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Health Insurance 101: Costs

All during the health care reform debates, the raison d’etre most often given for passing the act was the number of people without health insurance.  Proponents of the legislation laid the blame on high insurance costs, labeled insurance companies ‘greedy’, and promised affordable health care for everyone if the bill passed.  The legislation, the Patient Protection and Affordable Care Act, did pass.  Given that so much of it affects our health insurance, it might be worth our time to know more about health insurance, how it works and what factors affect its costs.

Insurance is essentially a mechanism for spreading risk.  We cannot guarantee that disaster won’t happen to us whether it’s a disaster that’s natural, man-made, or health related.  Historically, groups of people have mitigated the financial consequences of such catastrophic events by pooling resources so, if disaster struck, those affected would not be destitute.  As communities grew larger, however, something more formal was called for.

Commercial health insurance came into being in the US in the 1850′s when companies began offering disability insurance which provided funds to families in case of a breadwinner’s accident or death.  Hospital and medical expense policies weren’t introduced until the first half of the 20th century.  However, until World War II, day-to-day medical expenses were paid out-of-pocket by most families.   During the war, with so many men otherwise occupied, wages, and, therefore, prices, were sky-rocketing so the government responded with wage controls.  Companies, competing for workers, then expanded their benefits to include health insurance to lure the best workers.  As a result, most people under the age of 65 today have health insurance coverage through their employer.  The employees’ share of the insurance costs, however, are rising; with individually purchased insurance rates rising even more.  Why is this happening?

Insurance policy costs are determined by what the policy covers and the probability of the people applying for that policy to require medical care.  The policy price is the aggregate of the insurance company’s probable pay-out plus administrative costs divided by the number of contributing people minus any policy deductible.

In this regard, insurance costs whether home, auto, or business are all calculated in the same way.  Health insurance, at the beginning, when it covered just disability, was also the same as the others in that coverage was reserved for rare, unexpected events.  Today, unlike other insurance, it covers routine health maintenance and every-day ailments as well as catastrophic medical conditions.  Car insurance, for example, doesn’t cover broken radiators, gas cap replacements, or headlight misalignments unless these were part of an accident.  The frequency and intensity of health insurance interactions drives health insurance administrative costs higher than other types of insurance.

Another difference between health insurance and other types of insurance is a higher degree of government regulation.  These health insurance regulations, which differ from state to state, include required benefits that not all people need such as alcohol treatments, hair pieces, and in vitro fertilization, among others.  Another common form of regulation, called “community rating”, limits insurance companies’ ability to base pricing on risk, forcing individuals who carry less risk to pay as much as people who bear much more.  “Guaranteed issue”, another form of regulation, requires insurers to accept all applicants regardless of their medical condition.

The result is that the historic formula for calculating insurance is altered with the addition of state regulations, and this has contributed to higher insurance premiums.  As a result, states with the most regulations invariably have the highest insurance rates.  The most pertinent example today is Massachusetts whose health care reform laws include  insurance regulations remarkably similar to the federal bill just passed.  After 4 years in force, Massachusetts residents pay the highest insurance rates in the country.

The Patient Protection and Affordable Care Act legislation calls for various insurance mandates to be rolled out over the next few years.  Right now, officials are considering how to limit what insurers spend on administrative costs in an effort to increase the amount spent for member benefits.  Our next blog entry will explain how that will affect you.

Commercial health insurance


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