiums. Seniors may wish to research Medicare Part C if they require dental or vision care coverage. Part D refers to Medicare’s prescription drug benefit.
medicare federal health care plan
source: J.P.Morgan
  • Medicaid: Although it may have different names in different states, Medicaid is largely uniform throughout the country and provides free or low-cost healthcare coverage to qualifying individuals or families based on income. It is possible to qualify for both Medicare and Medicaid. Dental and vision care are included coverages.
  • CHIP (Children’s Health Insurance Program): Aimed squarely at providing healthcare for children, CHIP is available for families that earn too much to qualify for Medicaid but who need coverage for dependent children.
  • MHS (Military Health System): With over 9 million beneficiaries MHS is one of the nation’s largest healthcare institutions and provides coverage for veterans, active military members, and military reserve personnel. Eligibility for various coverage options are based on service status and/or awards.
  • IHS (American Indian and Alaska Natives): Providing coverage for any of the 567 federally recognized tribes, IHS provides a number of healthcare services including hospitalization, elder care, vision care, and more.

Take advantage of an HSA

If you’re able to use a high-deductible health plan, you can also qualify for a health savings account (HSA), a tax-advantaged savings plan which allows you to use pre-tax money to pay qualified medical expenses.

Health Savings Account (HSA)
source: J.P.Morgan

With an HSA, you can currently save up to $3,500 per year for individuals or $7,000 for covered families as a combined contribution from you and your employer (if applicable).

If you’re 55 or older, the IRS allows annual catch-up contributions of an additional $1,000 per year. Expect annual contribution limits to adjust higher each year.

If you don’t need to use the funds in your HSA, the funds can continue to grow tax free until you need them at a later date.

When you do need to use your HSA savings, the funds can be withdrawn tax-free if used for any of an expansive list of qualified medical expenses.

Be aware that you can’t use your HSA to pay for health plan premiums, but deductibles and many other out-of-pocket expenses are eligible.

The combination of lower premiums by using a high-deductible health plan and ability to cover medical expenses with tax-free money makes an HSA a wise choice for many households.

Depending on your tax bracket, using an HSA can provide up to 30% or more in additional funds you can use for health care whenever you need it.

You can use an HSA as a simple savings account or, if you have a larger balance, many providers also offer the opportunity to invest part of your HSA so it can grow faster.

When you reach age 65, your HSA works like an IRA and you can use the funds without restriction.

The primary concern with choosing an HSA and HDHP is to be certain you can spare the money to fund your HSA and pay the higher deductible if you have a medical need.

What is the penalty for not having health insurance?

Beginning in 2019, there is no longer a federal tax penalty for not having health insurance.

However, some states still have an individual mandate and others are reportedly drafting legislation which may become law in the future.

Even in cases where there is no penalty for not having health insurance, making the investment in health insurance is often a wise financial choice. The national average cost for inpatient hospitalization is over $2,000 per day.

Health insurance coverage puts a cap on potential expenses. Without coverage, a 30-day hospital stay following an illness or an accident could cost tens of thousands of dollars.

Longer stays could cost hundreds of thousands, putting your financial future at risk.

With coverage, your out-of-pocket costs are capped by the annual out-of-pocket limit. Insurance of all types is designed to protect against large losses, protection you would lose by not having health insurance coverage.

Buy health insurance to reduce your healthcare expenses

Healthcare expenses are difficult to predict on an individual level — and that’s exactly where health insurance shows its value.

By choosing the right plan for you or your family, you’re effectively smoothing out the peaks and valleys common to healthcare costs over time.

If you’re able to choose a high-deductible health plan and a health savings account, the combination of these two can help reduce your overall healthcare expenses in the short term while helping you save for the future as well.

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