At first, health insurance that covers 100% of health care costs sounds great. However, it can be very expensive. It also can be inefficient due to moral hazard. You generally wind up paying for services whose costs outweigh their benefits even if you do not use them. Even if your employer pays for your insurance, you probably pay for it indirectly because your take-home wages are lower.
Consider a colorful analogy. Have you gone grocery shopping and seen packages of chicken that include giblets and other parts that you do not want? It is not a good deal when you have to pay for things you do not want. A package without giblets may be a better deal. Health insurance that pays for everything can be like a chicken package with giblets. You can wind up paying a higher premium for marginal services that people use, but are not really very worthwhile. Health insurance that pays for the important things but does not cover everything can be a better deal.
To reduce the inefficiency of moral hazard, most health insurance plans have some way to limit use of marginal or extra services. Health Maintenance Organizations (HMOs) tend to have stronger constraints on care provided and indemnity health insurance plans tend to have stronger constraints on care demanded. The most common form of demand-side constraints is out-of-pocket costs.
“Out-of-Pocket Costs” are costs that you pay out of your own pocket when you get health care even though you are insured and have already paid a premium. When out-of-pocket costs are very low and there are no constraints on care provided, then insurance can be very expensive and inefficient. When out-of-pocket costs are very high and there are no limits on how much you might pay, then insurance can be almost worthless for reducing your financial risk. Intermediate levels of out-of-pocket costs are generally the best deals. For these reasons, you need to know what out-of-pocket costs a health insurance policy has.
There are different types of out-of-pocket costs. When you pay up to a certain dollar amount before insurance pays anything, this is called a “Deductible.” Only covered health expenses count toward your deductible. There may be a deductible for each service you get (such as paying $5 for each prescription) or there may be one deductible for whatever services you get for a whole year (such as paying up to $500 for all services during a year). A deductible for each service is often called a “Copay.” Generally, insurance with higher deductibles has much lower premiums. Insurance with a very high deductible is sometimes called “Catastrophic Insurance.”
An “Elimination Period” is like a deductible in days instead of dollars. An elimination period for hospital care means that your insurance will not start paying until after you have been in the hospital for a certain number of days. With increasingly short hospital stays, insurance with an elimination period pays you a lot less than insurance without an elimination period.
“Coinsurance” is what you pay out-of-pocket for health care after you have paid a deductible. Coinsurance is generally shown as a percentage of covered expenses above the deductible. For example, “20% Coinsurance” means that you pay 20% of covered expenses over the deductible. If your provider charges more than the covered amount, you might wind up paying for that difference in addition to the 20% coinsurance.
In addition to deductibles and coinsurance, some health insurance also has a “limit” or “cap” on how much it will pay for individual services, episodes of illness, or lifetime benefits. A “Lifetime Maximum Benefit” or “Benefit Ceiling” limits how much your insurance pays you over your lifetime. This can leave you vulnerable to risk if it is not high enough. If you must get a plan with a lifetime maximum benefit, it should be $1 million or more.
A maximum benefit limits what the insurance company will pay. The conceptual opposite is an out-of-pocket maximum. An “Out-of-Pocket Maximum” is the most that you will ever pay for covered medical services during a benefit period. With a true out-of-pocket maximum, the plan pays for all covered services above the maximum. However, be careful. Some out-of-pocket “maximums” are not true maximums. The plan only pays an allowable amount per service and you have to pay more if your provider bills you for more than that. A true out-of-pocket maximum is worthwhile because it limits your risk of large health care bills.
Before choosing a health plan, check what out-of-pocket costs a plan has for a hospital stay, outpatient visit, other physician services, drug prescription, and other services. Health plans with greater out-of-pocket costs should have lower premiums. Not only do they pay people less money for covered services, but their members who pay out-of-pocket use fewer services.
Different types of out-of-pocket costs leave you with different risks. Health insurance with out-of-pocket costs that include only modest deductibles leaves you at risk for some small things, but covers the big things. This is less risky. Health insurance with out-of-pocket costs that include benefit maximums and large percentage coinsurance covers the small things, but leaves you at risk for big things. This is more risky. If you are looking for a way to reduce your premium by increasing out-of-pocket costs, it is generally less risky to go with a policy with a higher deductible than one with a benefits maximum or high coinsurance.