What Is Health Insurance - Definition & How It Works - PART 1

Components of a Health Insurance Policy

A health insurance policy is a legal contract between an insurance company and the owner of the policy - in this case, you.

The contract term is typically limited, and the policyholder must make payments (known as premiums) to keep their coverage active. This contract also details various conditions under which the insurance company will be responsible for the costs of the policyholder’s medical care and possibly their family’s. Read about Two Wheeler Insurance, Home Insurance India, and much more related to the company.

A health insurance policy consists of the following components.

1. Insurance policy Premium

The health insurance premium is the fee that you pay to secure coverage of the medical conditions and treatments described in the policy. An underwriting process sorts you into specific risk categories based on factors like age, gender, and medical history. Your premium amount is based on these factors, and it’s intended to reflect the likelihood that you will incur medical costs equal to or less than the amount you pay to the insurer.

Underwriting is necessary to avoid “adverse selection.” Premiums are set high enough to deter those most likely to use the insurance and low enough to attract those least likely to use it. Underwriting ensures that those who purchase health insurance are a true cross-selection of risks and don’t only represent those who purchase health insurance coverage because they are ill or expect to need it.

Purchasing a health insurance policy for the first time is, in many ways, a rite of passage - a sign you’ve passed from child to adult. It’s also one of the more expensive acquwill beitions you’ll make during your life, rivaling that of buying a home.

Making matters worse, many people don’t fully understand health insurance or the components of specific policies. As a result, they buy policies that are unnecessarily expensive or don’t provide the coverage they need.

Here’s what you need to know to make sure you have the coverage you need when you need it most.

2. Deductible

Health insurance usually requires the covered policyholder to bear a portion of the risk by paying initial medical costs up to an agreed-upon amount before the health insurance policy is liable for payment. This amount is known as a deductible. As the deductible increases, the premium decreases.

Deductibles can apply to individuals or family groups. For example, a policy might have a $3,000 individual deductible and a $5,000 family deductible. In this case, the insurance company would pay an individual’s medical claims when either 1) the accumulated expenses for that individual exceeds $3,000 or 2) the total family expense exceeds $5,000, even though the total of no individual’s claims equal $3,000.

3. Copays

In addition to the deductible, policyholders usually must pay a portion of the cost of each covered medical treatment. These copays are meant to discourage frivolous use of medical services.

While higher copays reduce the insurance company’s total exposure, the amount of each copay is rarely high enough to result in a substantial premium reduction for the policy.

4. Coinsurance

In order to share the risk and limit excessive utilization, insurers hold policyholders liable for an agreed-upon level of expense, usually 80%. This limit is calculated after deducting any copay.

For example, suppose Joe has a cyst removed for a total cost of $2,500. After he pays a $50 copay, the insurance company pays 80% of the remaining $2,450, or $1,960. Joe’s share of the cost would be the copay ($50) plus the remaining 20% of the amount after the copay ($490). His total out-of-pocket cost would be $540.

5. Exclusions

Health insurance policies do not typically cover all medical expenses. Non-covered expenses may be defined by a medical condition, type of treatment, or healthcare provider.

For example, most health insurers don’t cover elective cosmetic surgery, such as facelifts, tummy tucks, or bariatric surgery, except on rare occasions. Policyholders remain 100% liable for any excluded treatment or expense, and these expenses usually do not apply to the deductible amount defined in the policy.

6. Coverage Limits

Health insurance is not open-ended. Insurance companies usually limit their liability by setting the maximum amount they’ll pay for medical costs. These limits typically run from $500,000 to $1 million and maybe either lifetime, annual, or both.

For example, you may have an annual limit of $100,000 and a lifetime limit of $500,000. That means the insurer pays up to $100,000 in any 12-month period and covers total lifetime costs up to an accumulated $500,000. Once a limit is reached, the health insurer ceases payments for the rest of that period, and the policyholder is responsible for paying any costs beyond that amount.

While a $1 million coverage limit may seem significant, medical expenses can add up quickly. For example, a premature baby can require weeks of hospital stays and numerous operations, resulting in hundreds of thousands of dollars in care. Organ transplants can easily run up against coverage limits if there are complications.

Some insurers offer higher coverage limits, but getting them usually requires negotiation, additional underwriting, and a higher premium. If you want a higher coverage limit, work with the insurer to agree upon the limits before you purchase the policy. Insurers are unlikely to raise limits on a policy already in force since higher coverage requests usually mean the policyholder already knows they’ll need more coverage.

Before you purchase a policy, pay particular attention to the policy language to ensure coverage is adequate to meet your potential needs.

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