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How health insurance works

By Paula Pant ·
Wednesday, October 23, 2013
Posted: 3 pm ET

Health insurance plans are hitting the headlines right now, with health insurance exchanges opening Oct. 1 as part of health care reform.

If you are shopping for a health insurance plan, you might be confused about how to find the best value. Here's what you need to know about how health insurance works.

Let's start with the important terminology. It includes:

  • Premium. Your monthly payment.
  • Deductible. The amount you pay out-of-pocket before any benefits kick in.
  • Co-pay. The base fee you pay for a doctor's visit. It usually does not count toward your deductible.
  • Co-insurance. The percentage of the bill that you pay after the deductible is maxed out.
  • Out-of-pocket maximum. The maximum you'll pay per calendar year through your co-insurance. It sometimes does not include your deductible or co-pays, and it never includes your premiums (aside from some government programs, such as Medicaid).

One example

Clear as mud, right? Here's an example (and for the sake of drawing a clearer picture, I will not increase health premiums over the years):

Sally has a health insurance plan with a $2,500 deductible, $35 doctor visit co-pay and $100 emergency room co-pay, 70/30 co-insurance and a $5,500 annual out-of-pocket maximum (which does not include her deductible or co-pay). She pays $100 per month in premiums.

Sally breaks her arm. Her total bill comes to $25,000. How much does Sally pay?

Her deductible plus co-insurance, up to the out-of-pocket maximum, equals $8,000. In addition, she pays $100 as an emergency room co-pay, $35 for a follow-up doctor visit and $1,200 per year ($100 per month) in premiums. In total, Sally spends $9,335 on health-related expenses that year.

But Sally doesn't get sick or injured for the next five years. In those following years, she pays only for her premium. After six years, Sally has spent a total of $15,335 on health costs, including premiums.

Alternately, her brother John purchased a plan with a $500 deducible, $50 emergency room co-pay, $10 doctor co-pay, 90/10 co-insurance and a $2,000 out-of-pocket maximum. John only paid $2,560 for his broken arm.

But his premiums cost $250 per month, meaning he spent a total of $5,560 that year on health care costs. And after six years, John has spent $20,560 on health costs – substantially more than Sally.

How does this information help you find a plan? When you're shopping around, weigh the likelihood of enduring an expensive health situation against paying higher premiums.

If you have a chronic illness or if you tend to get a lot of medical care, the higher premiums might be worth the increased coverage. But if you're generally healthy and want to protect yourself only against catastrophes, it may be more cost-effective in the long-run to opt for a cheaper premium.

Paula Pant blogs at about building wealth and living life on your own terms. She's traveled to 30 countries, owns six rental units that produce thousands of dollars in passive income, and runs her own freelance writing and digital marketing company. Follow Paula on Twitter: @AffordAnything.

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1 Comment
October 15, 2014 at 4:47 pm

definitions if not clarity