How Does Insurance Work

Today’s topic: How does insurance work? The simple answer is it’s about economy of scale.

Since time began, mankind has found safety in numbers. Health coverage is no different. When you sign up for coverage, you join a group of other people to combine your healthcare purchasing power. Your insurer covers the whole group rather than individuals so everyone shares the cost of staying healthy.

It’s a lot like an auto insurance company that collects premiums from its customers then uses that pool of money to pay accident claims when a customer has a wreck.

Here’s an example. Gary is a healthy guy but it’s his first time skiing. Moments after stepping off the lift, he plummets down the wrong slope and hits a tree. Then 5 more trees. Then he slides over the edge of a small cliff and is promptly hit by a falling safe. Just then his wife calls to inform him she’s about to deliver twins.

Gary’s about to be buried under a lot more than snow because costly medical events like these can be devastating without health insurance. His broken leg and concussion can cost thousands to treat, and depending on the circumstances, the birth of his twins could cost anywhere from a few thousand to a hundred thousand or more.

Fortunately, Gary has health insurance. Remember that group we spoke of? Since the costs are spread out over everyone, the people in Gary’s group are actually helping to offset his costs. Gary’s going to pay a lot less to treat his injuries and deliver his kids because his insurer is betting that the money the group pays in will offset the total costs of their health expenditures for the year.

In a sense, the healthy people in the group help pay the costs when someone is sick or injured, knowing that the same help will be there when they need it.

So instead of paying thousands of dollars, Gary’s out of pocket costs are minimal. He’s only responsible for his co-pay and his deductible, which vary by insurer.

So to sum it up, health coverage reduces your risk of financial disaster because your health costs are spread across a large group of people, and the healthy people help pay for the sick.

So now you know. Until next time, stay smart and stay healthy!

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