In this segment, we will introduce the concept of health insurance which is essentially a contract between a payer, could be a company like Blue Cross or a government agency like Medicare, and a member. This contract offers financial protection against medical care expenses incurred due to illness or injury. That is health insurance provide some peace of mind. If a person is ill and needs to see the doctor, insurance coverage would render the visit affordable and this person would be less likely to shear from care for financial reasons. As with any contract, both parties, the policyholder and the insurance company, must give something up. The insurance company guarantees to cover a portion of the medical bill and in doing that substantially reduces financial risks associated with negative health shocks. In return, the policyholder must pay a fee to the insurance company for this protection. This fee is called a premium. In our next segments, we will discuss what determines the size of insurance premiums. But for now, let's introduce what else we might find in a typical health insurance contract. In addition to a premium, most insurance contracts include a deductible, copayments, and coinsurance. These are ways in which insurers share the costs of medical services with policyholders. A deductible is a specified amount that the insured member must pay during a policy period, which is usually one year, before the insurance plan kicks in and starts to provide financial protection. A copayment or a copay is a specific flat fee you pay for each medical service. For example, if an individual went to visit the cardiologist before signing up for surgery, she may have had to pay a $25 copay for her visit. A coinsurance represents a fraction of the medical expenses that the insured member has to pay. For example, if you have an 80/20 coinsurance on your health insurance plan, it means that the insurance plan will cover 80 percent of covered medical bills, while you are responsible for paying the other 20 percent. Some individuals may experience high medical expenses in a given year. A typical heart bypass surgery in the US costs more than $100,000. If a patient needs such intervention at 20 percent coinsurance rate represents a considerable financial burden. This is why many policies include an out-of-pocket limit which sets an upper bound on the amount that a policyholder owes during a policy period, again, usually one year before the insurance plan starts to pay 100 percent of all coverage medical expenses. These covered medical expenses are typically limit to what are often known as essential health benefits which include 10 essential domains of medical care. Those benefits appear now on your screen. You're not expected to know all of these essential health benefits by heart, but it's useful to understand what situation coverage falls under. To better understand how these components work together, let's look at how health insurance works over the course of the policy period. On the y axis, we have healthcare spending, and on the x axis, we have days, which in our case span a year. So we have the beginning of the year, and we have, the end of the year. Our insured member, in this example, is using medical care quite routinely. Here are the medical expenses this person incured over the year. If this individual was uninsured this would be the amount they owe. But luckily, our individual did purchase health insurance. And so, the first component of this health insurance policy is a deductible. This line tells you when the insured member has paid their deductible. So, up to this point, the member pays for care out of pocket. The next element is the out-of-pocket limit. In this area, between the deductible and the out-of-pocket limit, the member pays a fraction off the medical expenses in the form of copayments or coinsurance. Know that the actual medical expenses are higher than what the member pays. Once the insured member hits the out-of-pocket limit, all medical expenses are paid in full by the insurer. So while medical expenses keep on accumulating, the individuals does not share in the payment. At the end of the year, this is the amount paid by the member and this is the amount paid by the insurance plan. So what is missing from this picture? Right. The premium. The premium is paid to the insurer regardless of medical expenditure. If the average amount paid to the insurer for all its members exceed the average premium this insurer collect, this insurance company will lose money. Up until now, we discussed the key components of all health insurance plans, but plans have different rules. So we are going to discuss the three major types of health plans being offered and how they differ from one another. These three health plans are HMO, PPO, and HDHP. We'll start with health maintenance organization, or HMO. Which is an insurance plan that offers relatively lower premium, but restricts the members access to providers, services, and products. For example, a policyholder will have fewer physicians to choose from, fewer procedures available to them, and fewer drugs covered under their plan. Additionally, policyholders are required to identify a primary care physician, who then serves as a gatekeeper when patients desire a referral to a specialist. The policyholder must pay a fixed copay at each visit to the primary care physician. Preferred provider organization or PPO is an insurance plan that gives policyholders more freedom of choice but generally involves a higher premium. Under a PPO, though the network of providers that a patient may visit is larger, there are still providers that are out of network. A patient may still visit those providers, but the insurance will likely cover less of the cost than for an in network provider. A key difference between a PPO and an HMO, is that the PPO does not require seeing a primary care physician, so patients can make appointments with specialists at their discretion. Finally, a high deductible health plan, or HDHP. Is an insurance plan that gives policyholders the most freedom over the providers they visit, and the services they receive. This plan is sometimes called consumer driven health plan or CDHB, which reflects the patients freedom to choose. The plan is structured in a way that policyholders bear substantial risk by selecting a high deductible plan. Since the insurer bears relatively less risk, they will offer lower premiums. HDHP are popular among individuals who have access to health savings accounts through their employers. These health savings accounts or HSA help individuals save money so they can pay the high deductibles in the case of a negative health shock. These plans are recommended for individual who use medical services infrequently. An HDHP plan would still provide coverage for catastrophic events. You should now understand the basic setup of health insurance, which should facilitate our discussion of the economics of the insurance markets in the next few segments.
