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What Is Health Insurance and How Does It Work?


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Finding the right health insurance plan is hard work. There are so many options to choose from and factors to compare — premiums, copays, deductibles, doctor networks. How are you supposed to make sense of it all? 

It helps to start with a basic understanding of what health insurance is. Knowing how health insurance works, the various costs of an insurance policy, and the different types of health insurance can help you determine which plan is right for you.

What Is Health Insurance?

Health care can be incredibly expensive. According to, it can cost $7,500 to set a broken leg, $30,000 for three days in the hospital, and hundreds of thousands for cancer treatment. Unless you’re a billionaire, there’s no way you can handle costs like that on your own.

And most people don’t have such high medical expenses. In a typical year, you might need an annual checkup and one or two other doctor visits. Only a few people need thousands of dollars’ worth of care. But there’s no way to predict who those people will be.

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Health insurance is a way around that problem. When you buy a health insurance policy, you’re basically agreeing to share the burden of medical expenses with a large group of other people. 

Each of you pays a certain amount of money into a pool each month. If anyone needs care, the money to pay for it comes from that pool. The healthy people with low medical costs help cover the bills for the sick ones knowing that if they get sick, the group will do the same for them. 

Health insurance companies handle the work of organizing these pools. They collect the monthly payments from subscribers and pay health care providers to cover patients’ medical care. They set the cost of premiums to make sure the amount they take in is more than they pay out so they can cover everyone’s medical bills and still make a profit.

How Does Health Insurance Work?

The basic idea behind all health insurance plans is simple. You pay the insurer a regular monthly premium, and it covers some portion of your health care costs in exchange. However, the details are considerably more complicated than that.

How You Pay for Health Insurance

The primary cost of a health insurance policy is the monthly premium. That’s the regular fee you pay to the health insurance company for your coverage. However, that’s far from the only cost associated with a plan. 

To ensure they make a profit, insurers require their customers to cover a portion of their own health care costs. This cost-sharing can take several forms, including:

  • Deductibles. A deductible is a sum you must pay out of your own pocket each year. If you have a $3,000 deductible, you pay the first $3,000 for your care entirely on your own. After that, insurance starts to pick up some of the costs. Some preventative care and other categories may be covered fully or partially before you meet it. 
  • Coinsurance. After meeting your deductible, you may continue to pay a portion of your medical costs through coinsurance. That’s a percentage of each bill you pay out of pocket. If your coinsurance is 15%, you pay 15% of each bill and the insurer pays 85%.
  • Copayments. Instead of coinsurance, some plans have copayments, or copays for short. A copay is a fixed fee you pay for a given medical service. For example, you might pay $20 for each doctor visit and $50 for each trip to the emergency room. 

All these costs together are known as your out-of-pocket costs. To protect you from overwhelming medical bills, health policies limit these costs with an out-of-pocket maximum. Once your health expenses reach this limit, the insurance company covers the rest.

What Health Insurance Covers

Under the Affordable Care Act (ACA), most health plans must cover certain essential health benefits. These include:

  • Hospitalization
  • Doctor visits
  • Emergency services
  • Maternity and newborn care
  • Mental health and substance abuse treatments
  • Prescription drugs
  • Lab tests
  • Preventive care, such as vaccinations, health screenings, and birth control
  • Rehabilitative or habilitative care needed to perform daily activities

Health insurance policies for children must also cover dental and vision care. Policies for adults usually don’t cover these types of care, but adults can buy separate plans to cover them.

These requirements do not apply to short-term health insurance plans. These policies, which are only good for up to a year, generally provide coverage for emergency care only.

Limits on Health Insurance

Cost-sharing isn’t the only way health insurance companies limit their expenses. They also limit the kinds of care they cover to keep costs down.

For starters, most health insurance policies have exclusions — types of care they don’t cover. Examples include elective cosmetic surgery, such as facelifts, or alternative medicine, such as acupuncture. You can still receive these treatments, but you must pay 100% of the cost yourself.

Many health insurance plans also use care networks to limit cost. Health insurance companies negotiate with specific health care providers for lower rates on their services. These providers make up the company’s network. If you go to a provider who’s not in the network, the insurance covers less of the cost or none at all.

Another common requirement is preauthorization. That means your policy only covers certain types of nonemergency care, such as surgery, drugs, or specialist visits, if the insurer confirms it’s medically necessary.

Keeping track of all these rules and limits can be difficult. That’s why insurers usually send an explanation of benefits after paying a medical claim. It outlines what the bill was for, what portion the insurer paid, and how much you still owe.

Types of Health Insurance

There are many types of health insurance coverage. Insurance can be publicly or privately funded. You can get it through your employer or buy it on your own. And there are many types of plans with different rules and requirements to keep costs down.

Public Health Insurance Programs

Unlike most developed nations, the United States has no universal health care. However, there are several different programs run by state and federal governments to provide health care coverage for different groups of people. They include:

  • Medicare. This federal program provides coverage for Americans who are over age 65 or disabled. Its funding comes partly from premiums and partly from a dedicated payroll tax. Different parts of Medicare cover hospital care, primary care, and prescription drugs. 
  • Medicaid. This plan covers health care costs for the lowest-income Americans. It’s funded partly by the federal government and partly by state governments. Each state has its own Medicaid program and sets its own rules about who qualifies for it.
  • Children’s Health Insurance Program. This program provides coverage for children from low-income families who don’t qualify for Medicaid. Like Medicaid, it’s a partnership between federal and state governments, with each state setting its own rules. 
  • Tricare. The Tricare program provides health care coverage for active and retired military members and their families. The funding comes from the U.S. Department of Defense budget.
  • Health Insurance Marketplace. Under the ACA, the government also helps low- and middle-income people pay for private insurance. It isn’t a public insurance program, but it gets some public funding. You can shop for a plan on your state or the federal health insurance marketplace and learn if you qualify for subsidies. 

Private Health Insurance Plans

According to U.S. Census data, more than half of Americans get their health insurance through their employers. Another 12% have private insurance they bought on their own. Types of private health care plans include: 

  • Fee-for-Service. Fee-for-service is the simplest form of health insurance. Your insurer pays your health care provider a fee for each service you receive with no restrictions. It’s the easiest type of plan to use, but it also has the highest monthly premiums.
  • Health Maintenance Organizations (HMOs). An HMO is the lowest-cost and most restrictive type of plan. It only covers care from in-network providers. It also requires you to have a primary care physician (PCP) who approves any care you receive.
  • Preferred Provider Organizations (PPOs). A PPO also has a care network, but it lets you see providers outside the network for a higher fee. You can also see doctors other than your PCP without a referral. PPOs have higher premiums than HMOs.
  • Point-of-Service (POS) Plans. A POS plan is like a PPO but with more of a focus on primary care. It doesn’t allow you to see any other doctor without approval from your PCP.
  • High-Deductible Health Plans (HDHPs). An HDHP can be any type of plan with a high deductible. HDHPs have much lower premiums than other plans but much higher out-of-pocket costs. To help offset these costs, you can often pair them with a health savings account that lets you pay for health care with pretax dollars.

Health Insurance FAQs

Health insurance can be a confusing subject. This quick rundown of the most common questions people have about health insurance coverage will clear a few things up.

Why Do You Need Health Insurance?

The most obvious reason you need health insurance is that you might need treatment you can’t afford. Without insurance, you could be on the hook for thousands or even hundreds of thousands of dollars in health care costs.

But you often need insurance to get medical care at all. By law, hospital emergency rooms have to treat you even if you can’t pay, but only enough to ensure that you’ll survive. And other providers don’t have to treat you at all if they’re not sure you can cover the cost.

Unfortunately, you can’t just wait and sign up for a health insurance plan if you need care. Typically, plans are only open to new members during an annual open enrollment period or after a specific event called a “qualifying life event,” like losing your job. If you suddenly need health insurance at any other time, you’re out of luck.

How Much Does Health Insurance Cost?

There are many different costs associated with health insurance that vary from policy to policy. For instance, higher monthly premiums usually mean lower out-of-pocket costs and vice versa.

If you’re talking about premium costs, eHealth found that the average American monthly premium in 2020 was $456 for an individual and $1,152 for a family. However, that’s only an average. Actual premium costs vary widely based on numerous factors, such as your age and location.

If you get health insurance from your workplace, the cost of your policy depends partly on how much of the tab your employer picks up. And if you buy a plan in the health insurance marketplace, the cost depends on whether you qualify for a subsidy.

How Do I Buy Health Insurance?

For most people, the easiest way to buy insurance is through the workplace. Under the ACA, any company with at least 50 full-time employees must provide a health plan or pay a penalty to the IRS. 

If you work for a company this size or larger, visit the human resources department to ask about your insurance options. You can enroll when you first join the company or during its annual open enrollment period.

If you work for a smaller company or are self-employed or unemployed, the easiest way to get health insurance is to buy a plan on the health insurance marketplace. Go to to find out when and how to sign up. The site can also tell you whether you qualify for subsidies or Medicaid.

How Do I Choose the Right Health Insurance Plan?

First, find out what plans are available — from your employer, the health insurance marketplace, or both. Then compare the plans, balancing the cost of premiums against the available coverage. 

If you’re young and healthy, a lower-cost plan with less coverage might be the best choice. If you need a lot of care, it could be worth paying extra for more coverage. There are tools on and some state health insurance marketplaces to help you estimate your total health care costs based on your usage. 

Then, consider the plan details. Check the networks for each available plan to see whether they include your providers of choice. Also, ensure the plans cover any prescription drugs you take regularly. For marketplace plans, you can also look at quality ratings

If you still need help deciding, talk to a health insurance assister. They help users find and apply for health insurance. To find one, check the Find Local Help page on

Final Word

Health insurance is a necessity, not a luxury. It’s the best way to protect yourself from out-of-control medical bills that could drive you into bankruptcy. It’s one of the key types of insurance you should never go without

If you want health insurance but can’t afford the premiums, look for ways to lower them. Check to see if you qualify for a subsidy or Medicaid. 

If that doesn’t work, consider downgrading to a cheaper plan with less coverage, such as an HDHP. These plans have higher out-of-pocket costs, but they’re still better than going without insurance at all.

Amy Livingston is a freelance writer who can actually answer yes to the question, "And from that you make a living?" She has written about personal finance and shopping strategies for a variety of publications, including,, and the Dollar Stretcher newsletter. She also maintains a personal blog, Ecofrugal Living, on ways to save money and live green at the same time.