How are Health Plans Paid For
Healthcare can be a costly affair, so understanding how to pay for health coverage and things like visits to the doctor essentially become a matter of financial literacy.
One survey by PolicyGenius in 2016 found that only 4% of Americans could successfully define four key terms related to health insurance ("deductible", "co-pay", "co-insurance", and "out-of-pocket maximum").
This newsletter is all about guiding you through the complexities of the healthcare system. One way we measure the effectiveness of health interventions is expenses, and if the details about how a member pays for their health plan is not fully understood, then we can't even begin to assess the impact of the health care system's structure on the average person's wallet.
So for today, let's go over some crucial health insurance terms. More specifically, I'm going to walk you through what a premium, deductible, co-pay, co-insurance, and out-of-pocket maximum are.
The premium is probably the simplest of the terms we will discuss. This is a monthly rate which you pay the health insurer.
Generally, these premiums are the revenue that health plans use to help pay for the healthcare of their members. The pricing levels used by a health plan can indicate a handful of factors behind the scenes.
If the members of a health plan are relatively healthy, then the health insurer can expect to pay care providers less for these peoples' treatments. Less chronic conditions or risky actions that would cause medical conditions and the need to see a doctor or get some treatment means that the insurer needs less revenue to cover the plan, and thus it can justify keeping premiums lower.
However, if the cost of covering members starts to go up, then premiums typically have to rise as well. One particularly concerning phenomenon is when the premiums become so high that the healthiest members of the plan decide it's not worth the higher premiums to stay in the health plan. If the healthiest members leave, then that reduces revenue and makes the average cost of care per person higher, because the health plan has a greater number of less healthy members.
The implications of this are the infamous "insurance death spiral", wherein the lowest-risk members of a health plan (AKA the healthiest) continue to leave a health plan. Due to a smaller but more medically expensive member base, the plan has to continue to raise premiums.
On the other hand, higher premiums for a health plan may indicate that the plan itself requires less out-of-pocket (OOP) spending from the members. If the member of a health plan is paying less out-of-pocket, then someone has to still pay the care provider. Low OOP spending must be compensated with higher reimbursements from the insurer to the provider, and so, the insurer needs higher premiums to pay for the plan.
On the topic of OOP spending, what actually determines the amount that patients spend?
Before getting into OOP spending, lets take a step back and consider the structure of a health plan as it concerns the care provider. The care provider is giving the member of the health plan a service. Typically, the health plan must negotiate with the care provider something called a "negotiated rate" or "allowable cost". Generally, if the health plan can ensure that a provider is going to see more patients from the health plan, they can negotiate a lower negotiated rate that the provider is obligated to get for their services to the health plan's member.
That is also why insurers might not be clamoring to have the biggest possible provider network. If the provider network is too big, then the insurer can't guarantee a greater number of patients for each provider to see, and thus in exchange for volume, the insurer must agree to a higher obligated rate.
At the end of a transaction, whatever the patient pays and whatever the insurer reimburses must add up to this negotiated rate.
The deductible, in short, is the amount that the health plan expects you to pay out of your pocket over a certain period of time (usually a year) before the insurer comes in to help you pay for care.
This means that you will generally be paying care providers the entire negotiated rate until the total spending hits your deductible.
If your deductible is $2,000 dollars, and you've spent only $150 on health services that year, then you will have to foot the entire $50 bill that you may be charged for a service. Only once you exceed that $2,000 deductible over the year does the insurer help pay a piece of that $50 bill.
A high deductible health plan (HDHP) is a special type of health plan with, as you guessed it, higher deductibles. In exchange for expecting the members to pay more out-of-pocket, the insurer charges lower premiums. This model of health plan became more popular in the past 15 years as a health plan option with low upfront costs in the face of ballooning health expenditures.
Co-Pays and Co-Insurances
Suppose you hit your deductible. What do you pay now?
If you have a co-pay arrangement, then after you hit your deductible, you only pay a fixed dollar amount specified by your co-pay. The insurer pays the rest. In the case of our $50 bill, a $10 co-pay means that you pay $10 out of pocket, and the insurer pays the remaining $40.
A co-insurance is very similar, but with a percentage. If your co-insurance is 15%, then out of that $50 bill, you'd pay $7.50 in co-insurance to the provider, and the insurer pays the other $42.50.
Out of Pocket Maximums
The out-of-pocket maximum is the last of the common terms we'll discuss today. Once your total out-of-pocket spending for a time period (once again, usually a year) hits this amount, the insurer agrees to pay everything.
So, suppose you have a $2,000 deductible and a $5,000 maximum. You will pay the full negotiated rate to your providers until you hit the deductible of $2,000 in total spending. Then after that, you will be paying co-pays/co-insurance until the total spending after your deductible and after adding your co-pay/co-insurance hits the $5,000 maximum. After this, you pay nothing out-of-pocket.
Here's a small graphic to sum up what we just covered.
Health Plan Literacy is Public Health
That was quite a bit to cover. Having reviewed all those terms, it's also pretty clear why many Americans may not be able to define all of these terms. Most of you reading this might not be able to fully define the deductible without looking above. These terms take time to teach and build into a person's vocabulary, let alone teaching millions of health plan shoppers about what a co-pay is.
Further, just consider the following Department of Education statistic from 2020:
54% of U.S. adults 16-74 years old - about 130 million people - lack proficiency in literacy, reading below the equivalent of a sixth-grade level
When most American adults aren't able to read at a middle school level, it raises the question of how well Americans can understand not just how a health plan is paid for, but also what they can get out of a health plan or how to get the most out a health service.
The ability to make Americans literate in their health and health plans is not just a matter of personal responsibility. Costs in the healthcare system affect everyone through domino effects. When people have a harder time reading text from their own health plan or care providers, that's less utilization of preventative services and treatments, and that's higher costs in the long run.
Going further, how are people expected to choose the health plan that's best for their needs and financial resources? How are people supposed to judge as voters if their healthcare costs are high because they don't know about existing policies and alternative options?