Deductibles, Coinsurance & Out-of-Pocket Limits in a Health Policy

A question that our online insurance school often receives is how to figure out a health insurance policy’s ‘out-of-pocket limit’, or maximum financial limit that an insured must meet in a calendar year based on incurred medical expenses. Before we can understand how to calculate a policy’s out-of-pocket limit, we must first review some key terms used in the insurance industry, namely: deductible, coinsurance, and stop-loss.

How do you calculate a health insurance policy’s out-of-pocket limit?

Deductible – The amount of expense that the insured must pay before benefits are covered by the insurance company.  This amount is covered 100% by the insured and is usually based on a calendar year medical expense basis, meaning that each new calendar year (January 1st – December 31st) the insured is responsible for satisfying a new deductible if medical expenses occur within the year.  This amount varies based on the policy chosen by the insured with common deductible amounts of $500, $1000, $2500, $5000, up to a less common $10,000 deductible.  The higher the deductible of a policy, the lower the monthly premium, so consumers choose a deductible amount within their monthly budget.

Coinsurance – The percentage of additional medical expenses that the insured meets in addition to the deductible.  The insurer and the insured split medical costs, typically with the insurer covering 80% of the cost while the insured covers 20%, also known as 80/20 coinsurance.  Some policies have a 100/0, 90/10, or 70/30 split where the insurance company is always responsible for the higher percentage amount.  A reputable major medical insurance policy will also include a ‘stop-loss’ (defined below), that limits the dollar amount of coinsurance that an insured must pay in a given year.

Stop-loss – The dollar amount of annual medical expenses that the insured is limited to paying in coinsurance.  Once the insured as paid the coinsurance up to the stop-loss limit, the insurance company covers 100% of any remaining medical expenses for the same calendar year.  A scenario that best illustrates this feature is as follows:  A medical policy with an 80/20 coinsurance up to a stop-loss of $5,000.  This means that the insured is responsible for 20% of $5000 in annual medical expenses, $1000 (20% of $5000 = $1000).

After a policyholder satisfies both the deductible and coinsurance dollar amount (up to the policy’s stop-loss) all policyholder expenses become covered 100% by the insurer for the remainder of the calendar year.

Formula: Deductible + Coinsurance dollar amount = Out-of-Pocket Maximum

Example – A policyholder has a major medical plan that includes a $1,000 deductible and 80/20 coinsurance up to $5,000 in annual expense.

Step 1:

Determine the deductible amount that must be paid by the insured – $1,000

Step 2:

Determine the coinsurance dollar amount that must be paid by the insured – 20% of $5,000 = $1,000

Step 3:

Simply add the deductible amount of $1,000 to the coinsurance dollar amount of $1,000 to calculate the maximum out-of-pocket limit of $2,000 for the calendar year.

Regardless of how much in medical expenses the policyholder incurs throughout the calendar year, the out-of-pocket maximum limits how much he or she is responsible to pay during the same calendar year.  The insurance company pays the remainder of all medical bills above and beyond this point for the rest of the calendar year.

If the policyholder were to have a medical claim of $10,000 due to major surgery for instance, he or she would first pay the $1,000 deductible and then 80/20 coinsurance, or 20% of $5,000, which still limits the policyholder to $2,000, even though the medical claim is far more expensive, and the insurer would pay for the remaining $8,000

More importantly, since the policyholder has reached the policy’s maximum out-of-pocket expense limit, any and all additional healthcare expenses the policyholder may incur throughout the remainder of the calendar year will be 100% covered by the insurer.  This can be considered as a policyholder’s ‘safety net’ against catastrophic events and the costly medical expenses associated with the illness or injury.