Health insurance

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Health insurance is a form of group insurance, where individuals pay premiums or taxes in order to help protect themselves from high or unexpected healthcare expenses. Health insurance works by estimating the overall "risk" of healthcare expenses and developing a routine finance structure (such as a monthly premium, or annual tax) that will ensure that money is available to pay for the healthcare benefits specified in the insurance agreement. The healthcare benefit is administered by a central organization, which is most often either a government agency, or a private or not-for-profit entity operating a health plan. [1]

Market-based health care systems such as that in the United States rely heavily on private and not-for-profit health insurance.

History and evolution

The concept of health insurance was proposed in 1694 by Hugh the Elder Chamberlen from the Peter Chamberlen family. In the late 19th century, "accident insurance" began to be available, which operated much like modern disability insurance.[2]. This payment model continued until the start of the 20th century in some jurisdictions (like California), where all laws regulating health insurance actually referred to disability insurance.[3] Patients were expected to pay all other health care costs out of their own pockets, under what is known as the fee-for-service business model. During the middle to late 20th century, traditional disability insurance evolved into modern health insurance programs. Today, most comprehensive private health insurance programs cover the cost of routine, preventive, and emergency health care procedures, and also most prescription drugs, but this was not always the case.

How it works

A Health insurance policy is a contract between an insurance company and an individual. The contract can be renewable annually or monthly. The type and amount of health care costs that will be covered by the health plan are specified in advance, in the member contract or Evidence of Coverage booklet. The individual policy-holder's payment obligations may take several forms[4]:

  • Premium: The amount the policy-holder pays to the health plan each month to purchase health coverage.
  • Deductible: The amount that the policy-holder must pay out-of-pocket before the health plan pays its share. For example, a policy-holder might have to pay a $500 deductible per year, before any of their health care is covered by the health plan. It may take several doctor's visits or prescription refills before the policy-holder reaches the deductible and the health plan starts to pay for care.
  • Copayment: The amount that the policy-holder must pay out of pocket before the health plan pays for a particular visit or service. For example, a policy-holder might pay a $45 copayment for a doctor's visit, or to obtain a prescription. A copayment must be paid each time a particular service is obtained.
  • Coinsurance: Instead of paying a fixed amount up front (a copayment), the policy-holder must pay a percentage of the total cost. For example, the member might have to pay 20% of the cost of a surgery, while the health plan pays the other %80. Because there is no upper limit on coinsurance, the policy-holder can end up owing very little, or a significant amount, depending on the actual costs of the services they obtain.
  • Exclusions: Not all services are covered. The policy-holder is generally expected to pay the full cost of non-covered services out of their own pocket.
  • Coverage limits: Some health plans only pay for health care up to a certain dollar amount. The policy-holder may be expected to pay any charges in excess of the health plan's maximum payment for a specific service. In addition, some plans have annual or lifetime coverage maximums. In these cases, the health plan will stop payment when they reach the benefit maximum, and the policy-holder must pay all remaining costs.
  • Out-of-pocket maximums: Similar to coverage limits, except that in this case, the member's payment obligation ends when they reach the out-of-pocket maximum, and the health plan pays all further covered costs. Out-of-pocket maximums can be limited to a specific benefit category (such as prescription drugs) or can apply to all coverage provided during a specific benefit year.

Prescription drug plans are a form of insurance offered through many employer benefit plans in the U.S., where the patient pays a copayment and the prescription drug insurance pays the rest.

Some health care providers will agree to bill the insurance company if patients are willing to sign an agreement that they will be responsible for the amount that the insurance company doesn't pay, as the insurance company pays according to "reasonable" or "customary" charges, which may be less than the provider's usual fee.

Health insurance companies also often have a network of providers who agree to accept the reasonable and customary fee and waive the remainder. It will generally cost the patient less to use an in-network provider.

Health Insurance companies are now offering Health Incentive accounts (HIA)[5], to reward users for living healthy and making healthy choices, like stop smoking and/or losing weight, may get you funds added into your Health Incentive Account, which may lower your out of pocket costs. The health incentive accounts also carry over from year to year but once you leave the program you lose those benefits in the HIA.

Inherent problems with private insurance

Any private insurance system will face two inherent challenges: adverse selection and ex-post moral hazard.

Adverse selection

Insurance companies use the term "adverse selection" to describe the tendency for only those who will benefit from insurance to buy it. Specifically when talking about health insurance, unhealthy people are more likely to purchase health insurance because they anticipate large medical bills. On the other side, people who consider themselves to be reasonably healthy may decide that medical insurance is an unnecessary expense; if they see the doctor once a year and it costs $250, that's much better than making monthly insurance payments of $400 (example figures).

The fundamental concept of insurance is that it balances costs across a large, random sample of individuals (see risk pool). For instance, an insurance company has a pool of 1000 randomly selected subscribers, each paying $100 per month. One person becomes very ill while the others stay healthy, allowing the insurance company to use the money paid by the healthy people to pay for the treatment costs of the sick person. Adverse selection upsets this balance between healthy and sick subscribers by leaving an insurance company with primarily sick subscribers and no way to balance out the cost of their medical expenses with a large number of healthy subscribers.

Because of adverse selection, insurance companies use a patient's medical history to screen out persons with pre-existing medical conditions. Before buying health insurance, a person typically fills out a comprehensive medical history form that asks whether the person smokes, how much the person weighs, whether the person has been treated for any of a long list of diseases and so on. In general, those who present a large financial burdens are denied coverage or charged high premiums to compensate.[5] One large U.S. industry survey found that roughly 13 percent of applicants for comprehensive, individually purchased health insurance that go through the medical underwriting process were denied coverage. Declination rates increased significantly with age, rising from 5 percent for individuals 18 and under to just under a third for individuals aged 60 to 64.[6] On the other side, applicants can get discounts if they do not smoke and are healthy.[7]

Starting in 1976, some states started providing guaranteed-issuance risk pools, which enable individuals who are medically uninsurable through private health insurance to purchase a state-sponsored health insurance plan, usually at higher cost. Minnesota was the first to offer such a plan; 34 states now offer them. Plans vary greatly from state to state, both in their costs and benefits to consumers and to their methods of funding and operations. They serve a very small portion of the uninsurable market — about 182,000 people in the U.S. as of 2004,[8] but in best cases allow people with pre-existing conditions such as cancer, diabetes, heart disease or other chronic illnesses to be able to switch jobs or seek self-employment without fear of being without health care benefits.[9] Efforts to pass a national pool have as yet been unsuccessful, but some federal tax money has been awarded to states to innovate and improve their plans.

Moral hazard

Moral hazard describes the state of mind and change in behavior that results from a person's knowledge that if something bad were to happen, the out-of-pocket expenses would be mitigated by an insurance policy--in this case, one which provides reduced prices for medical care.

Other factors affecting insurance prices

A recent study by PriceWaterhouseCoopers examining the drivers of rising health care costs in the U.S. pointed to increased utilization created by increased consumer demand, new treatments, and more intensive diagnostic testing, as the most significant driver.[10] People in developed countries are living longer. The population of those countries is aging, and a larger group of senior citizens requires more medical care than a young healthier population. Advances in medicine and medical technology can also increase the cost of medical treatment. Other factors that increase utilization and therefore insurance prices are lifestyle-related: increases in obesity caused by insufficient exercise and unhealthy food choices; excessive alcohol use, smoking, and use of street drugs. Other factors noted by the PWC study included the movement to broader-access plans, higher-priced technologies, and cost-shifting from Medicaid and the uninsured to private payers.[10]

Common complaints of private insurance

Template:Tfd Some common complaints about private health insurance include:

  1. Insurance companies usually only re-price their coverage annually.[citation needed] This means if one becomes ill, and is covered by a health insurance policy, and that illness will continue and be subject to a re-priced policy that person may find that their insurance premiums have increased to an amount they might not be able to afford. However, some states have rules and regulations which can limit price increases on certain types of health insurance coverage.
  2. If insurance companies try to charge different people different amounts based on their own personal health, people may feel they are unfairly treated.[citation needed] Exceptions to this differential in pricing can be found when an individual (and their dependents) become insured under a pre-existing pool of insureds such as a group of employees insured through their employer. In that instance, the underwriter assesses the financial risk based upon the entire group (sometimes referred to as a 'risk pool'). In these situations, a person with little or no medical expenses in their recent history will pay the same premium cost (and be subject to the same co-pays and deductibles) as someone who has had a large amount of medical expenses in their recent history.
  3. When a claim is made, particularly for a sizable amount, insureds may feel as though the insurance company is using paperwork and bureaucracy to attempt to avoid payment of the claim or, at a minimum, greatly delay it.[citation needed] One large industry survey suggests that claim processing times improved between 2002 and 2006. More claims are being submitted electronically; however, 29 percent of claims were not received by the insurer until more than a month after the date on which medical care was provided. The percentage of claims being adjudicated on an automated basis is also increasing. 14 percent of claims are "pended" by the insurer while additional information is requested or the information on the claim is verified. On average, pended claims are delayed by 9 days. Over 95 percent of the remaining "clean" claims are processed within 30 days; 57 percent are processed within one week.[11]
  4. Health insurance is often only widely available at a reasonable cost through an employer-sponsored group plan and online for individuals.[citation needed]
  5. In the United States, there are tax advantages to Employer-provided health insurance, whereas individuals must pay tax on income used to fund their own health insurance, although a small number of pre-tax health plans exist.[citation needed]
  6. Experimental treatments are generally not covered.[citation needed] This practice is especially criticized by those who have already tried, and not benefited from, all "standard" medical treatments for their condition.[citation needed]
  7. The Health Maintenance Organization (HMO) type of health insurance plan has been criticized for excessive cost-cutting policies in its attempt to offer lower premiums to consumers.[citation needed]
  8. As the health care recipient is not directly involved in payment of health care services and products, they are less likely to scrutinize or negotiate the costs of the health care received.[citation needed] The health care company has popular and unpopular ways of controlling this market force.[citation needed]
  9. Some health care providers end up with different sets of rates for the same procedure. One for people with insurance and another for those without.[citation needed]
  10. Unlike most publicly funded health insurance, many private insurance plans do not provide coverage of dental health care, or only offer such coverage with additional premiums and very low dollar-amount coverages.
  11. Insurance Companies can influence the type or amount of treatment that the insured receives by setting limits on the number of visits, types of treatment, etc., it will cover.

Health insurance in the United States

According to the United States Census Bureau, approximately 84% of Americans have health insurance. Some 60% obtain health insurance through an employer, about 9% purchase it directly, and various government agencies provide coverage to about 27% of Americans (there is some overlap in these figures).[12] In 2006, there were 47 million people in the U.S. (16 percent of the population) who were without health insurance for at least part of that year.[12] About 37% of the uninsured live in households with an income over $50,000.

Private: employer-sponsored

Health insurance paid for by business entities generally on behalf of their employees and other immediate stakeholders. Broadly classified as "Traditional/Indemnity" and "Managed/Preferred Provider." Most private health coverage in the U.S. is employment based, and the employer typically makes a substantial contribution towards the cost of coverage.[13]

Costs for employer-paid health insurance are rising rapidly: since 2001, premiums for family coverage have increased 78%, while wages have risen 19% and inflation has risen 17%, according to a 2007 study by the Kaiser Family Foundation.[14]

According the Centers for Medicare and Medicaid Services, nearly 100% of large firms offer health insurance to their employees.[15] Although much more likely to offer retiree health benefits than small firms, the percentage of large firms offering these benefits fell from 66% in 1988 to 34% in 2002.[16]

Many small employers provide employee health insurance, but the percentage offering is not as high as it is for larger employers. The types of coverage available to small employers are similar, but they do not have the same options for financing their benefit plans. In particular, self-insuring the benefits (see Self-funded health care) is not a practical option for most small employers. [17]

Private: individually purchased

Policies of health insurance obtained by individuals not otherwise covered under policies or programs elsewhere classified. Generally major medical, short term medical, and student policies. Fewer Americans are covered by individually purchased medical expense insurance than by employer-sponsored coverage. The range of products available is similar, however. Average premiums are generally somewhat lower than those for employer-sponsored coverage, but vary by age. Deductibles and other cost-sharing is also higher, on average, and the individual consumer pays the entire premium without benefit of an employer contribution.[18][6] Many states allow medical underwriting of applicants for individually purchased health insurance by insurance companies.

Private: long-term care insurance

Long-term care (LTC) insurance is growing in popularity in the U.S. Premiums have remained relatively stable in recent years. However, the coverage is quite expensive, especially when consumers wait until retirement age to purchase it. The average age of new purchasers was 61 in 2005, and has been dropping.[19]

The shift to managed care in the U.S.

Through the 1990s, managed care grew from about 25% of U.S. employees to the vast majority.

Rise of managed care in the U.S.
Year Conventional plans HMOs PPOs POS plans HDHPs
1998 14% 27% 35% 24% ~
1999 10% 28% 39% 24% ~
2000 8% 29% 42% 21% ~
2001 7% 24% 46% 23% ~
2002 4% 27% 52% 18% ~
2003 5% 24% 54% 17% ~
2004 5% 25% 55% 15% ~
2005 3% 21% 61% 15% ~
2006 5% 20% 60% 13% 4%


New types of medical plans in the U.S.

One approach to addressing increasing premiums, dubbed "consumer driven health care," received a boost in 2003, when President George W. Bush signed into law the Medicare Prescription Drug, Improvement, and Modernization Act. The law created tax-deductible Health Savings Accounts (HSAs). An HSA is a private bank account which is un-taxed and only penalized if spent on non-medical items or services. It must be paired with a high-deductible insurance plan. HSAs enable mostly healthy people to pay less for insurance and bank money for their own health care expenses.[20] HSAs are one form of tax-preferrenced health care spending account. Others include Archer Medical Savings Accounts (MSAs), which have been superseded by the new HSAs (although existing MSAs are grandfathered), Flexible Spending Arrangments (FSAs) and Health Reimbursement Accounts (HRAs). FSAs and HRAs are typically used as part of an employee-benefit plan.[21]

Limited Medical Benefit Plans pay for routine care and do not pay for catastrophic care. As such, they do not provide equivalent financial security to a major medical plan. Annual benefit limits can be as low as $2,000. Lifetime maximums can be very low as well.

Common health insurance terms

[22] [23]

  • Annual Limit - A benefit may be limited to a certain dollar or utilization limit (example: chiropractic care may be limited to 20 visits per calendar year).
  • Alternative Funding Arrangement - A hybrid funding arrangement that features benefits of both self funding and fully insured arrangements (ASO, Minimum Premium, et. al.).
  • Birthday rule - many insurance companies have adopted this rule to determine which parent is primary payer when both parents cover the same dependents. Who ever has the earlier date of birth, excluding the year, is designated primary insurance carrier. Exceptions to this rule usually arise when there is a court order for one of the parents to be the primary carrier.
  • Co-insurance - Generally expressed as the percentage that you pay of any covered medical services after you have paid the deductible and co-pay.
  • Co-insurance limit - The dollar amount you have to pay with Co-insurance before the insurance company begins paying your bills at 100% for the remainder of the plan year.
  • Co-ordination of benefits (COB) - How your plan pays when it is coordinating with another plan. There are three principle methods in US health plans.
  • Co-pay - A fixed fee you pay for services rendered. Most plans cover 100% after the co-pay for services rendered, however this can be adjusted to any amount depending on how the plan is set up.
  • Deductible - The fixed amount you have to pay before your insurance starts to pay.
  • Deductible carry-forward - Amounts for benefits incurred in the previous year may be subject to the prior year's deductibles.
  • Employee Assistance Plan - a health-related benefit for non-medical, work-place issues or employees that commonly develop into medical issues such as marital counseling, absenteeism, suicidal ideation, etc.
  • Experimental/Investigational - Most insurance companies will deny coverage for any procedures or tests which have not been medically verified by clinical trials conducted by recognized bodies of physicians or scientists. Many medical providers use tests which they believe in but have not been clinically validated.
  • Fully Insured - The insurance company collects the premiums and pays claims from its own money.
  • Incurred But Not Paid (IBNP) - under insurance based accrual accounting, a liability for claims that have not been paid, but may or may not be received. Incurred But Not Reported (IBNR) plus Reported But Not Paid (RBNP) equals IBNP. IBNP is a significant balance sheet item for insurers.
  • In-Network/Participating/Par Providers - Medical providers who have an established relationship with an insurance company
  • Life time maximum - The total your policy will pay out over the life of the contract. Many plans have a yearly restoration amount which will replenish the total so that after the policy money is exhausted there will still be some money in the following plan year for new claims. Life time maximums are easily avoided by switching policies or re-enrolling.
  • Self-Insured - Many major U.S. and world corporations hire insurance companies and Third Party Administrators as claims and eligibility administrators to manage a health plan or trust. Many state laws do not apply to these plans due to ERISA exemption.
  • Reciprocity - Most insurance plans deal with networks of doctors. If for example you have an HMO plan that allows you to see any HMO provider anywhere in the country, it is called Full Reciprocity, but if it only allows you access to local area networks of providers it is called Limited Reciprocity and if you can only go to select networks that your company has purchased access to, it is called No Reciprocity.
  • No-fault - This is generally for automobile insurances, however if your auto policy is no-fault and you are injured, the medical insurance will become a secondary payer and will not be able to process claims until explanation of benefits are received from the auto insurance carrier.
  • Out-of-Network/Non Participating/Non-Par Providers - Medical providers without an established relationship with an insurance company.
  • Out Of Pocket Maximum - The total dollar amount paid out by a subscriber (deductible plus coinsurance).
  • Subscriber - The primary member on the insurance policy. Also, "enrollee", "contractee".
  • Reserve - refers to the amount that must be set aside for statutorily required funds for dissolution (terminal liability).

Health Insurance in Canada

Most health insurance in Canada is administered by each province, under the national law that requires all people to have free access to basic health services. Collectively, the public provincial health insurance systems in Canada are called Medicare. Private health insurance in Canada is allowed only for services that the public health plans do not cover; for example, semi-private or private rooms in hospitals and prescription drug plans. Canadians also must use private insurance for elective medical services such as Lasik surgery, plastic surgery such as liposuction, and other non-basic medical procedures. Private health care cannot cover physician fees which are covered by Medicare. Private-sector services not paid for by the government accounted for nearly 30 percent of total health care spending.[24]. In 2005, the Supreme Court of Quebec ruled, in Chaoulli v. Quebec, that the prohibition on insurance for health care already insured by the state constitutes an infringement of the right to life and security. It is yet to be seen if this ruling will change the overall delivery of health insurance across Canada.

Health insurance in Australia

The public health system is called Medicare. It ensures free universal access to hospital treatment and subsidised out-of-hospital medical treatment. It is funded by a 1.5% tax levy.

The private health system is funded by a number of private health insurance organisations. The largest of these is Medibank Private, which is government-owned, but operates as a government business enterprise under the same regulatory regime as all other registered private health funds; the Howard government has announced that Medibank will be privatised in 2008 assuming it is returned to office at the 2007 election. Some private health insurers are 'for profit' enterprises, and some are non-profit organizations.

Most aspects of private health insurance in Australia are regulated by the Private Health Insurance Act 2007.

The private health system in Australia operates on a "community rating" system, whereby premiums do not vary solely because of a person's previous medical history or current state of health. Balancing this are waiting periods, in particular for pre-existing conditions. Funds are entitled to impose a waiting period of up to 12 months on benefits for any medical condition the signs and symptoms of which existed during the six months ending on the day the person first took out insurance.

The Australian government has introduced a number of incentives to encourage adults to take out private hospital insurance. These include:

  • Lifetime Health Cover: If a person has not taken out private hospital cover by the 1st July after their 30th birthday, then when (and if) they do so after this time, their premiums must include a loading of 2% per annum. Thus, a person taking out private cover for the first time at age 40 will pay a 10 per cent loading. The loading continues for 10 years. The loading applies only to premiums for hospital cover, not to ancillary (extras) cover.
  • Medicare Levy Surcharge: People whose taxable income is greater than a specified amount and who do not have an adequate level of private hospital cover must pay a 1% surcharge on the standard 1.5% Medicare Levy.
  • Private Health Insurance Rebate: The government subsidises the premiums for all private health insurance cover, including hospital and ancillary (extras), by 30%, 35% or 40%.


  1. How Private Insurance Works: A Primer by Gary Claxton, Institution for Health Care Research and Policy, Georgetown University, on behalf of the Henry J. Kaiser Family Foundation
  2. Howstuffworks: How Health Insurance Works Encarta: Health Insurance
  3. See California Insurance Code Section 106 (defining disability insurance).[1] In 2001, the California Legislature added subdivision (b), which defines "health insurance" as "an individual or group disability insurance policy that provides coverage for hospital, medical, or surgical benefits."
  4. AHRQ: "Questions and Answers About Health Insurance: A Consumer Guide"
  5. "The Bottom Line on Risk Classification in Individually Purchased Voluntary Medical Expense Insurance," American Academy of Actuaries, February 1999
  6. Teresa Chovan, Hannah Yoo and Tom Wildsmith, "Individual Health Insurance: A Comprehensive Survey of Affordability, Access, and Benefits" America’s Health Insurance Plans, August 2005.
  7. Task Force on Genetic Testing in Health Insurance, "Risk Classification in Individually Purchased Voluntary Medical Expense Insurance," American Academy of Actuaries, February 1999
  8. State High-Risk Health Insurance Pool Participation, December 31, 2004,, 2004, accessed 2007-10-09
  9. [2]
  10. 10.0 10.1 The Factors Fueling Rising Healthcare Costs 2006, PriceWaterhouseCoopers for America's Health Insurance Plans, 2006, accessed 2007-10-08
  11. Hannah Yoo and Karen Harner, "An Updated Survey of Health Care Claims Receipt and Processing Times," America’s Health Insurance Plans, May 2006,
  12. 12.0 12.1 "Income, Poverty, and Health Insurance Coverage in the United States: 2006." U.S. Census Bureau. Issued August 2007.
  13. [3]
  14. "Health Insurance Premiums Rise 6.1 Percent In 2007, Less Rapidly Than In Recent Years But Still Faster Than Wages And Inflation" (Press release). Kaiser Family Foundation. 2007-09-11. Retrieved 2007-09-13.
  15. [4]
  17. Hannah Yoo, Karen Heath and Tom Wildsmith, "Small Group Health Insurance in 2006",America’s Health Insurance Plans, September 2006
  18. Teresa Chovan, Hannah Yoo and Tom Wildsmith,"Individual Health Insurance: A Comprehensive Survey of Affordability, Access, and Benefits," America’s Health Insurance Plans, August 2005
  19. "Who Buys Long‑Term Care Insurance? A 15‑Year Study of Buyers and Non‑Buyers, 1990‑2005," America’s Health Insurance Plans, April 2007
  20. Health Care Spending Accounts: What You Need to Know About HSAs, HRAs, FSAs, and MSAs, America's Health Insurance Plans, July 2005, accessed 2007-10-09
  21. "Comparison of Tax-Advantaged Health Care Spending Accounts," America’s Health Insurance Plans, January 2005,
  22. Navigating your health benefits for dummies. Charles M Cutler MD Tracey A Baker CFP (c)2006 ISBN-13:978-0-470-08354-3
  23. R Adams, CSR Aetna Ins. Tampa fl
  24. Canadian Institute for Health Information: National Health Expenditure Trends, 1975-2003 (2003)

See also

External Links (United States)

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