Risk Pool and Health Insurance Premiums

BB–enough already with this health insurance risk pool “stuff”!  Why are you devoting yet another blog post about it!  I totally sympathize, really I do. Unfortunately, my mission demands that I lay a foundation of simple explanations for some insurance concepts (risk pool and its affect on health insurance premiums) before I can move on to why our healthcare system is unaffordable.

The business of health insurance works by dividing customers into risk pools where the riskier customers must pay more than the less risky.  While I understand this concept for car insurance customers (reckless drivers should pay more for car insurance), I have a fundamental problem with the concept when it comes to health insurance.  We do not choose to get older.  We do not choose to be born with less than perfect bodies. We do not choose to suffer a debilitating accident that disables us for life.  Is it right to penalize us financially for situations we cannot control? Enough of letting my personal thoughts spill out onto this page…it’s time to get back to the reason for this post…the fun topic of risk pools!

 Two Factors that Affect Health Insurance Premiums

The Composition (Distribution) of the Risk Pool

As we learned in an earlier blog post, the participants in an insurance plan make up the risk pool and the premium price is set based on spending demands within the risk pool.  Individual health insurance plans are artificial groupings of Americans for the maximization of profits.  Let’s look at three risk pools (insurance plans) that are identical in every way except that they contain different ratios of low, medium, and high spenders. In other words, I will be looking only at the variation of the risk pool composition (distribution) on premiums in the graphic below.

price of health insurance premiums and plan compositionThe average health spending per person figures come from an analysis I did using data from the Medical Expenditure Panel Survey.  It seems obvious that the larger the percentage of high spenders in a plan (risk pool), the higher will be the premium price. On average, Plan 1 costs are $931 per person, Plan 2 costs $4,436 per person, and Plan 3 costs $9,184 per person. The price of insurance premiums for these three plans will reflect these cost differences.

You might be in a higher priced insurance plan (like Plan 3 above) if you simply work for a company with an older work force (e.g., an automotive manufacturer).  For the same coverage, the employees at a company with a younger work force (e.g., a start-up tech company) will pay less for their health insurance premiums. Doesn’t seem fair does it?

The Risk Pool Size

Let’s now vary the plan (risk pool) size and keep the composition (distribution) within a plan the same.

price of health insurance premiums and plan sizeYou would think that the premium price would be the same for the plans above because the average cost per person ($4,436) does not change from plan to plan. In reality, the largest risk pool (Plan 1) has the lowest premium price and the smallest risk pool (Plan 3) will have the highest price. Why?

Let me explain with an example. Because premiums are set at the beginning of a policy year, the insurance company must predict how many people will be in each of the low, medium, and high spending categories.  If an expected Low Spender gets very ill and becomes a High Spender in a large risk pool, the impact on the plan will be much less than if that same person belonged to a small plan.  This situation has been illustrated for Plan 1 (large risk pool) and Plan 3 (small risk pool) in the figure below.

small plan size means higher health insurance premiums

The new “High Spender” (circled on the right) is much more obvious in the small plan than in the large plan.  While the cost per person in the large risk pool (Plan 1) would become $5,295 (a 19% increase in spending per person), the small risk pool (Plan 3) cost per person would become $8,732 (a 97% increase in spending per person)!  The small plan premium must therefore be priced higher than the large plan to reflect this possible adverse outcome in health claims. In general, the larger the risk pool, the more predictable and stable the premiums will be.  This is the reason many small businesses (small risk pools) have been charged 10-18% more for the same benefits compared to large businesses.  Doesn’t seem fair to the small business owner and his employees does it?  This analysis convinces me that in general Americans would be better off financially if they were in one big health insurance risk pool for their entire lives.

The analysis also shows that high health insurance premium prices are not only the result of “overly generous” health benefits.  By setting a threshold health insurance premium price for the Cadillac tax, our government is doubly penalizing some Americans who through no fault of their own have to pay higher prices for “less generous” health insurance and will additionally have to absorb the cost of a 40% excise tax.  For now, the message is clear–don’t get stuck in the wrong risk pool (health insurance group) if you can help it.  Because Americans are subdivided into hundreds of thousands (maybe more) of risk pools (plans) across the country, our health insurance premiums per person will be HIGHER than if we were one big risk pool of Americans.

health insurance premiums and the subdivided risk pool

The Bottom Line

In my simplified analysis above, you can see that for a given health coverage, health Insurance premiums are higher

  • if your health insurance plan (risk pool) is smaller or
  • if your insurance plan has a disproportionately high concentration of High Spenders.

If you find yourself in both situations above, you are doubly screwed financially. Your health insurance premiums will be high simply because you happen to belong to the “wrong” risk pool.  Our government thinks that high insurance premiums mean you are getting “overly generous” health benefits and it needs to financially penalize you  with the Cadillac tax. The analysis above shows that they are wrong. Join BB’s Healthcare Brigade for a united voice to correct the artificial subdivision of Americans into risk pools that do not forward Affordable Health Care and Beyond for ALL Americans.


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