Class 2 — How insurance works

Tuesday, September 1

This recap comes from a recording of class, transcribed with Whisper and summarized with Claude, with a light edit from me. It’s meant as a convenience rather than a careful document, so the phrasing will sometimes be a little off. If something here looks wrong, please tell me and I’ll fix it.

What we covered

The vocabulary of a health insurance contract. On the insurer’s side, managed care, networks, HMOs versus PPOs, and benefit design. On the patient’s side, premiums, deductibles, copayments, and coinsurance. We ran the first simulation in Commons, and with the time left I started on Thursday’s material about where employer coverage came from.

Key points

  • Health insurance is a financial product. It covers the cost of getting sick rather than keeping you from getting sick. Being insured also gets you the insurer’s negotiated price instead of the hospital’s list price, which matters even before any cost sharing.
  • “Managed care” just means the plan has a network. An HMO is in or out. A PPO has tiers, with your coinsurance rising as you move down them.
  • A PPO isn’t automatically a bigger or cheaper network than an HMO. The same insurer usually sells both, and a provider in its HMO is almost certainly somewhere in its PPO too.
  • Copayments go with predictable care and coinsurance with care that has a long tail. An office visit can’t turn into a $100,000 bill; a hospital stay can. Pharmacy drugs are usually a copayment for the same reason, while expensive drugs given in a physician’s office, where the dose can change that day, are often coinsurance.
  • Deductibles and out-of-pocket maximums are usually split in network versus out of network rather than by tier.
  • Between 2003 and 2017, deductibles went from about a fifth of out-of-pocket spending to about half, mostly at the expense of copayments. All else equal, a higher deductible is the cheapest form of cost sharing for the insurer, but it has moved alongside big price increases, so it’s hard to say what would have happened otherwise.
  • The medical loss ratio is the main constraint on insurers. It caps the share of premium revenue that can go to anything other than paying for care (85 percent must go to care in large employer plans, 80 percent in individual and small group plans).
  • Networks come out of a two-sided negotiation. The insurer wants your specialty in the network but not at your price, and either side can walk away. More and more, the physician’s side of that negotiation is a hospital, an insurer, or a private equity firm that owns the practice.
  • A surprise bill is what happens when the hospital and the surgeon are in network and the anesthesiologist they brought in isn’t. That’s what the No Surprises Act is about, and it’s been in litigation constantly.
  • A health savings account lets you pay your cost sharing with pre-tax dollars. At a 25 percent tax rate, a dollar of salary buys about 75 cents of care after tax or a full dollar through the account.
  • Cost-plus reimbursement pays a provider its costs plus a percentage, so higher costs mean more dollars at the same margin. That’s how hospitals were paid for decades, and how Medicare and Medicaid paid into the 1980s.
  • In the simulation, about half of you bought insurance in the first round, and almost everyone bought after the round where several people got sick. That relationship between risk and willingness to pay is where the module goes next.
  • The book I was trying to remember last week is T.R. Reid’s The Healing of America.

Clarifications and corrections

  • Which plan type is most common. I didn’t have the number in class. In KFF’s 2025 employer survey, 46 percent of covered workers are in a PPO, 33 percent in a high-deductible plan with a savings account, 12 percent in an HMO, and 9 percent in a point-of-service plan.
  • Who pays how much of the premium. My example had the worker paying $10,000 of a $22,000 family premium. In the KFF survey behind that chart, workers paid about $6,000 of it in 2021, so roughly a quarter. The employer pays most of the premium.
  • When the ACA changed the non-group market. I said “pre-ACA, so before 2012.” The law passed in 2010, and the marketplaces and the pre-existing condition rules started with 2014 coverage. The 2012 chart is just the last full year before the marketplaces opened.
  • Who approved wartime wage increases. I said the Department of Defense, which didn’t exist until 1947. Under the 1942 wage controls, raises went through the National War Labor Board. Either way, employers competed on benefits because they couldn’t compete on wages.
  • How dominant Blue Cross Blue Shield was. I said nearly every plan by mid-century. Thursday’s slides put it at about half of all plans by 1940.
  • Blue Cross Blue Shield today. I said it’s Anthem now. Blue Cross Blue Shield is an association of independent licensees, and Anthem, now called Elevance Health, is the largest of them.