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Understanding the Value of Health Insurance

By Graham McCaulley, Extension Associate, Personal Financial Planning, University of Missouri Extension

At the Office for Financial Success we aim to improve the financial lives of individuals by providing education on a range of financial topics from financial problem areas (e.g., credit, debt management, budgeting) to productive areas of personal finance (e.g., investing, insurance, employee benefits). We know financial education is maximized when consumers have greater financial literacy, which has been defined as “the ability to use knowledge and skills to manage financial resources effectively for a lifetime of financial well-being” (President’s Advisory Council on Financial Literacy, 2008). No matter how good the information provided is, if a consumer does not fully understand it, realize the value of the information, know how to apply it to his or her own situation, and is not internally motivated to act as needed, then the education is not of value.

We can apply this concept of financial literacy to all areas of personal finance education, including health insurance. We have covered health insurance issues in several Financial Tips, most recently covering the Affordable Care Act (ACA) implementation. The ACA has significantly changed the health insurance landscape in America, and one of the intended goals of the ACA has been to increase access to health care and insurance, particularly for the uninsured. The highest uninsured rates by age group are for young adults, with roughly 24% of 18 to 24-year-olds and 28% of 26 to 34-year-olds being uninsured, compared to a national average of about 16% for all adults. Whether or not one agrees with the full scope of the ACA, and whether young adults access health insurance through their parents’ plans, employer-sponsored coverage, ACA-created Health Insurance Marketplaces, companies operating outside of these Marketplaces, or by other means, virtually everyone can agree that better health outcomes and financial successes are achieved when individuals have health insurance coverage.

Health Insurance Literacy

But the best intentions of policymakers, financial educators, insurance brokers/agents, and other organizations are lost if consumers, especially young adults, do not only value health insurance coverage, but also have some level of health insurance literacy. Health insurance literacy has been conceptualized as how well an individual can understand and (potentially) use health insurance information. This can include being able to select the right plan for yourself or your family, using the plan correctly/to the maximum benefit, and the ability to understand and confidently act on health insurance-related choices.

What affects your health insurance literacy level? Background skills, such as reading ability or numeracy, combine with health insurance-specific knowledge (e.g., what health insurance is and how to choose it), skills (e.g., calculating how much coverage a plan offers), and confidence (e.g., the ability to take actions that will benefit you and your family). In theory, health insurance education can improve your health insurance literacy and lead to choosing and using a health plan in ways that work best for your personal or family health and financial situations. However, a first step in being able to use education to improve health insurance literacy is being able understand the basic value of health insurance.

A Basic Understanding of Insurance

Most of us probably know that health insurance is meant to protect us from the financial effects of expenses associated with health problems, such as illness or injury. But how do you communicate this to others, especially young adults or teens, with little health insurance knowledge? One strategy may be to present the basic concept of insurance as risk management. Many young adults and teens understand car insurance, so making analogies between the two may be helpful. Although most Financial Tip readers may already be familiar with these concepts, I present them as a refresher and hope that they are useful for those who may be financial educators in any context, whether it be to students, the public, financial services clients, or even to younger family members. The following builds off of Weagley and Ivey’s (2011) personal finance work.

Insurance may be thought of as a tool to manage the risk in our lives. Life is full of risk, which is the chance or the uncertainty of outcomes that will occur in our daily lives. For example, each time we drive a car there is risk of getting into an accident. Also, the longer we live and the bigger our families become, the risk of incurring expenses from medical issues such as disease, illness, injury, or catastrophic accidents also increases. Unfortunately, no one can completely escape these risks, but it is possible to try to limit risk (e.g., control risk) or plan for it (e.g., risk financing).

Within these two general approaches there are four ways to manage family financial risks, and they can be used in combination with one another. You can try to control your exposure to risk by avoiding or reducing it. For example, you can avoid driving at all and face no risk of a car accident. Or, you can reduce your risk of auto accidents/injury by wearing seat belts, driving safely, not drinking alcohol before driving and keeping your car in good repair. You can avoid health risks by avoiding risky activities all together (e.g., boxing, smoking), and you can reduce health risks by increasing healthy activities (e.g., exercise, eating well) and protecting yourself against risks (e.g., wearing a bicycle helmet, engaging in preventative care through regular health screenings). However, it is impossible to completely control for health risks- no one can completely avoid or reduce the risk of expenses from medical issues in their lifetime. Even people who are young or very healthy who rarely need health care could incur considerable health care costs quickly if they develop a chronic condition or are in an accident.

You can also take the approach of financing your risk. Financing all or part of the risk can be thought of as retaining it. For example, you could keep enough money in savings to cover losses from an accident or injury from driving. This can be very difficult to do for auto accidents, and nearly impossible to do for all potential health risks, especially chronic illnesses or major accidents. With 62% of personal bankruptcies resulting from medical debt, retaining all of your potential health expense debt is not a smart strategy. Therefore, many transfer a large part of their risk by purchasing insurance. To transfer the risk of driving, you can buy auto insurance to protect yourself financially in case you injure or kill yourself or someone else, damage someone’s property, or need major repairs to your own car. Obtaining health insurance coverage transfers the risk of medical expenses. Health insurance is a contract that requires your health insurer to pay some or all of your health care costs in exchange for payments you may make directly to the insurance company, or that others (e.g., an employer) may make to the insurance company on your behalf. Based on the plan you select, the insurance company and you will share costs of most health expenses (although many preventative services are fully covered), usually until you spend a certain amount, at which point the insurance company will usually pay all of the expenses.

Through insurance, you are transferring your risk to someone else, for a price. This price is most commonly identified as your premium, which is a fee that must be paid for you/your family to have an insurance plan. Premiums are usually monthly fees, but can also be paid quarterly or yearly, and you pay whether you use your insurance or not. Insurance plans vary greatly on the amount of premiums, so it is important to consider the full range of benefits a plan offers and find the one that best suits your personal financial and medical situations.

Overall, with insurance, you are “financing” or sharing the risk of a large loss by paying premiums to an insurer, who will cover your loss if the insured event takes place. Additionally, health insurance can aid in reducing your risk by often covering most preventive services, including counseling, screenings, and vaccines to keep you healthy, and care for managing a chronic disease. Once you, or a consumer you are working with, understand the basic value of health insurance, health insurance literacy may be increased through education by building on health insurance knowledge, skills, and confidence. To learn more about health insurance visit healthcare.gov or contact a local health insurance agent, broker, or navigator.

Further Readings:

Consumers Union. (2012). Measuring health insurance literacy: A call to action. Retrieved March 10, 2014 from http://consumersunion.org/wp-content/uploads/2013/03/Health_Insurance_Literacy_Roundtable_rpt.pdf

Huston, S. J. (2010). Measuring financial literacy, Journal of Consumer Affairs, 44 (2), 296–316.

Weagley, R. O., & Ivey, S. G. (2011). Personal and family finance workbook. Dubuque, IA: Kendall Hunt.

Vetter-Smith, M., McCaulley, G., & Procter, B. (2013). Health insurance education: Options for you and your family. University of Missouri Extension curriculum, accessible at http://extension.missouri.edu/cb24)