How Are Health Insurance Premiums Determined

As the subject of health insurance premium increases receives more attention, here are some materials to help people understand how premium rates are calculated and the different factors contributing to premium increases.
How premium rates are calculated
Health insurance premiums are not arbitrary decisions.  They are based on actuarial calculations that take into account a variety of factors, including the type and amount of coverage purchased, the cost of providing medical care, and changes in the risk pool.  This presentation provides a good overview of how premium rates are calculated:
The Hay Group: How Health Insurance Premiums Are Determined
New benefit requirements incur additional costs
Starting on September 23, 2010, many individuals and small businesses will be required to have additional health care coverage beyond what they originally purchased.  These new benefits will of course incur additional costs that will be reflected in the cost of health care coverage.  The impact that these new reforms will have on premiums will vary depending on the type and amount of coverage the policyholder has today.  Here are some of the benefit requirements that go into effect later this month:

  • Prohibition on lifetime limits
  • Restrictions on annual limits
  • First-dollar coverage of preventive services
  • Extension of dependent coverage up to age 26
  • New internal and external appeals processes
  • New rules regarding coverage for emergency services
  • Prohibition on pre-existing condition exclusions for children

Rising medical costs drive premium increases
Rising medical costs are a key driver of premium increases.

  • The New York Times highlighted a recent report which found that drug prices rose 8 percent in 2009.
  • A recent Bloomberg article (subscription required), “Hospital Monopolies Ruin MRI Bill as Sutter Gets Price It Wants”, shows how hospital consolidation has led to higher prices for services.
  • A New York Times article and editorial highlight a requested 40 percent rate increase by a major hospital chain in New York City.
  • An Orlando Sentinel article highlights one Florida hospital seeking a 63 percent rate hike.

Medical inflation is not the only factor contributing to rising health care costs
Medical inflation is only one of the factors contributing to rising health care costs.  The medical component of the Consumer Price Index (Medical CPI) simply measures the inflationary component of prices charged for a defined group of services.  It does not include other major factors that drive increases in health care spending, such as increased utilization, the needs of an aging population, and the development of new medical technologies and prescription drugs.  As a result of these other factors, the cost of providing health benefits increases significantly above Medical CPI.

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