Accident, Critical Illness, and Hospital Indemnity Insurance: Extra Add-On Benefits Explained

At open enrollment, many jobs offer a few extra add-on benefits next to the health plan. You may see them called voluntary, supplemental, or worksite benefits. Three common ones are accident, critical illness, and hospital indemnity insurance. You usually pay for them yourself. Here's what they are, how they pay, and what to ask before you sign up.

The big difference: they pay you cash, not your doctor

Regular health insurance pays part of your medical bills, usually straight to the doctor or hospital. These add-on plans work differently:

• They pay a set dollar amount when a covered event happens, like a hospital stay or a covered diagnosis.
• The amount is not based on your actual bill. The federal Centers for Medicare & Medicaid Services (CMS) says fixed indemnity benefits must be paid regardless of the amount of expenses you have.
• The money usually goes to you. CMS says you can use the cash as you wish, such as for out-of-pocket costs your health plan doesn't cover, or for non-medical bills like rent or a mortgage. The North Carolina Department of Insurance notes that cancer policy benefits are normally paid directly to the insured person.

They do not replace health insurance. CMS says hospital indemnity and other fixed indemnity insurance is "not a substitute for comprehensive coverage." CMS says fixed indemnity plans that meet the federal rules aren't subject to the federal requirements or consumer protections that apply to comprehensive coverage, and the U.S. Department of Labor says those requirements generally don't apply to the other "excepted benefits" described below either. HealthCare.gov's list of "qualifying health coverage" (coverage that meets the Affordable Care Act requirement) does not include them.

What each one is

Accident insurance

The National Association of Insurance Commissioners (NAIC) describes accident-only coverage as paying a lump sum when you have death, dismemberment, disability, or hospital and medical care caused by an accident. Think of a broken arm, a bad fall, or a car crash. It doesn't pay for an illness.

Critical illness insurance

These plans pay a set amount if you're diagnosed with a serious illness the policy names. The policy lists exactly which illnesses count and how each one is defined. An IRS legal memo describes a critical disease or specific disease policy as one that pays a specific amount for the diagnosis of a particular disease. The NAIC describes a close cousin, specified disease coverage, as covering a specifically named disease or diseases, such as cancer. Some plans cover only one disease, like a cancer-only policy.

Hospital indemnity insurance

The NAIC describes hospital confinement indemnity coverage as insurance that pays a fixed amount for each day you're in a hospital. CMS gives "$100 per day" as an example. In job-based (group) plans, CMS says payments must be a fixed dollar amount per day (or other time period) of hospitalization or illness. Plans you buy on your own may also pay per service, such as a set amount per doctor visit.

The official name: "excepted benefits"

Federal agencies group these plans under the name excepted benefits. That means they are "excepted" (left out) from many of the rules that apply to regular health coverage. The U.S. Department of Labor explains that:

• Accident-only coverage is in the group of benefits that are generally not health coverage at all.
• Specified disease coverage (like a cancer-only policy) and hospital indemnity or other fixed indemnity insurance are called "independent, noncoordinated excepted benefits."
• To count this way, the plan has to be a separate policy, and it has to pay without regard to what your regular health plan pays for the same event.

Who might consider them

Some people may want to consider them if they:

• Have a high deductible and not much savings to cover it if something big happens.
• Would struggle with non-medical bills (rent, child care, travel to a specialist) during a hospital stay or serious illness.
• Have read the policy and can name a specific gap the plan would fill.

Who may not need them

They may be less useful if you:

• Already have enough emergency savings to cover your health plan's out-of-pocket maximum.
• Already have disability insurance that would replace part of your paycheck if you couldn't work. (See Life and disability insurance.)
• Would be buying one instead of a real health plan. These don't do that job.

Remember that you pay the premium every year whether or not you ever file a claim.

Questions to ask at open enrollment

Before you sign up, get the plan's summary or certificate and ask:

1. What exactly is covered? Which accidents, which illnesses, which hospital stays? How does the policy define each one?
2. Is there a waiting period? How long after I enroll before benefits start?
3. Are there pre-existing condition limits? Will it pay for a condition I already have? The NAIC notes that limited plans like these may choose not to cover you or charge you more if you have a pre-existing condition.
4. How much does it pay, and how often? Is the benefit per event, per day, or a one-time lump sum? Is there a yearly or lifetime maximum? Does a second diagnosis or a repeat event pay again?
5. What will I pay in premiums each year, and how does that compare with what it would likely pay me? Do premiums go up with age?
6. Is it portable? If I leave my job, can I keep it, and at what cost?
7. Are my premiums taken out pre-tax or after-tax? This can change whether the payouts are taxed (see below).
8. Will it affect my HSA? (See below.)
9. Does it replace my health plan? No. Keep your regular health coverage either way.

How they relate to an HSA

If you have a high-deductible health plan (HDHP) and an HSA, you generally can't have other health coverage. But IRS Publication 969 lists some kinds of insurance you can have and still contribute to an HSA, including insurance that provides benefits only for:

• A specific disease or illness.
• A fixed amount per day (or other period) of hospitalization.

It also lists coverage for accidents, disability, dental care, vision care, long-term care, and telehealth.

The Department of Labor adds that insurance for a specified disease or illness is a type of insurance you're specifically allowed to have and still contribute to an HSA, as long as you have an HDHP and no other coverage that would disqualify you.

Something to check: Some add-on plans also pay for things like doctor visits or wellness screenings. Those features don't fit neatly into the IRS list above. If you have an HSA, ask your HR team or the plan before you enroll whether the plan keeps you HSA-eligible. (See What is an HSA?)

Are the payouts taxed?

It depends mostly on how you pay the premiums. IRS Publication 525 says:

• You pay with after-tax money: If you pay the entire cost of an accident or health plan, you don't include what it pays you for personal injury or sickness as income.
• You pay pre-tax through a cafeteria plan: If your premiums weren't included in your income, you aren't considered to have paid them, and you generally must include the benefits you receive in your income.
• Your employer pays: In most cases, amounts you receive through an accident or health plan paid for by your employer are reported as income. If you both pay, only the part due to your employer's payments counts.

Publication 525 also says amounts paid to reimburse you for medical expenses you had are not reported as income. But these plans pay a set amount no matter what your bill is. In a 2023 legal memo, the IRS Chief Counsel's office said that fixed indemnity payments from a plan paid for pre-tax, made without regard to actual medical expenses, are included in income and treated as wages. (The IRS notes that kind of memo can't be cited as precedent.) CMS says the Treasury and IRS proposed clearer rules on this in 2023 but did not finalize them in 2024.

Bottom line: Ask whether your premiums are pre-tax or after-tax, and talk with a tax professional if a large payout could be taxable.

A simple example

Made-up example: Rosa signs up for a hospital indemnity plan at work. It costs her $12 a paycheck, after tax. The plan pays $200 for each day she's in the hospital. Later that year, she spends 3 days in the hospital. Her health plan pays its share of the hospital bill as usual. Separately, the hospital indemnity plan sends Rosa $600. She uses it toward her deductible and her electric bill. Because she paid the premiums after tax, that $600 generally isn't taxable income under IRS Publication 525.

Quick tips

• Read the list of covered events, not just the headline benefit amount.
• Do the math: a year of premiums versus what you'd likely get back.
• Keep your regular health plan. These are extras, not replacements.
• Check your HSA if you have one.
• Ask about pre-tax vs. after-tax premiums.