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Understanding Health Insurance

Updated on September 7, 2009

The term 'health insurance' covers a broad variety of plans by which individuals are indemnified for hospital and medical care expenses and loss of income resulting from illness or injury. It is also called "accident and health insurance", "accident and sickness insurance", and "disability insurance". Such policies may vary considerably in the types of expense covered. Some are limited to hospital expenses, or surgical expenses, or dental care, but others cover any combination of these and other expenses.

Health insurance plans may be either private (commercial) or public (governmental). In the United States and Canada a broad variety of commercial policies are available and are purchased on a voluntary basis. But in the second half of the 20th century the U.S. and Canadian governments have increased their activities in health care. In the rest of the industrialized world government plays a much more dominant role, in comparison with voluntary private insurance, in the financing of medical care. This larger government role often stems, in part at least, from the fact that a large part of the population lives below what is regarded as a poverty level. In addition, many industrialized nations have a long history of government involvement in health care—for instance, West Germany traces payment of sickness and maternity benefits back to a program instituted by Otto von Bismarck, chancellor of Germany, in 1883.

Principles of Health Insurance

Commercial health insurance, like other insurance, is based on the principle that an individual can substitute a small, definite cost (the premium) for what otherwise might be a large loss. The premiums paid by all participants are used to benefit the persons who incur losses from injury, illness, or other medical conditions.

A related principle is that the insured persons pay the expenses of operating an insurance system. In a private system part of the premiums go to pay for the overhead; in a public system taxes are levied for this purpose. The insurer's expenses of operation (maintaining offices, investigating claims, and paying benefits) constitute an essential part of the insurance system and obviously increase the total outlay beyond what is paid out in benefits. Generally, the fewer the number of medical cases that are reimbursed by an insurance system, the lower the expense connected with operating that system.

Large-Loss Principle

One school of thought holds that a person should insure only those costs that he cannot afford to bear if they occur. For example, many persons would find that the accidental breaking of a pair of ordinary eyeglasses would be only a minor financial setback; in contrast, almost all persons would find that a total and complete disability such as complete paralysis would be financially unbearable. The concept of insuring only the unbearable risk is known as the large-loss principle or the large-risk principle.

Under this principle the insured and the insurer may enter into contracts that exclude many types of costs from reimbursement. For example, many policies contain a "deductible" clause stipulating that the insured must bear some loss himself—perhaps the first $50 of medical expenses— before the insurance will begin paying. These actions lower the number of claims and the cost of administration, permitting lower premiums.

The large-loss principle is exemplified by what is known as major medical insurance. With rising levels of education and income in the United States people are more aware of the need to see their doctor on some regular basis and of the merits of paying for the first visit to reduce administrative costs. As a result the large-loss principle is growing in popularity.

First-Dollar Principle

An opposite viewpoint is expressed in the first-dollar principle, in which the policy pays the full cost of all covered medical expenses. There is no "deductible" clause; when the insured person goes to his doctor, he does not have to pay for the visit out of his own funds.

Proponents of first-dollar policies stress the merits of preventive care: if the insurance encourages people to go to their physician and to obtain medical treatment, then the cost of serious illness will be reduced. These proponents say that people would rather spend their money on things other than medical care until they must go to the doctor. Also, they point out that many persons lack enough income to purchase medical care except on an emergency basis, so that first-dollar insurance fulfills a need for them.

In the United States the first-dollar principle has appealed to the public and to the insurance industry more than the large-loss principle, and it has become the more firmly entrenched in health insurance.

Moral Costs

Another principle of insurance is that ownership of insurance should not encourage a person to have a loss. The moral-costs principle is violated by false claims of medical cost, false claims of disability, and by collection of benefits from more than one policy on the same illness or injury. Many insurance economics hold that the presence of health insurance makes persons more willing to seek medical care. Therefore, even without false expenses, an insurance system has to be designed carefully to reduce the human tendency toward waste.

Private Health Insurance

The U.S. public has chosen to meet a sizable part of its medical costs through voluntary or private insurance. A variety of organizations exist to serve these needs.

Corporate insurers that provide health insurance include stock companies (owned by stockholders), mutual companies (owned by members), hospital associations, and associations of physicians. The stock and mutual companies include both life and nonlife insurance companies. A few companies offer only health insurance, but most of them sell other types of insurance as well.

The most common hospital association is the Blue Cross hospital association. There are scores of Blue Cross associations, each serving its own metropolitan area or state but affiliated with the national Blue Cross association that represents the plan in national affairs. Typically, instead of providing so much money for so many days of hospitalization, the Blue Cross provides so many days of hospital care in a semiprivate room.

The most widespread medical association is the Blue Shield association. Typically, if an insured person has an income below a certain level the physicians and surgeons will provide care for just the amount given by the association. For other persons the surgeon may charge what he likes, and the Blue Shield will pay a certain amount that varies according to the surgical procedure.

Some organizations, the largest of which are labor unions, provide direct health care for their members. About 60 health centers in the United States are owned and operated by labor unions. Community-wide groups of physicians and hospitals also undertake to provide all health care for members of a group.

Private insurers take two approaches to providing health insurance: group and individual. Group insurance is a means of insuring a large number of persons in one contract. In a typical case an employer purchases a group insurance policy to cover his employees and perhaps their dependents. The major advantages of group insurance are that there may be few if any questions asked as to the health characteristics of the insured persons and the premium expense is lower. From the employee's standpoint there is the advantage of the employer paying all or part of the premium, and in addition the employee does not have to include the employer's payment as part of his taxable income.

Individual contracts may be more personally tailored to an individual's desires. Also, they are available to those people who may not have group policies available to them.

Public Health Care

Governmental medical programs in the United States reach those persons in the general population who are entitled to care by reason of their age, income, mental condition, or status as a military veteran. In addition, the government provides medical care for all active and retired persons in the military services and for its other employees. The health facilities of the Veterans Administration are primarily available to those veterans with service-connected disabilities and to war veterans who are financially unable to pay the costs elsewhere.

In 1966 all persons over 65 who receive federal Social Security benefits became eligible for hospitalization, hospital diagnostic services, extended care in nursing homes, and some health services, at federal expense, within certain limits. This program, called "medicare", is financed by contributions paid by employees, employers, and self-employed persons in their working years. In addition, for a small monthly payment for medical insurance, a person over 65 can have the government pay 80% of most medical costs except drugs and certain minor services.

  • Disability. Persons who are fully insured under the Social Security program may also draw an income benefit for themselves and for certain dependents if they become totally disabled for work and if the disability is expected to last more than one year.
  • Mental and Tubercular Disease. All states provide prolonged hospital care for the mentally ill and for those suffering tuberculosis. These are the major health expenditures of the states. Most states levy charges according to the patient's financial ability. Mental and tubercular care are important health services since generally the period of care is lengthy and the cost great.
  • Workmen's Compensation. All states require that some or all of the expenses in injuries and diseases arising in the course of and out of employment must be paid by the employer and his insurer. In addition, the states require cash income payments based on the employee's wage level, the length of disability, and the nature of the disability. Workmen's compensation provides benefits to a machinist in the loss of a finger or to a miner who suffers a lung disease.
  • Welfare. Most cities or counties and also most states provide some health benefits. There is great variety in the kinds of benefits. In the larger cities and counties medical care is generally provided on an outpatient and bed basis to indigent persons. The more widespread and specifically organized programs include medical care for the aged, dependent children, and the blind, and the permanently and totally disabled. In these programs the federal government reimburses the state.

In a federally funded program called "medicaid", benefits are available to all persons whose income falls below a level set by the state. Some states have set the income level higher than other states, and so they make medicaid available to a larger proportion of their residents.


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