Background Chronic disease-related catastrophic health spending is frequent in Ethiopia affecting several households, particularly the poorest ones. A community-based health insurance (CBHI) scheme has been in place in Ethiopia since 2011. The scheme aims to provide financial protection against health expenditure but there is little evidence of how well it protects chronic patients financially. Objective The objective of the study was to evaluate the effect of community-based health insurance in reducing the incidence of catastrophic health expenditure among patients attending chronic disease follow-up departments in Asella referral hospital, Southeast Ethiopia. Method A health facility-based comparative cross-sectional study was conducted in Asella referral hospital from March 2022 to May 2022. Systematic random sampling was used to select 325 chronic patients. Data were collected using an open data kit (ODK) collect app and then imported to STATA version 16 for analysis. Propensity score matching was used to evaluate the effect of community-based health insurance on catastrophic health expenditure. Result The study enrolled a total of 325 chronic patients (157 insurance members and 168 nonmembers). More than 30% of the study participants incurred health spending that could be catastrophic based on the 15% nonfood threshold. Catastrophic health expenditure was found in 31% of insured and 47% of uninsured participants. Overshoot and mean positive overshoot were 10% and 33% for insured members, respectively and the corresponding figures were 18% and 39% for nonmembers. Community-based health insurance contributes to a 19% ((ATT = -0.19, t = -2.97)) reduction in the incidence of catastrophic health expenditure among chronic patients. This result is found to be consistent for alternative measurements of the outcome variable and the use of alternative matching algorithms. Conclusion Chronic patients, particularly those in uninsured households, had a high incidence and intensity of catastrophic health expenditure. Hence, it is relevant to expand community-based health insurance to provide financial protection for people suffering from chronic conditions.