Health insurance premium price increases have been featured in the news recently. In general, premiums are set at a level that will cover the expected payouts for a group or class of insured people plus profit. To provide a context for understanding these increases, this document identifies the factors that insurance companies consider when setting rates for the next year.
Factors Considered in All Years
- "Normal" trend: This refers to increases in the allowed charges of goods (e.g., prescription drugs) and services (e.g., hospital stays, physician visits) covered by the policy, increases in utilization, and changes in the intensity of service use and is generally the largest component (8-9%).
- Deductible leveraging: This is an additional factor in the base cost trend that reflects increases related to paid charges after accounting for deductibles and copayments. This factor can be 3-5% on top of normal trend.
- Profit margin: Over the last decade, profit margins have averaged about 5%; in 2008 profit margins were just above 2%.
Factors Occurring Last Year
- Underpricing or base adjustment: If premiums in the prior year have failed to cover costs, some companies may make an adjustment to the subsequent year pricing. This adjustment may either attempt to recover losses from the prior year or serve as an adjustment to the base amount.
- Changes in the composition of the insured population: With the economic downturn, there were likely two changes in the composition of insured populations. First, the insured population was likely older which would occur if younger people were more likely to drop coverage. An increase of 3 years in the average age of an insured group (e.g., from 37 years old to 40 years old) would increase the average cost of coverage by about 1.5%. Second, the insured population was likely in worse health because those retaining insurance in a downturn are likely to have a higher need for coverage.
Distribution of Increases
- Insurance companies offer a variety of types of products (HMO, PPO) in different markets (large group, small group, individual) and the distribution of price increases across these products and markets may vary. Larger increases are more likely in the high actuarial value, low deductible plans whereas smaller increases are more likely in the low actuarial value, high deductible plans.
Elizabeth A. McGlynn, Associate Director for RAND Health, RAND Corporation
This op-ed was one of a panel of experts' responses that originally appeared on healthcare.nationaljournal.com.
This commentary originally appeared on National Journal Online on February 22, 2010.