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How healthcare insurance works

For those in a rush: Skip to the pictures to learn how healthcare insurance works

A while back, I heard a story about someone in the US that ended up in a car crash and had to spend some time in the hospital – let’s call her Jane. To add insult to injury, Jane did not have healthcare insurance. When she got the bill, she quickly realized she could not afford it. Jane talked to the hospital administrators about her lack of coverage, which resulted in a far lower bill. The bill still was not cheap, but it was at least feasible for Jane to pay for it. Relieved, she left the hospital. She didn’t start contemplating how easily the hospital administrators had lowered the bill until later.

At first, she thought they had just felt bad for her and made an exception. But it had been so easy for them. Would it not have been more complicated to get the authority to lower the bill if it was a rare exception?

When Jane asked around, she found out that other people in her position (no healthcare insurance) had had the same experience. Maybe they were all just very lucky? Or maybe it was standard for hospitals to reduce the bills of people with no healthcare insurance?

The first seems unlikely; there are too many people who have had the same experience. The second begs the question: If prices can be lower, why would insurance companies – who notorious for avoiding payouts at almost any cost – pay more? And so much more too.

That is the question that I could not get out of my head: Why do healthcare insurance companies get far higher bills for the same treatments? And perhaps more importantly: Why should you care?

Why do healthcare insurance companies pay more?

The answer to this question is baked into the very regulations that govern how healthcare insurance companies can make money. These regulations limit the annual profit a healthcare insurance company can make to 20% of the payouts made during the year. The idea is to avoid a scenario where healthcare insurers hike the premiums to increase their profits. Super high premiums would be bad for the people who need insurance, so this seems like a good measure.

However, insurance companies are profit-seeking enterprises and as the adage goes: Where there’s a will, there’s a way.

It requires some creative thinking, but it is not hard to increase profits under these conditions. All you have to do is increase payouts:

Healthcare insurance companies benefit from increased payouts, since profits are limited to a percentage of payouts.
By doubling the payouts, profits double too. Thus, payouts are good for the healthcare insurance provider.

Typically, companies want to limit their expenses in order to increase profits. But this is not a typical scenario. Since the profits are dependent on expenses, increasing payouts (expenses) is, in fact, the only way healthcare insurers can increase their profits.

Thus, insurance companies are happy to pay more than necessary for medical treatment. Hospitals and other medical facilities are, of course, more than happy to oblige, as it puts more money in their pockets too.

Why should you care that healthcare providers pay more?

So we have established that more expenses mean more profit for the healthcare insurance providers and the medical facilities, but why should you care?

Well, at the end of the day, the insurance companies need to bring in more money to afford the increased payouts while still having revenues that are higher than expenses. Where do they get the money from? You, the insured.

Though the goal of limiting the profits to 20% of payouts was supposed to ensure lower premiums, it has not. As often is the case, there are unforeseen consequences to new regulations. In this case, healthcare insurance premiums are simply increased to accommodate higher expenses (and profits). At the end of the day, you are still paying more than you should for medical care. It is just hard to tell, as it is paid indirectly through insurers.

That is why Jane and others like her were able to get cheaper medical care from the hospitals: The price paid by healthcare insurance companies – the default price for treatment – is artificially high.

Summed up in a couple of pictures:

Costs of medical treatment without healthcare insurance vs. without.
Why higher profits for healthcare insurers are dependent on higher payouts and higher premiums: Map of logic.

NOTE: If you found this topic interesting, I recommend listening to Peter Attia’s podcast with Marty Makary on how the healthcare system works and how it might get fixed.

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