Health Care Reform

How insurers set premium rates

medical bill

Imagine setting a household budget that will cover your expenses about 18 months from now. How will you calculate that? Probably by tracking your existing expenses for housing, utilities, food, clothing, travel and routine expenditures, plus savings and taxes.

Then, look ahead to see what new costs may be heading your way: a new roof, auto maintenance, etc.

This is essentially what Regence does, when we set the coming year's premium rates. The basic formula looks like this:

equation for setting rates: (last year's claims x % of medical inflation) + (administrative costs + increased utilization of services + newly approved drugs or procedures)/number of people in the insurance pool

Rising medical costs = rising premiums

As this equation shows, several factors affect premium price:

  • Cost of care—the actual price per service that insurers negotiate with providers
  • Usage of care—the number and type of services used: routine and preventive care, medical imaging, medications, joint replacements, organ transplants, etc.
  • Administrative costs—cost of processing claims plus cost of medical advisory and review staff, and usual costs of doing business, especially in an intensely regulated business like insurance.

Learn more about administrative costs.

Plus, in health care, there are new procedures, medications and services continually entering the marketplace, which increase the usage part of the equation.

In the past decade, the cost of care itself has increased far faster than inflation or wages:

Chart showing health care prices outpacing general inflation between 2009 and 2010

Other factors that affect your premium rates

  • Adverse selection—The tendency for healthy people to drop insurance coverage, while people with medical conditions keep their coverage. A delicate balance in the pool of healthy and sick people is key to keeping insurance sustainable for all. The more healthy people drop out of the insurance pool, the more expensive coverage becomes for those who remain.
  • Benefit plan changes—People often want coverage for particular services they use, and extending this coverage means higher premiums for all. Additionally, states pass laws to require insurers to cover certain services, referred to as "mandates."
  • Baseline—If last year's medical costs turn out to be higher than the insurance company estimated, then premiums for next year need to "catch up," so the company can pay all claims during the upcoming policy year.
    • On rare occasions, it happens the other way: In 2005, Regence members used less medical care, creating an unexpected gain. As a result, many members saw their 2006 premiums lowered, some by as much as 26 percent.
  • Demographic changes—As we age, our medical costs tend to increase as a result of higher utilization. That is why when you turn 40, for example, you get an automatic increase in addition to market-driven rate increase. States may regulate how insurers factor in age, and federal health reform will revise the age factor starting in 2014.
  • Changes in the law—State and federal governments can pass laws requiring what companies cover in their policies, such as preventive screenings or certain procedures.
    • Mandates in states Regence serves: Idaho–13; Utah–25; Oregon–49; Washington–57
    • The Center for Affordable Health Insurance estimates that mandates account for 20-50 percent of premium rates
  • Inflation. There's inflation, and there's medical inflation. Health care costs rise faster than the overall economy because of continuing advances—and usage—of medical treatment discoveries, from organ and joint replacement to medications that cost $20,000 a year.
    • During the two decades from 1985 to 2006, health care spending in the U.S. grew at 7.7 percent, while spending on GDP grew at the slower rate of 5.6 percent, according to the U.S. Centers for Medicare and Medicaid. (see chart here)

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