What is Health Insurance?
Every American needs to understand some basic concepts of health insurance to be an informed consumer. Like all insurance, health insurance is a product that serves the purpose of sharing the financial risk of a loss with a large group of people. For taking on the financial risk associated with health care costs, the insurance company charges an annual fee (paid out monthly). This fee is called the insurance premium. The premiums are collected by the insurance company and are used to pay for the health claims of plan participants. Money left over represents earnings for the insurance company. Premium prices for a given plan are set a year in advance and are based on a number of factors such as the benefits covered, cost-share provisions, risk pool composition, and local prices for healthcare services and products. The higher the prices for healthcare services and products, the higher the health insurance premium will be.
The insurance policy is the legal agreement between the insured (participants) and the company that takes on the financial risk. It spells out which health benefits are covered (and often which are not covered), access to doctors and hospitals (network), and the specific cost share details. In addition, it includes a list of prescription drugs covered (formulary), medical management programs available, and any special (non-core) benefits provided. When we refer to the insurance product in general, we use the words insurance plan.
An insurance policy identifies a specific set of health products and services that will be covered. It will not pay for all your healthcare needs nor will it pay for every service/product sold by healthcare businesses. If you need to have a healthcare product or service that is not covered by the plan, then you will have to pay 100% of the cost. For example, some insurance policies cover primary health care, dental, and prescription drugs while others only cover primary health care. Dental and vision coverage is often provided in stand-alone policies. Insurance plans sold on the Health Insurance Marketplace (non-group) must cover a specific set of benefits called Essential Health Benefits (EHB).
Employers who provide employer-sponsored health insurance for their employees are required to make available the document called the Summary Plan Description (SPD) to all participants. It is a document that explains the plan’s benefits, claims review procedures and participants’ rights. Before making a final decision about a plan, it is wise to have a copy of this document since all reimbursement decisions are based on the wording within this document. On the Health Insurance Marketplace for non-group insurance, this detailed document is not routinely available.
In addition, Obamacare (PPACA) requires all insurance administrators to provide participants in a given plan with a Summary of Benefits and Coverage (SBC) during open enrollment. If your insurance plan admininistrator is not making these documents available to you, report this to the government (see the Reporting and Disclosure Guide for Employee Benefit Plans by the Department of Labor) There are fines for not making the documents readily available. Every individual should make sure that they have a copy of these two documents. On the Health Insurance Marketplace, this document is called Summary of Benefits and is available for each plan under Learn More About This Plan.
What is a Risk Pool?
Health insurance premiums are calculated based on the healthcare needs of the particular individuals who make up a given insurance plan. The insurance company defines this group of individuals as the plan’s risk pool. If your employer offers two different plans (like a Preferred Provider Organization (PPO) plan and a High Deductible Health Plan (HDHP)), then the employees might be divided into two risk pools. Even with the exact same coverage, two plans can have wildly different premium prices simply because of the makeup (composition) of the risk pool. One of the largest risk pools is includes all Medicare beneficiaries, many of whom are also part of smaller risk pools in supplemental health insurance plans.
Each risk pool is made up of a composition (distribution) of health spenders. In any given year, a single individual can incur anywhere from $0 to over $1 million. We can categorize the individuals within the risk pool as “low spenders”, “medium spenders”, and “high spenders” for this general discussion. If we compare two different insurance plans (or risk pools), we will find that the composition of health spenders affects the premium price set by the insurance company. For a given risk pool (plan) size, a large number of higher spending people increases the premium price for all plan participants. In other words, there will be fewer “low spenders” (green people in the figure below), to subsidize the higher spenders (yellow and red people in the figure).
In the past, insurance companies were allowed to reject potential “high spenders” from their fully-insured health plans thus keeping health care claims low and profits high. Obamcare (PPACA) reforms have stopped some of these practices (e.g., they can no longer reject people with pre-existing conditions) and have put a cap on excessive profiteering in some insurance plans (this is called a medical loss ratio (MLR) cap).
Risk pools with higher percentages of “high spenders” include those with high average age participants (e.g., Medicare and companies where the workforce is older) and with participants from riskier professions (e.g., logging workers and some construction workers). If you happen to work for an employer with one of these unfavorable risk pools, then you will be stuck paying more for your health insurance coverage.
Shopping For Health Insurance
Unlike most industrial countries around the world, our government does not ensure accessibility to affordable health care through universal health systems and therefore we are expected to purchase our own health insurance. Shopping for health insurance is an annual event during an open enrollment period and people are usually free to change insurance plans during this annual event. For employees, the health insurance choices are limited to what the employer is willing to subsidize (two or three choices at most). For non-group individuals, the health insurance shopping choices are much larger and can often be from a list of over a hundred possibilities (in large, competitive marketplaces).
The Bottom Line
This brief description of how insurance works is not meant to be comprehensive. There are many detailed descriptions on other websites and I encourage you to seek them out. The important points about health insurance are given below:
- A health insurance plan is a product that serves the purpose of sharing the financial risk of a loss with a large group of people
- The participants in a given insurance plan are members of the plan’s risk pool
- An insurance company takes on the financial risk in exchange for an annual fee called the health insurance premium
- A given insurance plan does not pay for all health services and products sold by healthcare businesses, but rather identifies a specific subset for coverage. If you want or need a healthcare product or service that is not covered by the plan, then you will have to pay 100% of the cost personally
- There are two insurance plan documents that all Americans should have for reference; namely, the Summary Plan Description (SPD) and the Summary of Benefits and Coverage (SBC)
- The composition (distribution) of the risk pool in any given year is made up of “low spenders”, “medium spenders”, and “high spenders”
- For a given risk pool size, the greater the number of high spending people in the risk pool (plan), the higher will be the health insurance premium charged.