How do water insoluble medications get absorbed in the blood stream?
Well, firstly the capsule itself is not entirely insoluble. You can see this for yourself - if you drop one into water, it will start to dissolve very slowly and the water will turn cloudy. This process usually goes faster in the stomach, which has a very acidic environment, or the small intestine which is more alkaline. The capsule material is designed to dissolve when it's eaten, hence releasing the drug - if it didn't dissolve, the whole capsule would just pass through your digestive system and come out... at the other end.

On to the issue about the drug itself. In general designing a drug is not very simple at all, because it has to survive the very same enzymes that break down our food - if the enzymes break down the drug then it becomes useless. For example, if you tried to eat insulin it wouldn't do you any good - insulin is a protein and will be immediately digested by protease enzymes. If the drug survives those enzymes, it has to be able to diffuse through the lining of the small intestine in order for it to enter the bloodstream. The cell membrane, being a non-polar lipid bilayer, doesn't easily let polar or charged molecules diffuse across it. So normally drugs have to be somewhat lipophilic, which is a fancy way of saying non-polar. But at the same time, as you rightly note, they also have to be water-soluble. Most drugs try to strike a balance between the two.

One way that drugs are absorbed is by reversible protonation. Many drugs have amine functional groups with a $\text{p}K_{\text{aH}}$ of around 6-8. At the physiological pH of 7.4, an equilibrium will exist in which both the unprotonated and protonated forms exist in significant amounts. The unprotonated form can cross cell membranes more easily, and the protonated form is more soluble in water.

There are other drugs that don't diffuse across cell membranes very well, due to their large polarity. They may be absorbed via different means, such as active transport (in which the cell uses energy in order to let the molecule enter), or facilitated diffusion (which is the same as diffusion, except that a protein helps out). An example is levodopa; it is structurally similar to the amino acid phenylalanine and the transport protein for phenylalanine can't quite tell the difference. Being polar molecules, these drugs are already water-soluble.

In fact, that's only half the story, because different drugs have different targets. Some need to go to the brain and for this to happen, they have to cross the blood-brain barrier. Some need to stay in the intestines to kill off bacteria - so you have to make them really polar so that they can't diffuse into the bloodstream. Absorption is only a small part of a drug's journey in the human body. If you are interested in finding out more, look for a textbook on medicinal chemistry and read the section about pharmacokinetics - it should have all the info you want.