The basic idea of insurance is that you pay a premium to an insurance company who agrees to cover you for a low probability large loss. For example, you might pay $500 per year for house insurance, and the insurance company agrees to rebuild your house if it burns down. For some reason, typical health insurance plans have this basic idea of insurance backwards.
To illustrate what I mean, I’ll look at Sun Life’s basic personal health insurance plan. I don’t intend to promote or criticize Sun Life in particular; other insurance companies have very similar plans.
Sun Life’s basic plan has fairly low yearly dollar limits:
- Prescription drugs: max $750/year
- Dental: max $500/year
- Alternative treatments: max $25/visit and $250/practitioner
- Hearing Aids: max $400 per 5 years
- Dental accidents: max $2000/injury
- Medical equipment and in-home nursing: combined max $2500/year and max $20,000 lifetime
To run a profitable business, an insurance company has to charge more than it expects to pay out in claims. This means that the yearly premium you pay is likely to be more than the amount you claim in a year. This can still be a good deal for you if you are being protected against a large, devastating loss. But, most people could afford to pay the maximum amounts in the list above.
Even worse, if you get a serious condition requiring $10,000 worth of drugs each year, you’ll pay $9250 of that out of your own pocket in addition to the health insurance premium. This health insurance plan offers no protection against serious loss.
These health insurance plans would make more sense if they were reversed to pay for everything above some limit instead of paying for amounts below the limit. Of course, there would have to be some upper limit; insurance companies shouldn’t be expected to take on unlimited risk, but these upper limits would be high. Think of the roughly $1 million liability limit in most car insurance policies.
Many employers offer health insurance plans with similar low caps on claims. These plans aren’t really a form of insurance because they offer little protection against serious loss. They are really just extra income.