#2 How Health Insurance Works in the US and Its Impacts on the US Population

Insurance is typically needed for markets that have a high amount of financial risk and high degree of unpredictability. Most types of insurance, such as for your car or for your house, do not cover routine operations, such as an oil change or everyday maintenance. Health insurance is similar in the amount of risk and unpredictability, but differs in the sense that it covers most routine utilization, like checkups and daily medication. 

Healthcare insurance is a tricky business with a lot of nuance involved. The bottom line of how it functions is that insurers need a large number of healthy, low maintenance/cost individuals that subsidize the relatively small number of sick/high cost individuals in their system. For this reason, many insurance providers will try to “game” the system to try to select healthy people for their plans. This is called “cream-skimming” or “cherry-picking” and why some insurance providers used to refuse individuals with pre-existing conditions. The Affordable Care Act (ACA) outlawed this practice in 2010.  

Another way around this is through risk pooling, which relies on the law of large numbers: the larger the risk pool, or the number of insured individuals, the more predictable their health experiences and health costs will be. In the eyes of the insurer, having a large risk pool allows for less financial risk. This is why the ACA had placed the Individual Mandate, which states that every individual must be insured. While this part of the ACA was federally repealed in 2017, some states still have this mandate in place. In this way, having health insurance is similar to a “social contract,” in that we all gain and lose from having this agreement. 

On the flip side, insured people can also have the tendency to over utilize. Moral Hazard is the concept that a person who has less financial risk (such as through being covered by insurance) behaves differently than someone who is paying completely out of pocket. For this reason, all insurance plans have components that the insured party must pay for:

  • The first is a premium, which is typically a monthly amount you pay to have the insurance plan in the first place. If you have employer based insurance (EBI) it just comes out of your paycheck. 
  • The second is through a deductible, which is the amount an insured person must pay out of pocket each year before the plan kicks in. For example, if you have a high deductible plan of $600, that means you must pay $600 worth of costs and afterwards your plan will cover utilization under its plan. If you have a “first dollar coverage” plan, it means that there is no deductible. 
  • A co-pay is the fixed amount you must pay at the time a service is utilized, and a co-insurance is a percentage of the cost of a service that must be paid. These out of pocket costs unfortunately still add up over time, and can be burdensome for many. 

The overall purpose of health insurance is to ensure greater access for everyone. However, studies such as the Oregon Medicaid Experiment show that in reality it only increases utilization, but does not change overall population mortality/morbidity (the exception being it helps control and detect chronic issues, such as diabetes, at a higher rate).