Insurance plans are ways that we can pay a little money to stop us from paying a lot of money. It is necessary to understand how it works since all of us will have insurance at some point. Even if we aren’t required to have it, there are many times it makes sense to buy it anyways. Insurance companies sometimes get a bad rap, but insurance is a necessary thing to help manage your risk.
The Main Concept
It is often helpful to look through the lens of an insurance company. An insurance company’s job is to insure as many people as possible for as little as possible (profit!). If you had to figure out how much to charge for your plans, you can imagine how that is done. You figure out how much money it would cost if the insurance plan was invoked, and how likely it is to be invoked.
Say you are insuring customers about getting struck by lightning. For sake of argument, let’s say that if your insured customer gets struck, you will pay them or their family $500,000 for their medical bills / funeral bills. The next step is to figure out what the chance of getting struck by lightning is in a given year. Let’s go with a 1 out of a million chance estimate (source). This means in order to break even, our policy would cost $500,000 / 1 million, or $0.50 a year. Then in order to make a profit you increase the cost a little bit (let’s say to $1 a year). If you had 10 million customers, they each pay you $1, so you make $10 million in a year. Chances are, around 10 of your customers will get struck, so you will have to pay out $500,000 x 10. This is a simplified example of how insurance companies work in the real world!
The insurance company benefits because they profit, and you benefit because even if you don’t get struck by lightning in a given year, you only had to pay $1. Just $1 for peace of mind that if you were to get struck, your medical bills and family would be taken care of. In a more realistic example, you can imagine what would happen if you got cancer and didn’t have Health Insurance. You may be responsible for more than $200,000 for chemotherapy treatments. This would cripple the large majority of people, but with insurance can become more manageable.
Different Types
There are many different kinds of insurance that you are able to purchase. Many of us have heard of the major types like Health Insurance, but there are many more. Here are just some of the many different types:
- Auto Insurance
- Life Insurance
- Homeowners Insurance
- Renters Insurance
- Dental Insurance
- Vision Insurance
- Travel Insurance
- Pet Insurance
For each of these types, there are even different subcategories. Take Auto Insurance for example, you can have collision insurance in the case you get in an accident, but you can also have liability insurance that helps protect you from paying medical fees and repair fees of others if you’re the one who caused the accident. You can even have uninsured motorist insurance which will protect you get into an accident with someone uninsured. When picking any insurance plan, be prepared to dive in and do some research about the different subcategories.
Premiums and Deductibles
Premiums and Deductibles are two of the most important words when it comes to insurance. The Premiums for your insurance plan is just simply what you pay for the plan. Premiums are often written as biweekly amounts, monthly amounts, or annual amounts. If your monthly premium for your plan is $100, that just means you owe the insurance company a hundred dollars a month in order to pay for your plan. Sometimes premiums can even be increased by your behavior or even your genetic information. If you regularly get speeding tickets, then Auto Insurance premiums may go up. If you have a family history of Alzheimer’s, you may have to pay more for Life Insurance policies.
The plan Deductible is the amount of money you will need to pay before your insurance “kicks in”. Now there can be exceptions to this, for example many Dental Insurance plans allow 2 bi-annual appointments that are covered by the plan even without meeting the deductible. Ignoring this exception, if your Deductible is $500, that means you will need to spend $500 before your insurance will cover anything.
Premiums and Deductibles are also related to each other. With all else being equal, Premiums will be higher when the Deductible is lower, and vice versa. This is because if your Deductible is low, its more likely that you will meet the Deductible each year. In order for the insurance company to profit they need to increase the Premiums to compensate. This balance is something you get to decide when picking a plan. If you expect to use your insurance a lot every year, maybe a low Deductible high Premium plan is better for you. If instead you are just getting the insurance to be safe and don’t expect to use it much (and can afford the Deductible if needed), a high Deductible low Premium plan may be better for you.
What about Copay?
Most commonly with Health Insurance plans, you will also see a Copay listed next to different procedures. This is the amount of money you will need to pay for a certain procedure once you have hit your Deductible. For example, if the Copay for a hospital visit is $15 plus 10%, that means if your hospital charges $7,000, you will owe $15 + $700 = $715 for the visit and your plan will cover the rest. You will typically notice that the higher the premiums are for a plan, the lower the Copay will be (meaning you will owe less for an incidence).
Some Examples
It is helpful to see some examples since the topic of insurance can be intimidating. These are the types of numbers you should be thinking about when choosing any insurance plan.
Auto Insurance Example
| Coverage | Limits | Deductible | Premium (Annual / Monthly) |
|---|---|---|---|
| Bodily Injury Liability | $200,000 Per Person | $0 | $528 / $44 |
| Property Damage Liability | $100,000 Per Accident | $0 | $252 / $21 |
| Uninsured Motorist Bodily Injury | $200,000 Per Person | $0 | $240 / $20 |
| Collision | Cash Value of Vehicle | $1,000 | $372 / $31 |
| Towing and Road Service | $100 Per Incident | $0 | $24 / $2 |
| TOTAL | TOTAL | $1,416 / $118 |
When looking at the above table, notice the 4 different columns. The first column is the Coverage, which is the type of thing the insurance will provide for. For example in Auto Insurance, Bodily Injury Liability is when you are responsible for injuring someone else. If we look at the next column for the same row, we see the $200,000 limit per person. This means if you hit another car and it’s your fault, the insurance company will pay up to $200,000 per person that you injure (for their medical bills). This specific row has $0 deductible meaning you don’t have to cover any of this money, but you will have to pay the monthly premium which is $44 in this case.
If we look at the row that has Collision as the Coverage type, we see that this row has a listed Deductible. This means if you get into an accident, you will need to pay the first $1,000 of damages for accidents in that current year. That’s right, if you hit a mailbox and get a dent in your car that will cost $700 to fix, you will be responsible for the entire amount (unless you have already met your Deductible).
Even if you have met your Deductible, you have be sure that your plan doesn’t have any exclusions. Some Auto Insurance companies could add a clause in their plans that says damage from a mailbox is not covered. You need to be aware of what is covered and what is not by your plan, and shop accordingly. These sorts of summary tables are nice, but they can miss out on part of the picture. Make sure to always check out plan brochures and ask questions about exclusions.
Health Insurance Example
Health insurance is grouped a little bit differently than Auto Insurance. The Deductible is typically plan wide, meaning all medical costs go toward a common amount. Premiums also aren’t typically specified for each type of procedure since there are so many different types. When shopping for a Health Insurance plan, make sure to dive into the plan brochure. Make sure what you want is covered (do you plan on giving birth, is your family prone to cancer, etc).
| Plan | Premium (Annual / Monthly) | Deductible | Out of Pocket Maximum | Primary Care Visit Copay | Inpatient Surgery Copay |
|---|---|---|---|---|---|
| A | $2,088 / $174 | $3,000 | $15,000 | 30% | 30% |
| B | $5,652 / $471 | $1,000 | $8,000 | 15% | 15% |
| C | $7,968 / $664 | None | $5,000 | $15 | $30 |
The table above shows 3 different plans in ascending order of their Premiums (yes, they are high and realistic). The next column is the Deductible, which is the amount you have to pay out of pocket before your insurance kicks in. A new column here is the Out of Pocket Maximum. Some insurance plans will specify this maximum so you will know what the maximum amount of money you can pay a year is. Since some medical bills can be ridiculously expensive, this is an important number to pay attention to.
The last 2 columns are some examples of Copay’s for a primary care visit, and an inpatient surgery. If a percentage is listed there, that means if you visit your primary care physician and it costs $600, you pay that percentage as a copay (30% would be $180). You can see the trends as you move to a higher or a lower Premium. Plan A has the lowest Premium, but it also has a fairly high Deductible and Out of Pocket Maximum. Along with that, a 30% Copay for inpatient surgeries and primary care visits is quite high. Contrast this with Plan C that has a Deductible of $0, a lower Out of Pocket Maximum, and a $15 or $30 Copay for doctor or surgeon visits. The downside with the last plan is the Premiums you have to pay are almost 4 times as high as Plan A.
With real plans, each plan has an available brochure with it that has dozens or hundreds of pages of covered/non covered procedures. If you have existing conditions or a family history of certain diseases, make sure to look for how plans you are shopping for cover any relevant procedures.
Wrapping it Up
Insurance is a broad topic with many different nuances depending on the type of insurance you are talking about. Before deciding on any insurance plan, it is important to do research about what these plans cover.. While you can make mistakes and change some plans regularly (like Homeowner’s Insurance), there are other types of insurance that are much harder to change (may need a qualifying life event for Life Insurance). If you are uncomfortable with any thing you see listed in any plans you see, make sure to ask questions to those companies. You may even want to consider consulting with a financial advisor for further assistance.
