Health Insurance:
Definition, Types, Formula & Comparison

Health insurance is a contract between an individual and an insurance company that covers some or all of the costs of medical care and health-related expenses in exchange for a monthly premium payment. It works by pooling financial risk among many individuals, allowing the insurer to create a payment structure, typically through monthly premiums or payroll taxes, to cover the health care benefits specified in the insurance agreement. The benefit is administered by a central organization, such as a government agency, private business, or not-for-profit entity.

Health insurance reduces the financial burden of high-cost medical care by sharing expenses between the insured person and the insurance company. After paying a deductible (the amount you must pay before your plan begins to cover costs), the insurance plan typically covers a percentage of medical expenses, with the insured paying the remaining portion through coinsurance. Most plans cover preventive care, such as annual check-ups, flu shots, vaccinations, and wellness screenings, at no cost to the insured.

Related terms: premium, deductible, coinsurance, copayment, out-of-pocket maximum, network provider

Health insurance operates through a structured payment and coverage system. Members pay a monthly premium to maintain their health plan. Most plans include a deductible, which is the amount members must pay out of pocket before the insurance company begins sharing costs. Once the deductible is met, the plan typically covers a percentage of medical expenses (often 80%), while the member pays the remaining portion through coinsurance (typically 20%).

Preventive care services are covered at 100% by most plans, including annual check-ups, vaccinations, and certain wellness screenings. Members save money by using in-network providers, doctors and facilities that have agreed to provide services at reduced rates negotiated with the insurance company. Plans may also include copays, which are small fixed fees paid at the time of a doctor visit. Each plan has an out-of-pocket maximum, which caps the total amount members pay in a year; after reaching this limit, the insurance covers 100% of eligible costs.

There are 6 main types of health insurance plans, each with distinct coverage structures and cost-sharing arrangements:

• HMO (Health Maintenance Organization): Covers only providers within the plan's network; requires referrals from primary care physicians to see specialists
• EPO (Exclusive Provider Organization): Covers only in-network providers but does not require referrals for specialists
• PPO (Preferred Provider Organization): Allows members to see any doctor or hospital, with lower costs for in-network providers; no referrals required
• POS (Point-of-Service Plan): Permits visits to any in-network doctor without referral; requires referrals for out-of-network providers
• HDHP (High Deductible Health Plan): Features low monthly premiums and high deductibles; compatible with health savings accounts and health reimbursement arrangements
• Catastrophic Plan: Available to people under age 30 or those with hardship exemptions; offers low premiums and high deductibles, primarily protecting against major medical expenses from serious injuries or illnesses

Health insurance plans cover a wide range of medical care and services, organized into categories known as essential health benefits. These include ambulatory patient services (outpatient care), emergency room visits, hospitalization, pregnancy and newborn care, mental health and substance use disorder services, prescription drugs, rehabilitative and habilitative services and devices, laboratory services, preventive and wellness services, chronic disease management, and pediatric services including oral and vision care.

Coverage specifics depend on whether the member has met their deductible, the coinsurance percentage, whether care is provided by in-network providers, and whether services are preventive or non-preventive. Preventive services, including annual check-ups for adults and children, vaccinations (such as flu shots and childhood immunizations), health screenings (mammograms, colonoscopies, cholesterol screenings), and birth control, are typically covered at 100% with no cost to the member.

Health insurance plans typically exclude certain services and treatments. Common exclusions include alternative medicine (massage, acupuncture, herbal healing), cosmetic surgery (plastic surgery, laser skin removal, liposuction, rhinoplasty), weight-loss surgery (gastric bypass and bariatric procedures unless medically necessary), vein surgery (laser treatment for spider veins unless medically necessary), and elective surgeries without proven medical need.

Plans also do not cover unapproved medical care (services requiring prior authorization that was not obtained), experimental treatments or procedures using unproven technology or methods, and certain non-medical items like disposables and taxes. Coverage exclusions vary by plan, so members should review their Summary of Benefits Coverage document to understand which services are covered and which are not.

These are 4 fundamental cost-sharing components of health insurance plans:

• Premium: The monthly amount paid to the insurance company to maintain coverage, regardless of whether medical services are used
• Deductible: The amount members must pay out of pocket for covered services before the insurance company begins to pay its share; for example, a $7,500 annual deductible means the member pays the first $7,500 of medical costs before insurance coverage activates
• Copay (Copayment): A fixed amount paid at the time of service; for example, a $45 copay for a doctor's visit or prescription refill, paid each time the service is obtained
• Coinsurance: The percentage of costs the member pays after meeting the deductible; for example, if the plan has 20% coinsurance, the insurance pays 80% of covered costs and the member pays the remaining 20%

Plans with higher monthly premiums typically have lower deductibles and copays, while plans with lower premiums often have higher out-of-pocket costs when medical care is needed.

The out-of-pocket maximum is the limit on the total amount a member must pay for covered health care services in a plan year. Once this maximum is reached, the insurance plan covers 100% of all remaining covered costs for the rest of the year. This maximum includes deductibles, coinsurance, and copays, but does not include monthly premiums or costs for services not covered by the plan.

Out-of-pocket maximums provide financial protection against catastrophic medical expenses. They can be limited to specific benefit categories (such as prescription drugs) or apply to all coverage provided during the benefit year. The specific amount varies by plan and is set annually by insurance companies within federal regulatory guidelines.

In-network providers are health care professionals, facilities, and hospitals that have contracted with an insurance company to provide services at pre-negotiated, discounted rates. Insurance plans offer lower coinsurance, copayments, or additional benefits when members use in-network providers. These providers have agreed to accept rates discounted from their usual charges in exchange for being included in the insurer's network.

Out-of-network providers have not contracted with the insurance plan. Members who use out-of-network providers typically pay the full cost of services or a significantly higher percentage of costs. Even for emergency services, out-of-network providers may bill patients for additional costs beyond what the insurance covers. Members can locate in-network providers through their insurance company's website or by contacting member services.

Prior authorization is a certification or approval that an insurance company requires before certain medical services, procedures, or prescription medications are provided. Obtaining prior authorization means the insurer has agreed to cover the service, assuming it matches what was authorized. This process helps insurers manage costs and ensure that proposed treatments are medically necessary and appropriate.

Many smaller, routine services do not require authorization. Services that commonly require prior authorization include specialized imaging (MRI, CT scans), surgical procedures, certain prescription medications, durable medical equipment, and referrals to specialists. Members should check with their insurance company before scheduling these services to avoid denial of coverage or unexpected out-of-pocket costs.

Preventive care includes health services that prevent illness or detect health problems early when they are easier and less expensive to treat. Under the Affordable Care Act, health insurance plans must cover preventive care at 100% with no cost-sharing (no deductibles, copays, or coinsurance) when provided by in-network providers.

Covered preventive services include 3 main categories:

• Screenings: Blood pressure checks, cholesterol screenings, diabetes screenings, depression screenings, and cancer screenings (mammograms, colonoscopies, cervical cancer screenings)
• Children's health services: Autism screenings, hearing tests for newborns, vision screenings, well-child visits, and childhood vaccinations
• Adult health services: Annual wellness visits, flu shots, tobacco cessation support, birth control, and aspirin use for heart disease prevention in certain age groups

There are 4 primary ways to obtain health insurance coverage:

1. Employer-sponsored coverage: Most nonelderly Americans receive health insurance through their own job or a family member's employment; employers typically offer enrollment during onboarding and annual enrollment periods
2. Individual market coverage: Individuals can purchase health insurance through the Affordable Care Act Health Insurance Marketplace (HealthCare.gov or state exchanges), directly from insurance companies, or through insurance agents and brokers
3. Public programs: Government-sponsored programs include Medicare (for people age 65 and older or those receiving Social Security disability benefits), Medicaid (for low-income individuals and families), and CHIP (Children's Health Insurance Program)
4. Supplemental plans: Additional coverage can be purchased to supplement primary insurance, including dental insurance, vision insurance, accident insurance, and Medigap policies for Medicare beneficiaries

Open enrollment is a designated time period when individuals can start, stop, or change their health insurance coverage. This period occurs once per year for most health insurance types, including employer-sponsored plans, Medicare, and Affordable Care Act Marketplace plans. The timing of open enrollment varies depending on the type of coverage.

For ACA Marketplace plans, open enrollment typically runs from November 1 through January 15 for coverage starting the following year. Employer-sponsored plan enrollment periods are set by individual employers. Medicare open enrollment runs from October 15 through December 7 annually. Outside of open enrollment, individuals can only enroll in or change coverage if they experience a qualifying life event, such as marriage, birth of a child, loss of other coverage, or relocation to a new area.

The Affordable Care Act (ACA), enacted in 2010, introduced 8 major reforms to health insurance:

1. Prohibited insurance companies from denying coverage to people with pre-existing medical conditions
2. Eliminated annual and lifetime dollar limits on essential health benefits
3. Required coverage of preventive care at no cost to the insured
4. Allowed young adults to remain on their parents' insurance plans until age 26
5. Created Health Insurance Marketplaces where individuals can compare and purchase coverage
6. Established premium tax credits to reduce insurance costs for eligible individuals and families
7. Expanded Medicaid eligibility in participating states to cover more low-income individuals
8. Mandated that all health plans cover 10 essential health benefits, including emergency services, hospitalization, prescription drugs, maternity care, mental health services, and pediatric services

These reforms expanded health insurance coverage to more than 20 million previously uninsured Americans and established consumer protections that improved coverage quality and affordability across the health insurance market.

A formulary is the list of prescription drugs that a health insurance plan agrees to cover. Insurance companies determine which drugs to include based on factors such as price, availability, therapeutic effectiveness, and the availability of equivalent medications. Formularies are typically organized into tiers, with each tier representing a different level of cost-sharing for the insured member.

Most formularies include 3 to 5 tiers. Lower-tier medications (usually generic drugs) have the lowest copays or coinsurance, while higher-tier medications (typically brand-name drugs and specialty medications) require higher out-of-pocket payments. Some medications may require prior authorization before the insurance company will cover them. Members can review their plan's formulary on the insurance company's website or by requesting a copy from member services.

Medicare and Medicaid are 2 distinct government-sponsored health insurance programs that serve different populations:

Medicare is a federal social insurance program primarily for people age 65 and older, regardless of income level. It also covers certain younger individuals receiving Social Security disability benefits and those with end-stage renal disease or amyotrophic lateral sclerosis (ALS). Medicare is funded through payroll taxes, premiums, and general federal revenue. The program includes Part A (hospital insurance), Part B (medical insurance), Part C (Medicare Advantage plans), and Part D (prescription drug coverage).

Medicaid is a joint federal-state program that provides health coverage to low-income individuals and families who meet specific eligibility requirements. Each state administers its own Medicaid program within federal guidelines, determining eligibility criteria and covered benefits. Medicaid is funded through a combination of federal and state tax revenues. Eligibility is based primarily on income level, family size, and other factors such as pregnancy, disability, or age.

A health savings account (HSA) is a tax-advantaged savings account designed to help individuals with high-deductible health plans (HDHPs) save money for medical expenses. Contributions to an HSA are made with pre-tax dollars (either through payroll deduction or as a tax deduction), the money grows tax-free, and withdrawals for qualified medical expenses are also tax-free.

To be eligible for an HSA, individuals must be enrolled in an HDHP, cannot be claimed as a dependent on someone else's tax return, and cannot be enrolled in Medicare. HSA funds can be used to pay for deductibles, copays, coinsurance, and other qualified medical expenses not covered by insurance, including dental and vision care. Unlike flexible spending accounts, HSA funds roll over from year to year and remain with the account holder even if they change jobs or health plans.

Health insurance is often compared to 3 related concepts:

Health insurance vs. Health savings account: Health insurance is a contract where an insurance company agrees to pay for a portion of medical expenses in exchange for monthly premiums. An HSA is a tax-advantaged savings account individuals use to set aside money for future medical expenses. HSAs complement high-deductible health plans by providing a way to save for and pay out-of-pocket costs.

Health insurance vs. Supplemental insurance: Comprehensive health insurance covers a broad range of medical services including doctor visits, hospitalization, prescription drugs, and preventive care. Supplemental insurance policies provide additional coverage for specific situations or expenses not fully covered by primary health insurance, such as dental care, vision care, accident-related costs, or critical illness expenses.

Health insurance vs. Health care sharing ministries: Health insurance is a regulated insurance product with legally enforceable coverage requirements and consumer protections. Health care sharing ministries are voluntary organizations where members share medical costs based on shared religious or ethical beliefs, but these arrangements are not insurance and carry no legal obligation for the ministry to pay members' medical expenses.