Everything You Should Know About Insurance, Healthcare Coverage, and Medicare

In this week's financials edition of Industry Focus, guest analyst Kristine Harjes and longtime Motley Fool contributor and personal-finance expert Dan Caplinger talk about the basics of insurance, healthcare coverage, and Medicare.

Tune in to hear Kristine and Dan talk about how the insurance industry works and how health insurance differs substantially from other types of insurance. With information about evaluating supplemental health insurance policies, planning for Medicare at age 65, and managing the transition from work-related coverage to Medicare, this program will tell you what you need to make a more informed decision for your financial and health situation.

A full transcript follows the video.

This video was recorded on Sept. 18, 2017.

Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Monday, Sept. 18. I'm Kristine Harjes, filling in for Gaby Lapera on this week's Financials show. Motley Fool personal-finance expert Dan Caplinger is joining me via Skype. Dan, how's it going?

Dan Caplinger: I'm good, Kristine. How are you doing today?

Harjes: I'm doing great. I'm preparing to leave for Greece in a couple of days, and I'm super excited!

Caplinger: Oh, that's awesome. I'll tell you, it's much better to be on the about-to-leave side of a vacation than the just-got-back-from-vacation, which is kind of where I still am a couple of weeks after coming back from Europe.

Harjes: Yikes, a couple of weeks. You're still digging out?

Caplinger: Just, a little bit, yeah. I'm just about there, though.

Harjes: Well, I know I'll have that to look forward to in a couple of weeks myself. [laughs] Anyway, before I leave, today's show is going to walk our listeners through the insurance industry -- how it works, some interesting quirks about it, and some practical advice so that you all can make the best decisions when it comes to your own insurance. Dan, do you want to kick us off with a high-level overview of the industry?

Caplinger: Basically, the way that the insurance industry works is that people face different kinds of risks. Most of the time, a lot of the risks that you face are things that don't happen that often, but if they do, there's a really big consequence. Something like, if there's a hurricane, then my house might be destroyed. Or, if I get into a car accident, my car might be totaled. These aren't things that you expect to happen every day, but when they do, it's a big deal, and you usually need some big financial help in order to recover from it, and that's where the insurance industry comes in.

An insurer will offer you a policy that will protect you in the event that some of these major catastrophes happen. Ideally, they get together a large group of people who are in similar situations to you, the idea being that, hopefully, if an insurance company does a good job, they have a bunch of different people who face different risks at different times, so they can pool together the premiums that they collect, pay out any losses that they have to pay, because those events are going to happen to a select set of individuals, and then still have some money left over for profits to reward their shareholders.

Harjes: Exactly. And it makes sense from a consumer perspective why people will buy into this kind of policy, because, as you mentioned, the events that they're covering are often pretty catastrophic. So even if you know that you're really probably not going to face a certain situation, if you did, on the off chance, that would be really terrible. So most people are very happy to pay in a little bit month in and month out to protect themselves in the case of a fairly extreme situation.

Caplinger: That's right.

Harjes: One of the biggest insurance markets out there, and of course, I'm bringing this up because I normally host the Healthcare show, but the health-insurance industry is enormous, and it's also a little bit different than a lot of the other insurance industries, because a lot of its costs are fairly predictable. You go to the doctor for an annual checkup; you have drugs that you take every single day. But there are also some very large unpredictable costs.

Caplinger: That's right. Like you pointed out, there's different kinds of problems that can come up with health. The interesting thing about the health-insurance industry in the U.S. is, it's really evolved to be more than what your traditional insurance policy would cover. Like you said, you can carve out some pretty low-probability but high-consequence events in healthcare. Suffering a major illness, getting injured, those kinds of things match up well with what I was just describing about the insurance industry in general. They don't happen that often, but when they do it's a really big deal, and you need help covering the financial consequences.

But somewhere along the way, health insurance evolved to cover not just those low-probability, high-problematic events, but also the everyday things, everything from going to see your doctor for an annual physical to buying a single set of prescription drugs that you might need once and never need again. All those things are things that health insurance has evolved to cover, and that has made the industry a little bit different from what you have with other players in the insurance industry, and it causes some issues to come up.

Harjes: It definitely does. One of the things that's interesting to me about health insurance is, if the same psychology is at play here where you want to protect yourself in case of something really catastrophic, but health insurance works best if everybody is in the same plan, the same pool of patients, or at least it's a very large pool of patients, so that you can spread out the people who are really, really expensive to treat, because they either have a very expensive chronic condition or they do have something catastrophic happen one time. So the best way to do this is to make as large of a pool as possible. So they're able to convince people that you need to get on this, and people will do it because they don't want to end up footing the bill for something that could be really, really bad.

Now, of course, you saw with the Obamacare exchanges, it was actually very difficult to get people to sign up for insurance who felt like they might be invincible. A lot of these people are younger, they're healthy, they looked at the price of the Obamacare plans and said, "No, that's not for me. I would rather pay the penalty for not being a part of this system than be a part of it and feel like I'm wasting my money, because I'm not going to get sick." So with that, you saw a lot of insurers not be able to make the money that they thought they would be able to, because they weren't getting as large patient pools as they could.

Caplinger: That's right. And one of the problems was, some of the criticisms of the Affordable Care Act was the idea that it did take away some of the options that people had as far as health insurance coverage was concerned. It generally pushed people toward more inclusive types of coverage and made it harder for those who were looking for the catastrophic, last-ditch-effort types of insurance policies where you would be responsible for almost all of your ordinary costs, and the insurance policy would only cover things like the most expensive hospital bills after a really huge deductible. Those plans became more out of favor, and what replaced them instead were more comprehensive policies that covered more things but were also correspondingly more expensive from a monthly premium standpoint.

And that mix, like you say, it appeals very well to people who do have high healthcare costs, but for those who are relatively healthy, including a lot of younger people, paying for that kind of coverage that they felt they didn't need, and for all intents and purposes, many of them don't need, that was a tough sell, and it was a problem getting people involved in the exchanges.

Harjes: Yeah. Let's talk about people who are on the other end of that spectrum that might be looking to get insurance against things that the average plan doesn't cover. This is an industry that's called supplemental insurance, and one of the big names in supplemental insurance is Aflac (AFL 0.63%). Companies like Aflac will fill in the gaps where normal insurance might not have you covered. You can buy a specific supplemental plan to cover certain costs. For example, Aflac sells plans that will cover some different things that aren't included in an employer-sponsored health plan. This could be something like dental or vision, or it could even be in direct costs of an illness or an injury, stuff like loss of work income if you have to take time off work. It could even be things like travel costs to get to a specialist, or hotel lodging while you're there if you had to go to a very specific surgery center and it's very far from where you live. So you can buy extra insurance to cover you in that sort of situation, too.

Caplinger: Yeah. Most traditional health insurance only covers the direct cost of your healthcare -- what you pay the doctor, what you pay the hospital, the cost of your prescription drugs. So that has left open this niche industry for Aflac and other players to say, look, when you suffer a medical loss, it's not just about the costs that you have to pay to your health professionals. It's also about loss of income and the incidental expenses that those health insurance policies don't cover. And they've had great success merging and working with employers who offer group health plans to say, "Look, what you're offering is great, but we at Aflac can give your employees something extra," and a lot of times many of those workers do go ahead and get supplemental insurance policies as a result. 

Harjes: This has been a pretty profitable company. It's publicly traded. It's about a $30 billion or so market-cap company. It's very well known within the U.S., mostly because of the duck commercials that I'm sure everyone is familiar with. But also, they generate most of their revenue in Japan, which is kind of interesting. Currently about 25% of Japanese households have Aflac insurance of some sort. So if you're interested in the company, check it out for its dividend. It's a Dividend Aristocrat and paying about 2% recently. And it's been increasing its dividend for 34 straight years, which is a pretty fantastic track record, speaks to it being a very calculating industry where you know exactly how much money you're going to make, and they've been able to do a very good job of managing their risks and also finding new avenues for growth.

One thing I do want to talk about, since we're talking about very specific supplemental insurances, is to warn listeners not to buy insurance that they might not really need. I've seen a lot of crazy policies out there. I think it can be very easy to get caught up in fear of, "Oh my gosh, what if this very, very low-probability thing happens to me?" Some of these things are just not worth it when you actually do the cost-benefit analysis. For example, extended warranties. There are so many studies out there showing that they almost never pay off. Another one to watch out for is rental-car insurance. I did not know this until I was in Canada recently trying to rent a car, and they asked me if I wanted to buy the supplemental rental insurance, and I turned to my friend who was traveling with me, and I was like, "Yeah, probably, right?" And he's like, "Absolutely not. You have car insurance, right?" I'm like, "Yeah." Apparently, my normal car insurance will cover me for a rental car, too, which is interesting, and I felt a little bit betrayed by the company that was offering me to buy this insurance that I didn't really need.

Caplinger: Another thing, Kristine, to take a look at is, a lot of credit cards now offer things like rental-car insurance, like extended warranties. Even more valuable insurance, like, if something happens to a product that's not generally covered by a warranty, like if you drop your phone or something gets stolen or you lose something, some credit cards actually offer a type of coverage. And while there might be a deductible that won't give you a full recovery on that, you still can get some of your money back. It's something that a lot of people don't know. So be sure to check with your credit card company, and see what kinds of extra insurance is included with your card. You don't have to pay anything extra for it in most cases, and it can be a real saver if something happens and you suffer a loss.

Harjes: Yeah, that's great advice. Let's pivot once again and talk a little bit about Medicare. Going back to the world of healthcare, Medicare is extremely important, mostly for retirees. Once you turn 65, you are eligible for health insurance that you've been paying into for your whole working life, and all of a sudden you can be the beneficiary of it.

Caplinger: That's right. Most people, as long as you have worked long enough at a job in which you paid for Medicare payroll taxes, you will automatically be eligible to join Medicare at age 65. At that point, you will receive a number of valuable benefits, including coverage for hospital expenses. You'll also be able to join Medicare to pay regular medical expenses like doctor's visits and other outpatient care. That second part, which is called Part B, as opposed to the Hospital Part A, Part B comes with a monthly premium, but the amount that you pay is very reasonable compared to what a private insurance company would charge you immediately prior to becoming eligible for Medicare. So it's something that most seniors really look forward to, being able to join Medicare, because it's a real life saver as far as your healthcare costs are concerned.

Harjes: Yeah, especially when you reach the point in your life where you're likely to have higher healthcare bills. It's kind of interesting, because as a worker, you pay into this for a long time, usually 10-plus years, but you still have to pay for it when it comes time to be eligible. But as you mentioned, it's fairly inexpensive. Monthly premiums are around $100. It can be more if you make more as an annual salary. But that actually is a great price, but it doesn't cover everything. Typically, you will have a 20% coinsurance, meaning that 80% of the costs are covered, but you still end up having to pay. And one really important thing to know about Medicare is that there is not written into it a maximum amount that you will pay out of pocket.

Caplinger: That's right. There are a number of provisions, the 80-20 that you just mentioned for doctor's visits and other outpatient coverage is one of them. On the other side of the equation, hospital stays -- Medicare has deductible amounts depending on the length of time that you stay. But for extremely long hospital stays, Medicare coverage does end, and at that point you are potentially on the hook for the entire cost of your hospital stay beyond that initial time period. And that can make it really smart to look at some of the supplemental insurance products that have come out in the private market to pad onto Medicare and provide protection from those catastrophic risks, including things like out-of-pocket maximums.

Harjes: Yeah, absolutely. One very popular way of dealing with all of the different issues that we've brought up regarding Medicare and the different holes that you might fall into where you're not covered is to get something called Medicare Advantage, which is run through private insurers. This is a very popular choice, by the way. About a third of all Medicare beneficiaries are enrolled in Medicare Advantage. It's usually fairly comprehensive. It'll replace completely Part A, the hospital insurance, and Part B, which is your doctor visits, your outpatient costs, sometimes it even replaces Part D to Medicare, which is the prescription-drug plan. So there's a lot of variability in what you can get with a Medicare Advantage plan, but it might cover things like vision and hearing and dental. So depending on how much you're willing to pay for it, you can get extremely comprehensive coverage.

Caplinger: That's right. Because they're offered by private insurance companies, there's a required list of healthcare expenses that these Medicare Advantage plans have to cover in order for Medicare to accept them as Medicare Advantage plans, but it's up to the individual private insurance company to decide above and beyond that, do we want to offer additional services? One of the reasons that retirees really like Medicare Advantage, as you say, it has become increasingly popular recently, it's because of the way that these private insurance companies tailor their coverage -- they're often able to offer that coverage at an extremely attractive price.

The flip side is, it's also possible for private insurance companies to offer the same sorts of incentives that you'll see in group healthcare coverage for working-age people. You will find Medicare Advantage plans where there's a really big incentive for you to stay within network healthcare providers. If you don't, the costs can be much higher. Compare that to traditional Medicare, where you can go visit any doctor that you want, as long as that medical professional accepts Medicare --

Harjes: Which they all do.

Caplinger: -- then there's no difference in the charges that they make.

Harjes: Yeah, pretty much every doctor will accept Medicare, just because it is so huge. Especially if you're someone who's a specialist that works with age-related diseases, there's no reason why you wouldn't accept Medicare. That's what most of your patients will be covered by.

Caplinger: Exactly.

Harjes: As an individual, when you're looking at making that transition, say you're turning 65 in the next year or so, and you're starting to think about, do I want to be on Medicare? Should I enroll? There's two different scenarios that we should talk through. The first would be, if you are still working at 65. And after that, we'll talk about, what if you want to retire before 65? But first, if you're still working at 65, what sorts of things should you consider when you are trying to decide whether or not to sign up for Medicare?

Caplinger: If you're still working at 65 and you are covered by a group health plan at work, then the big question is going to be, is it OK to just stick with my group health plan, or do I need to enroll for Medicare as well? For most people, that depends on the size of their employer, because the size of your employer helps to define whether Medicare or your group health plan is going to be the primary payer. In general, for larger employers, the group health plan will remain the primary payer, so it doesn't make as much sense to sign up for Medicare immediately.

For smaller employers, Medicare can become the primary payer, and there it becomes more important to look at Medicare as a coverage option. It's something to talk to your human resources department about, because different companies have different rules about whether they're going to require workers who reach age 65 to get Medicare coverage or not.

But one thing you don't have to worry about is, if you have group health plan coverage, ordinarily there can be penalties if you wait beyond age 65 to sign up for Medicare. But an exception to those rules is, if you have qualifying group healthcare plan coverage, then you can wait and sign up later when that group health plan is no longer available, because you finally decide to retire. Then you can sign up at a special enrollment period, avoid the penalties, and still get your Medicare coverage.

Harjes: Yeah. And this is pretty important, because that penalty is an added percentage on top of the premiums, meaning that you're going to pay it for the rest of your life every single time you pay your premium. So it's not just a one-time thing. So that's definitely something to look into, whether or not you'll qualify for a special enrollment past the age of 65 if you continue working. Let's talk about the other situation, though, which is if you decide to retire before you become 65.

Caplinger: This is a very common situation that comes up, often unwillingly, because if you lose your job before you reach 65, you'll find yourself in the health-insurance gap. There are several things that you can do. Probably the easiest one is, if you're married and your spouse has access to a group health plan, then you may be able to get coverage as a spouse on a family plan there. That can be fairly expensive depending on how your spouse's employer handles family plans, but it at least gets you the coverage that you need. In addition, when you leave a job, you generally have eligibility for what's called COBRA, which is called continuation insurance. That can buy you another 18 months in most cases. So if you're looking at retiring when you're 63 or 64, COBRA coverage can be a good way to go forward.

The other thing that you can do is turn to the individual health-plan market. Until the advent of the Affordable Care Act, that was a really difficult market to break into, especially for people in their 60s who were trying to bridge to Medicare. The premiums were often prohibitively expensive. Obamacare has made that a little bit easier to get coverage, but the price, we've seen some of the same challenges with respect to price. So it's something that you have to look at very carefully to make sure that you can get the healthcare coverage that you need in order to make it to age 65, when you can then sign up for Medicare and have the system in place that most people are a part of.

Harjes: Yeah. Unfortunately, a lot of these options are fairly expensive. I think that points to an overarching lesson when you're thinking about Medicare and your healthcare coverage in retirement, which is that it can be a very expensive line item in your budget, so it's important as you're trying to figure out how much money you need to save for in order to retire comfortably, to really take a hard look at your healthcare costs, and don't assume that they're going to be the same as they are when you're, let's say, 30 years old, once you're 65, 70, 75, because they will rise pretty substantially, regardless of whether or not you choose Medicare or Medicare Advantage, whatever it is. There's really no way to avoid fairly expensive healthcare costs in retirement.

Caplinger: Sad fact of life about aging, Kristine. Enjoy your youth while you have it.

Harjes: Yeah, absolutely, and pocket the extra money, because hopefully it will grow and appreciate, and you can use it when you become older and need it.

Caplinger: You got it!

Harjes: One last thing before we sign off. I found a couple of really insane types of insurance while I was doing research for this episode, and I wanted to share them. Dan, I don't know if you've ever come across these before, but I hadn't, so I got a kick out of them. There's a company called Lloyd's of London that offers some really crazy types of insurance. Some of the ones that I found, I'm not sure if these are all offered by Lloyd's, but they are coverages that are out there -- you can get insurance for if you have twins, which makes sense. Twins are expensive. You can also get change-of-heart insurance, which is specifically for the financial backers of a wedding if the bride and groom decide that they're going to call it off. So it's not necessarily to give them back the money, because come on, guys, that's your fault. It's for the completely innocent bystanders who just happened to be financing the wedding. One last one, there's an insurance policy that I came across that's for employers specifically for if a group of their employees win the lottery and then they all quit. 

Caplinger: Those are awesome!

Harjes: Yeah. [laughs] 

Caplinger: These are great things. The favorite one I've run into is called hole-in-one insurance. A lot of charities, corporate events, they will do a golf tournament to raise money, and they will have a special prize, a big money prize if someone gets a hole in one. Now, the charity can't afford to pay for that, so insurance companies will offer this hole-in-one insurance so that if someone actually wins the prize, then the insurance policy pays out. It only costs the charity a fraction of what the payout would be, but it makes everybody happy.

Harjes: Yeah, that definitely makes me happy that that exists. I think if I were at a tournament like that and I made the hole in one -- which, I'm a terrible golfer; that would not happen -- but, if I did, I think I would feel bad taking the prize from the charity. But now, if that ever happens, I won't feel as bad.

Caplinger: You're taking it from the insurance companies, so keep it.

Harjes: That's perfect. Thanks for sharing that, Dan. And thanks for being here with me today, I appreciate it.

Caplinger: Yeah, thank you.

Harjes: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Dan Caplinger, I'm Kristine Harjes. Thanks for listening, and Fool on!