Health Insurance: Definition, How It Works

What Is Health Insurance?

Health insurance is a contract between a company and a consumer. The company agrees to pay all or some of the insured person's healthcare costs in return for payment of a monthly premium.

The contract is usually a one-year agreement, during which you are responsible for paying specific expenses related to illness, injury, pregnancy, or preventative care.

Health insurance agreements in the U.S. generally come with exceptions to coverage including:

• A deductible that requires the consumer to pay certain healthcare costs "out-of-pocket" up to a maximum amount before the company coverage begins
• One or more co-payments that require the consumer to pay a set share of the cost for specific services or procedures

How Health Insurance Works

In the United States, health insurance is tricky to navigate. It is a business with a number of regional and national competitors whose coverage, pricing, and availability vary from state to state and even by county.

About half of the U.S. population has health insurance coverage as an employment benefit, with premiums partially covered by the employer. The cost to the employer is tax-deductible to the payer, and the benefits to the employee are tax-free, with certain exceptions for S corporation employees.

Self-employed people, freelancers, and gig workers can buy insurance directly on their own. The Affordable Care Act of 2010, commonly called Obamacare, mandated the creation of a national database, HealthCare.gov, which allows individuals to search for standard plans from private insurers that are available where they live. The costs of the coverage are subsidized for taxpayers whose incomes are between 100% and 400% of the federal poverty threshold.

People over the age of 65 and those with disabilities, End-Stage Renal Disease, or ALS qualify to receive federally-subsidized care through Medicare, while families whose incomes are near the poverty level are eligible for subsidized Medicaid coverage.

Types of Health Insurance

Health insurance can be tricky to navigate. In the U.S., managed care insurance plans require policyholders to get their care from a network of designated healthcare providers. If patients seek care outside the network, they must pay a higher percentage of the cost. The insurer may even refuse payment outright for services obtained out of network.

Many managed care plans—for example, health maintenance organizations (HMOs) and point-of-service plans (POS)—require patients to choose a primary care physician who oversees the patient's care, makes recommendations about treatment, and provides referrals for medical specialists.

Preferred-provider organizations (PPOs), by contrast, don't require referrals but do set lower rates for using in-network practitioners and services.

Insurance companies may deny coverage for certain services that were obtained without preauthorization. They may refuse payment for name-brand drugs if a generic version or comparable medication is available at a lower cost. Check an insurance company's rules before your buy their insurance.

What Are Copays, Deductibles, and Coinsurance?

Most health insurance plans require their customers to pick up some of the costs of their coverage in various ways:

• The deductible is the amount you pay out of pocket every year before the insurer begins to meet the costs. This is now capped by federal law.
• Copays are set fees that subscribers must pay for specific services such as doctor visits and prescription drugs even after the deductible is met.
• Coinsurance is the percentage of healthcare costs that the insured must pay even after they've met the deductible (but only until they reach the out-of-pocket maximum for the year).

Insurance plans with higher out-of-pocket costs generally have smaller monthly premiums. When shopping for plans, weigh the benefit of lower monthly payments against the potential risk of large out-of-pocket expenses in the case of a major illness or accident.

High-Deductible Health Plans (HDHP)

One increasingly popular type of health insurance is the high-deductible health plan (HDHP). These plans have higher deductibles and lower monthly premiums. Their users are the only ones eligible to open a Health Savings Account (HSA) that has substantial federal tax benefits.

For 2024, a high-deductible health plan is one that has deductibles of at least $1,600 for an individual or $3,100 for a family. Total out-of-pocket maximums are $8,050 for an individual and $16,100 for a family.

High-deductible health plans offer a unique advantage in that if you have one, you're permitted to open—and contribute pretax income to—a health savings account, which can be used to pay for qualified medical expenses. These plans offer a triple tax benefit in that:

• Contributions are tax-deductible
• Contributions grow on a tax-deferred basis
• Qualified withdrawals for healthcare expenses are tax-free

Federal Health Insurance Plans

Not all health insurance in the US is provided by private companies. Medicare, Medicaid, and the Children's Health Insurance Program (CHIP) are federal health insurance plans that extend coverage to older, disabled, and low-income people.

The Affordable Care Act (ACA)

In 2010, President Barack Obama signed the Affordable Care Act (ACA) into law. In participating states, the act expanded Medicaid, a government program that provides medical care for individuals with low incomes.

The Affordable Care Act has prohibited insurance companies from denying coverage to patients with preexisting conditions and has allowed children to remain on their parents' insurance plan until they reach the age of 26.

In addition to these changes, the ACA established the federal Health Insurance Marketplace. It also prohibits insurance companies from denying coverage to patients with preexisting conditions and allows children to remain on their parents' insurance plan until they reach age 26.

The Marketplace helps individuals and businesses shop for quality insurance plans at affordable rates. Insurance available through the ACA Marketplace is required to cover 10 essential health benefits.

Under the ACA, tax-payers were required to carry medical insurance that meets federally designated minimum standards or face a tax penalty, but the Tax Cuts and Job Act removed that penalty after December 31, 2018.

A Supreme Court ruling in 2012 struck down an ACA provision that required states to expand Medicaid eligibility as a condition for receiving federal Medicaid funding, and a number of states chose to refuse to expand their Medicaid programs.

Medicare and CHIP

Two public health insurance plans, Medicare and the Children's Health Insurance Program (CHIP), provide subsidized coverage for disabled individuals and children. Medicare, which is available to people age 65 or older, also serves people with certain disabilities, End-Stage Renal Disease, and ALS. The CHIP plan provides health coverage for low-income children under the age of 19.

The Bottom Line

Unlike many countries, the U.S. does not have a universal government health care system. Instead, it has a complicated system of subsidies and tax incentives that make health care affordable for most people most of the time.

If you are employed, you probably have health insurance that is subsidized by your employer. If you are self-employed, you can get insurance directly from a private insurer. If your income is low, you can get a subsidy for the costs. If you are elderly or disabled, you can get coverage through the federal Medicare or Medicaid programs.