When setting health premiums, insurers balance covering their financial risk and administrative overhead with offering competitive rates. Insurance companies consider factors like age, medical history and cost of care to set premiums for the coming year.
The basic formula for setting health insurance premium rates equals the previous year’s claims multiplied by the percent of medical inflation plus the sum of administrative costs, increased utilization of services, and new drugs/procedures, all divided by the number of people in the insurance pool. [See illustration below.]
Various rating practices, the methods insurers use to set premiums, help tailor the basic formula into a more accurate representation of the insurance pool in order to better forecast the level of risk insurers will be responsible for. A mix of industry and member specific rating practices can be used to set health insurance premiums.
Factors that affect premium rates:
- Cost of Care – The actual price per service that insurers negotiate with providers.
- Utilization of Care – The number and type of services used by the insurance pool.
- Administrative Costs – The cost of processing claims, medical advisory, review staff and usual costs of doing business.
- Cost Sharing – How much of health costs is paid for by co-payments and deductibles.
- Adverse Selection – When healthy people drop coverage, the ratio of medically ill individuals is much higher and the premium becomes higher. A greater number of healthy individuals in the insurance pool help to lower premiums.
- Benefit Plan Changes – Changing and extending coverage for particular services may cause higher premiums
- Baseline – Premiums are adjusted each year to make up for underestimated medical costs from the previous year. Premiums may increase to cover the under-estimations or may lower to balance out a previous year’s over-estimation.
- Law Changes – Changes to State and Federal regulations can have a dramatic impact on premiums by mandating
- Inflation – Inflation of medical costs greatly affects the price of health insurance premiums.
Member specific factors that affect premium rates:
- Health Status Rating – Typically, higher premiums are charged to people with more extensive medical histories.
- Demographic Rating – Several factors make up demographic ratings, and insurers typically use demographics to determine where more health services will be used and charge more.
- Age Rating – Insurers charge more for older individuals. For example, individuals are automatically charged a higher rate upon turning 40 because it’s estimated as the age range when people begin utilizing more health services.
- Gender Rating – Insurers charge more for women in childbearing age than men, and more for elderly men than elderly women.
- Geographic Rating – Insurers charge more for people who live in higher medical cost areas.
- Industry Rating – Some insurers charge more for people who work in higher risk industries such as construction and mining.
- Experience Rating – Most insurers charge higher or lower premiums to groups based on their history of insurance claims.
- Tier Rating – Some insurers charge different premium levels/tiers for people in the same policy based on their healthcare service utilization. Tier rating is also known as re-underwriting.
- Durational Rating – Particularly aggressive insurers raise premiums for people who have been in a plan for a long period of time with the reasoning that the person’s health may have drastically changed since it was first evaluated for their insurance.
- Lifestyle – Insurers charge more for smokers than nonsmokers and have recently begun charging more for obese members than those who take actions to live a healthy lifestyle, such as enrolling in wellness programs.