Everything You Need to Know About Health Insurance Costs
One of the largest expenses (both expected and unexpected) that you'll ever receive are medical expenses. We've already talked about the importance of being prepared for large/unexpected expenses, and health insurance is an important example of being prepared.
According to the Centers for Medicare & Medicaid Services, in 2018, spending on Medicare/Medicaid in the U.S. was ~$1.35 trillion, spending by private health insurance was ~$1.24 trillion, and spending by individuals was ~$376 billion! Healthcare expenditures accounted for 17.7% of GDP! A range of common procedures/services, from $3,000 CT scans to $30,000 for a 3-day hospital stay, make health insurance a necessity. But how does it work?
In this edition, we'll get into the basics of health insurance so you can navigate this (perhaps intentionally) confusing space with confidence. First things first: what is health insurance? Insurance is a contract between you and an insurance company that spells out how you and the company will share the costs of some category of expenses. Health insurance or a health insurance plan is just insurance that shares the cost of healthcare-related expenses.
The key to understanding health insurance is to understand how the cost is shared between you and the insurance company. Learning what costs you pay vs. what costs the insurance company covers will be the focus of the first several sections of this article. After we understand how cost-sharing works, we'll talk about how to determine coverage (i.e. what kinds of expenses qualify for cost-sharing, and to what extent). Finally, we'll finish things off by talking about the considerations with picking the right insurance plan for you. Let's dive in!
The U.S. Health-Care System from 1000 Feet
There are 3 main actors in the health-care system:
Health Services (e.g. physicians, hospitals, pharmacies) → They serve patients and need to get paid. They charge $X for a given service.
You → You need healthcare services. In order not to be stuck with the entire bill of $X (which, as we saw in the intro, can be super high), you get an insurance plan that charges a monthly premium (think membership fee) of $Y (much less than $X), is what you pay to have access to the health insurance plan. When it come times to pay the $X for the actual health service, the amount that you pay is called out of pocket (since it comes out of your pocket, not the insurance companys')
Insurance Company (e.g. Blue Cross Blue Shield, Aetna, etc.) → They pay a portion of the cost of health services for its insured participants. The portion of the $X that is the insurance company's responsibility is the covered amount.
That's the health-care system in a nut-shell! You pay a monthly premium for health insurance, and that splits the cost of health services between you and the insurance company. Let's take a look at the two costs that are your responsibility in more detail.
Health Insurance Premiums
Whether you have insurance through your work or buy insurance through the healthcare exchange, you will be paying a premium to have access to your health insurance plan (either taken out of your paycheck or paid directly). Premiums can vary from company-to-company, plan-to-plan, and person-to-person. As of the Affordable Care Act, the only factors that are considered when an insurance company sets your premium for a given plan is:
Age: Older people typically have higher premiums because they typically get sicker more often (which costs more).
Location: State/Local rules, cost-of-living, and other factors come into play.
Tobacco Use: Smoking kills (and costs more to insure).
Individual vs. Family Enrollment: the more people that are covered, the higher the premium.
Plan Category: Plans on the health insurance marketplace and most plans in private companies are categorized into the "metal categories". Categories range from Bronze (higher out-of-pocket costs, lower premium) to Platinum (lower out-of-pocket costs, higher premium).
The monthly premium is a key data-point when comparing health insurance plans, because it'll become a constant part of your budget.
Out-Of-Pocket Healthcare Expenses
While premiums are a constant, monthly cost, out-of-pocket healthcare expenses only arise when you actually utilize a particular health service. How much your out-of-pocket expenses come out to depends on whether/to what extent the health service you're utilizing is covered. We'll come back to coverage in the next section, but let's see a concrete example where everything is covered to illustrate some of the common lingo (numbers roughly based on individual plans found on eHealthInsurance for similar demographics):
Kylo identifies as male, and is 22 years old living in Seattle. Kylo has a health insurance plan from Cigna with a $300 monthly premium, $6000 annual deductible, and 20% coinsurance. They have co-payments of $25 for prescription drugs and $50 visits to their primary care physician (PCP). Their annual out-of-pocket maximum is $8000 with an annual coverage limit of $2 million. Kylo enrolls in this plan January of 2019. In June of 2019, they go to their PCP because of a stomach ache 🤢 and get prescribed indigestion medications 💊. In August of 2019, they go to their PCP for their annual physical and immunizations 💉. How much does Kylo pay by August?
Co-payment/Copay: this is a "flat-rate" payment per-service that is specified by your insurance plan. Unless you hit your out-of-pocket maximum, you'll always have to pay all copays in full.
In this case, we have $25 for the indigestion medications and $50 for the PCP visit in June. In almost all insurance plans, annual physicals and immunizations (called preventative care) are 100% covered by your insurance, so Kylo won't have to worry about any costs associated with those.
Out-of-pocket Maximum: this is maximum amount of money you have to pay until you don't have to pitch in for the costs anymore. This takes into account most out-of-pocket expenses* (e.g. copay, coinsurance, etc.) but excludes other types of expenses (e.g. premiums).
* Note: It's important to know what costs factor into the out-of-pocket maximum. Check your health plan if you're unsure!
Since Kylo paid $25 + $50 = $75 as of August in copayments, their total out-of-pocket expenses are $75, which is well below the out-of-pocket maximum of $8000, so they'll have to pay those $75 in full. Kylo didn't rack up that big of a balance for those first 8 months. However, in September, Kylo experiences some very bad luck...
In September of 2019, Kylo unfortunately got hit by a bus 🚌, and was sent to the hospital. Kylo stayed at the hospital for 2 days before being discharged, which cost $20,000 in total. If things couldn't get any worse, Kylo gets struck by lightning ⚡️ the next day, forcing him to get lightning repair surgery and spend another 3 nights in the hospital, totaling $300,000. How much does Kylo pay at the end of September?
Deductible: this is a set amount that you have to pay (usually excluding copays and premiums) before the insurance company starts paying anything. Until you "meet the deductible", the costs are out-of-pocket.
Let's say the $75 paid before doesn't count toward the deductible, but that the hospital bills for both accidents do. For the first hospital bill of $20,000, Kylo would pay the first $6,000 of that out-of-pocket. There's a special name for health plans with "high deductibles" (federal guideline, set at $1.4K for 2020), and since Kylo's health plan has a deductible of $6,000, it'd be categorized as a High Deductible Health Plan (HDHP) (more on this later).
Coinsurance: once you've met your deductible, coinsurance tells you what % of the cost of the health service you have to pay (excluding copays). Coinsurance, like copays, count toward the out-of-pocket maximum.
Post-deductible, Kylo's hospital bill came out to be $20,000 - $6,000 = $14,000. With 20% coinsurance, Kylo is responsible for $2,800. By the time Kylo gets the lightning hospital bill, they've already met the deductible, so their responsibility of that bill is $60,000. That brings the total from coinsurance to $60,000 + $2,800 = $62,800
Since Kylo's out-of-pocket maximum is $8000, and they've already paid $75 in copays, they'll only pay $7,925 towards these two hospital bills. That leaves the remaining $62,800 - $7,925 = $54,875 to be paid by Cigna! For the rest of 2019, if Kylo has any copays/coinsurance for any future care, then Cigna will pay the bill in full. This is until the total expenses go over the $2 million annual limit, in which case Kylo is on their own 😢.
The previous example assumed that the health services costs were covered, but how do you know if a particular health service is covered by your insurance? Answering the question of coverage involves two sub-questions: what services are covered and where can I receive health services?
What will be covered?
When you look at your health insurance plan, you'll have access to a Summary of Benefits and Coverage, which gives (a) a short overview of what's covered and (b) a list of all services. According to the Affordable Care Act, there are 10 essential health benefits every health insurance plan must provide (e.g. hospitalization, mental health, prescription drugs, etc.). Some of these benefits are covered 100% without regard to copay (e.g. preventative care).
Services besides this minimum may include common services like dental/vision or other services that you may need personally, so you may have to purchase separate plans to get dental or vision coverage or even disease-specific like diabetes. Since there is a multitude of prescription drugs out there, there will also usually be a formulary (list of covered drugs), that often group drugs into "tiers" based on how expensive they'll be for you (e.g. generic brand drugs are more expensive than name-brand drugs).
Getting a health service bill covered is a matter of filing a claim or giving the health service provider your insurance information so they can bill them directly (depending on your insurance plan). Once either of these happens. you'll receive a bill as well as an explanation-of-benefits (EOB) which explains how a given medical cost was broken down, what was actually covered, etc. These can be pretty hefty documents, but it's important to read them carefully because if something is not covered or there's a mistake, you can appeal the decision to potentially recover some of your losses! Blue Cross Blue Shield (popular U.S. insurance organization) has a good sample EOB here.
Where can I receive health services?
Insurance companies typically sign contracts with individual hospitals/doctors to get discounted rates for their insured participants. The healthcare providers who signed these contracts are considered "in-network" providers for a particular insurance company. Providers who didn't enter into those contracts are considered "out-of-network" (usually more expensive than in-network and usually require some paperwork like filing a claim). The details between in-network vs. out-of-network are what constitutes the major differences between the major types of insurance plans (which we'll see in the next section!)
Picking Your Insurance Plan
Health Maintenance Organization (HMO)
No coverage for out-of-network health providers and need an in-network PCP that decides when to make referrals to other in-network providers.
Usually has the lowest premiums.
Good if you want a cheap plan and don't have any specific/chronic health conditions.
Point of Service (POS)
Supports coverage for out-of-network, but need a PCP that's in-network to give you a referral.
Higher premiums than HMO, but less than PPO.
Good if you have a chronic/specific condition or might be traveling a lot.
Exclusive Provider Organization (EPO)
Like HMO, but usually with a larger network. Referral may or may not be required from in-network PCP. No coverage for out-of-network.
Higher premiums than HMO, but less than PPO.
Good if you have a chronic/specific condition or might be traveling a lot.
Preferred Provider Organization (PPO)
Most flexibility/coverage for out-of-network providers. Don't need referrals. Basically see whoever you want!
Good if you have very specific needs, and want to ensure you get the best specialty doctors for your needs at the most affordable price.
High-Deductible Health Plan (HDHP)
An HDHP can include one of the other plan types (i.e. HMO/PPO/etc.), and is characterized by lower premiums and higher out-of-pocket costs (i.e. higher copays/coinsurance/deductible/out-of-pocket maximum).
The key consideration when choosing between a high premium vs. HDHP is: how much do you expect to utilize health services? If the answer is "not very much" (e.g. generally in good health), then you'll save on premiums by opting for an HDHP. If the answer is "probably a lot" (e.g. have a chronic condition), then you'll save on out-of-pocket expenses by opting for a higher premium plan.
It's important to think about your situation carefully when deciding HDHP vs. non-HDHP. Talk to your doctor about risk factors, talk to family about family history, and do your own research so you can get insured for the amount of care that you need. Be careful not to be in a situation where you're avoiding the doctor 👩🏼⚕️ because you want to save on out-of-pocket costs.💀
For more information on the different types of plans, check out Aetna's (large U.S. insurance company) guide.
Saving for Medical Expenses
As we saw in the example, sometimes you'll be paying thousands of dollars for medical expenses. One way is to dip into your emergency fund (e.g. high-yield savings account or regular savings account). However, you may have access to some neat tax-advantaged savings accounts that you can use instead. In some ways, you can think of these accounts like pre-tax retirement accounts. That is, the money you put in these accounts won't count when you're calculating your income taxes, and (for the most part) if you spend the money on qualified medical expenses (e.g. out-of-pocket expenses, bandages, eye-drops; can be more inclusive than your insurance plan!!), then that money is tax-free.* There are 3 popular plans offered by employers that accomplish this in 3 different ways:
Note: For more information on the tax implications of these 3 different accounts, check out the IRS: Publication 969.
Health Savings Account (HSA)
An HSA is a bank account that you own that can be used for medical expenses. They can be taken out of your paycheck (pre-tax contribution) or you can contribute to them directly and deduct from your taxes how much you contribute. The funds roll-over at the end of each year, and you can take them with you even if you switch employers. However, you must have an HDHP in order to be eligible for an HSA. The contribution limit for a single contributor was $3550, and $7100 for family plans in 2020.
The neat thing about HSA's is that you can invest the money in your HSA into stocks/bonds/mutual funds. That means that the money in your HSA that you aren't currently using to pay off medical expenses can sit in mutual funds, getting all the benefits of compound interest with 0 taxes. If you're under 65 and use the money for non-qualified medical expenses, you'll have to pay a fee AND taxes. HOWEVER, if you're over 65, all you'll have to pay is the taxes, so it's basically like a traditional IRA.
Flexible Spending Account (FSA)
This savings account is owned by your employer and is contributed to by taking set amounts from your paycheck. You can put in a maximum of $2,650 per year into your FSA. You'll likely have to use all the money in the FSA by the end of the year, otherwise, the money just goes away (though some employers allow you to carry over a fixed amount/give you a grace period to use up the money). If you leave your employer, you can't take the funds with you.
There are 3 types of FSAs:
Healthcare → this is the most common one, and you can use the funds on qualified medical expenses. Once you agree to a certain amount for a given year, those funds are "pre-funded" into your account. For example, if you commit to contributing $2K into your FSA this year, then you have access to all $2K even if it's the beginning of the year (you can ask for reimbursement if there's not enough in the account).
Dependent → this FSA is for dependents (e.g. for kids ≤ 12 or disabled family members). This FSA is not pre-funded, so you can only use as much as is in your account.
Limited Purpose → like a Healthcare FSA, but only for dental/vision. This can only be used if you have a separate HDHP with an associated HSA.
Health Reimbursement Arrangement (HRA)
Some employers offer lump-sums of money that can be used to reimburse medical expenses. These are owned by the company and the rules/contribution limits are usually company-specific. There are 2 major types:
Individual Coverage → Employees buy health-care for themselves on the healthcare exchange, and reimburse the costs.
Excepted Benefit → Reimburse up to a certain amount a year for medical expenses. Can use even if not insured.
If you have an offer → be prepared to read about your health care plan options in-depth and don't be afraid to ask your HR department questions! Print out the docs, highlight/annotate, and make an informed decision! 😤 If you don't have an offer and you're under 26 years old, you can stay on your parent's plan 👶.
If your company provides HDHP + HSA, think through if that'll be worth it for you. Use this calculator to help you explore your options.
Become informed on the cost estimates for procedures/prescriptions/services/etc. Healthcare costs are notoriously opaque, but there are databases that are starting to bridge this gap. Here are 2 options: fairhealthconsumer and ClearHealthCosts (+ corresponding Ted Talk).
Phew! That was a lot of information. But hopefully, this post gave you the introduction to health insurance that you need to (a) make informed decisions about your health care and (b) dive deeper into topics that are useful for your circumstances. Finally, hopefully, this post has gotten you thinking more about your health and how it impacts your life, both financially and otherwise. I think this anonymous quote sums it up nicely:
You can't enjoy wealth if you're not in good health.
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Disclaimer: The content on Young, Not Broke is for informational and educational purposes only and should not be construed as professional financial advice. Should you need such advice, consult a licensed financial or tax advisor.