A lightly edited version of my first Balloon Juice post concerning deductibles, co-pays and co-insurance:
Why do insurance companies charge deductibles, co-payments and co-insurance? What is the point of three forms of making the buyer of insurance pay? Why wouldn’t there be a single form? What are the incentives and how do the different cost share payments save the insurance company money?
These three types of pocket payments have slightly different purposes but they all serve to minimize costs and risks for the health insurance company.
Deductibles serve two purposes. The first is to transform insurance from being purely pre-payment of average medical expenses for a particular population into an insurance product. Insurance is the payment of defined sums for protection against uncertain losses for an individual. The first purpose of deductibles is to get the insurance company off the hook for the first chunk of expenses.
A zero deductible plan is very attractive to people who know that they have major medical expenses coming their way. A very high deductible plan is attractive to people who anticipate very low health care expenses due to their general good health or belief in their own invincibility.
An employer group that offers a $500 deductible plan and a $2,500 deductible plan to its employers will not see random selection of those two choices by its employees. Most of the time, older, sicker people will choose the lower deductible plan. This choice is extremely valuable information for the insurance company. The insurer expects high usage of expensive services, so premiums are higher. Conversely, the high deductible plan is more attractive to the younger, healthier people who don’t use expensive services . Bigger spreads between deductible amounts allows for insurance companies to aggressively identify adverse selection risks and then price that risk.
Co-payments are fixed dollar amounts that members pay for services that don’t apply to deductible sums. There are two reasons for co-pays. The first is to make a service slightly less expensive for the insurance company. This is a minor factor. The main factor is to add a marginal cost for a service from the member’s perspective after a deductible has been satisfied. This is supposed to make members slightly cost sensitive. A $100 co-pay for an MRI is supposed to get the member to question whether or not they really need an MRI or whether the no co-pay X-ray is sufficient. Co-pays for cost sensitivity purposes are extremely common for prescription drug benefits where generic or cheap brand name drugs have nominal co-pays, while patented drugs that have reasonably available and effective substitutes have very high co-pays.
Co-insurance is a percentage of costs that a member is responsible for after their deductible has been satisfied. The primary purpose is to make the member become extremely cost sensitive. For instance, a 20% co-insurance for a non-complicated labor and delivery when my wife gave birth to Reproductive Success #1 and #2 could have put me on the co-insurance hook for roughly a paycheck at the local mid-wife center or a couple of paychecks at the hospital. These type of variable marginal costs for identical services are designed to get people going to the cheaper providers or to eliminate the less essential services.
To review – deductibles are designed for adverse selection identification and effective repricing of risk while co-payments are designed to steer people to cheaper option with fairly simple incentives. Co-insurance is designed to get members to price compare between a variety of providers for a single array of services. Finally, total out of pocket exposure is often capped because there is no reasonable ability of people to finance $30,000, $40,000, or $50,000 in medical expenses from a single incident.
The more cost-sharing through deductibles, co-pays and co-insurance, the less risk the insurance company bears, and the more risk the individual carries on their own. A high deductible, high co-pay, high co-insurance plan is an adequate plan for individual members who either have significant free cash flow OR have a high degree of confidence in their health AND have some ability to access assets in an oh-shit hit by a bus scenario. High deductible, high co-payment, and high co-insurance plans will be the dominant plans on the Catastrophic and Bronze exchanges. Conversely, low deductible, low co-payment and low co-insurance is “rich” coverage that are used by people who can either afford a high premium but few surprises, or know they need to use a lot of medical resources.
Elizabelle
Richard, I am so glad you are here. Apologies for not following healthcare more closely, but it’s marvelous to have you as a resource and a series of blogposts to read up on.
Please don’t take the lack of comments as lack of interest. Same goes for Elon.
Phylllis
I’d be interested to know what the thinking is behind having dental and vision separate from health insurance.
terraformer
Bottom line: health recipient pays insurance company, insurance company pockets a portion of the payment, medical facility/professional gets the rest of the payment.
Insurance company serves no purpose whatsoever, other than to take a portion of that money, and to enact rules/procedures to get even more of it before passing on to medical facility/professional. And any criticism of this or suggesting that it might not be the best approach = communism/socialism/what have you.
America!
Mnemosyne (tablet)
@terraformer:
I wouldn’t give the doctors and hospitals a free pass in this equation, if I were you. The majority of hospital chains and medical groups these days are for-profit, so they have just as much of an interest in ripping you off as an insurance company does.
The problem is that we have a for-profit system, not that we have insurance companies per se. If you look at everyone else’s healthcare systems, they all have some kind of private insurance you can get — yes, even in the UK (where it’s more about being able to get a private hospital room than getting better or faster treatment).
Insurance companies are a red herring, and for-profit companies like Tenet are happy to wave them in front of you to distract you from the fact that Tenet is extracting billions of dollars in profits from your hospital stays and doctor visits.
terraformer
Great point, Mnemosyne. It’s more about the for-profit structure than it is about insurance companies. They’re just players in the same game. I guess insurance companies are more visible in this regard than are the more opaque profit-seeking machinations of the providers themselves.
MomSense
I have to find a new doctor because mine is moving/location is closing. I’m having a hard time finding a doctor who is accepting new patients let alone my plan.
Cervantes
@MomSense:
Does the doctor who is leaving not feel any obligation to help patients find continuing care?
Cervantes
@Phylllis:
Cost.
MomSense
@Cervantes:
The doctor is awesome and treated us at reduced rates for years when we were uninsured. A few years ago, he could no longer compete with the borg (large medical conglomerate) and he became one with the borg. Now the borg is closing locations and doing a consolidation so a bunch of practitioners are being moved. They are not happy about it either.
MomSense
@Phylllis:
It is probably cost, but it is really not good from a health perspective especially now that we now how connected dental and vision health are to other illnesses.
JCJ
@Mnemosyne (tablet):
A little over one year ago there was am article in the Milwaukee newspaper about salaries for the CEO’s of area health care networks. These CEO’s of “non-profit” health care systems were bringing in some serious cash. I suppose it is not as much as the for-profit chains and there are no shareholders skimming money off the system, but I was amazed how much they make. Perhaps there is a compilation of how much money all of the health care systems CEO’s are paid by state or nationally. It must be impressive.
jsonline.com/business/health-systems-turning-to-clinical-quality-to-determine-compensation-b99124604…
Systems mentioned in the article vary by size. Aurora is quite large while ProHealth is nowhere near the size of Aurora.
Stacy
Off topic. Wow Charles CW Cook really should go back to England or under his rock from whence he came. He’s on with Tamron Hall talking about gun control. Ugh he’s repulsive.
Cervantes
@MomSense:
Sorry to hear you’re losing access to a good doctor — and a good person.
Hope you have good luck finding a replacement. Not sure how I might help but am willing to try, so let me know here.
japa21
@terraformer: The key element of insurance is spreading the risk. No insurance, people would be paying their own bills and most could not afford to.
Secondly, insurance companies do lower the cost of the care, through negotiating with the providers.
Thirdly, there is always the option of single payer, but that is impossible in our current climate. If a public option couldn’t pass you certainly are not going to get single payer.
Point being, as of now, we have no option other than insurance companies. Without them, many people would be out of luck in regards to medical care.
benw
I don’t quite follow this. How does the deductible turn health insurance into “insurance product”?
In the case of “traditional” insurance (e.g. fire, flood), the insurance company is mitigating individual risk against a catastrophic payment that most regular folks can’t cover. The company does this by spreading the risk over many individual policies. These policies have deductibles so that the insurance doesn’t have to pay for the small fry stuff, like a broken toaster, but will pay out for a broken house. The deductibles are there to save the companies money, but what makes it “insurance” is the spreading of risk. This model works in health care when health insurance companies can spread risk by selling many policies over a healthy population. That’s what makes health insurance act like “insurance product”, not deductibles. Does that make sense; or am I just being pedantic? One caveat of this model of health insurance is that deductibles can actively discourage small fry routine care, like wellness visits for heathy people who know their one visit to the physician each year will cost most of their deductible out of pocket. One good thing about the ACA is making children’s first wellness visit each year free.
For these folks, the size of the deductible is not important, it’s the out of pocket maximum (unless you have a super kick-ass plan with only low copays so the effective OOP max is the deductible). I know that every year I’m blowing right through my deductibles on my first specialist visit and shipment of meds, and hitting the OOP max by halfway through the year. People like me are not using health insurance like traditional product. For us, health insurance is “purely pre-payment” of mandatory medical expenses, where we are effectively paying the insurance company like a middle man to negotiate rates and payments for us, and then pay off the big bills to the doctors every year. For us, it’s the “no denying policies to people with preexisting conditions” part of the ACA that is a lifesaver. And the truth is that for-profit insurance companies try to wriggle out of covering people like this and/or pay for their care.
MomSense
@Cervantes:
Thanks. I’m hoping to move since the economy is so tough up here and this is another reason to step up my efforts.
Brachiator
@terraformer:
Well, I suppose you could always save up, and pay for your medical expenses yourself.
Linnaeus
Thanks for this explanation, Richard. It’s particularly timely for me because my health insurance provider just sent me a notice that my current plan is ending and that – unless I choose otherwise during the open enrollment period – I will be switched to a new plan. Of course, my deductibles, co-pays, and co-insurance will be going way, way up should I accept the new plan.
millekat
What Phyllis said, in spades.
I’d be interested to know what the thinking is behind having dental and vision separate from health insurance.
Any comment on the awfulness of “dental plans” in general? Since I left gainful employment I have looked at multiple dental plans, some heavily advertised, and some offered through Obamacare website.
Some of them have those waiting periods, where there’s no treatment for you before you pay 6 months’ premiums…then there’s your deductible, co-pays, and a pitiful yearly max – my last plan, from Anthem offered $750 total. So seriously, why buy insurance if I can cough this up in the bank? Except some dentists won’t see you without a policy.
Somehow this develops into blowing through my budget just to get the exam, and having dentist present me with long lists of procedures which I “need” but which my plan doesn’t cover.
Mnemosyne (iPhone)
@JCJ:
The CEO of Kaiser Permanente — which is a pretty good closed HMO nonprofit system out here on the West Coast — was paid over $7 million last year. Cigna, a for-profit insurance company, paid its CEO $27 million. It’s pretty obscene.
As I said above, most countries with universal healthcare also have some form of insurance, but the insurers are usually nonprofit or low profit and very heavily regulated. Plus it’s not up to the insurance company what you can get treated for — there are medical boards (death panels, if you will ;-) that make those kinds of decisions.
Docg
Cover less and less, charge more and more. Eventually greed will cause the whole health insurance industry to collapse and the vulture capitalists will move to the next warm body from which to suck out the life.
bin Lurkin'
@MomSense: I’ve been on Medicare for six months and still can’t find a doctor in my are who will take new Medicare patients, I’ll eventually end up at the clinic I suspect.
It seems that most of the doctors in my area are no longer independent practitioners but rather working under some sort of corporate umbrella system and the corporate systems aren’t interested in Medicare patients and the doctors no longer have any discretion in the matter.
katdip
Richard – I’d be curious if the research indicates if any of these things work to actually drive health consumer behavior (and thereby save money to the system as a whole) or simply result in jacking up the cost of health care administration? Does a $25 co-pay really affect the marginal decision to go to the doctor, enough to justify the expense of processing, tracking, depositing those funds? Does an 80/20 coinsurance requirement actually steer people toward lower cost providers vs, a 90/10 plan? These assume typical micro-economic behavior in response to price signals – in a world of complete information, if the marginal cost goes up the marginal demand goes down. But given the information assymetries in health care (e.g. prices aren’t very transparent) plus the sense that high price = high value, I don’t know if they actually succeed. When my wife had a difficult labor I didn’t shop around, I wanted the best damn hospital with a NICU, stat!
catpal
So my employer and insurance company that has a $250 ER (and $200 ambulance) copay and $1000 Hospital admission copay – is really just telling me that is it better (cheaper for them) for me to just Die — than go to the ER/Hospital.
Or go bankrupt. Great.
Mnemosyne (tablet)
@catpal:
Wow, that’s pretty assholish. Our employer insurance has a $250 ER copay UNLESS you’re admitted, in which case it’s waived. It’s more to discourage people from using the ER for non-emergencies than it is to discourage you from getting treated in an emergency.