Image: Flickr / David Goehring
With increasing healthcare costs a major concern for many, we take a look at some frequently asked questions when it comes to how health insurance companies make money.
Health insurance companies are the center of attention when it comes to healthcare financing and reform. And with healthcare costs being a focus for many, there’s a lot of confusion for consumers on why costs are increasing. One key question for some: how do health insurance companies make money?
We’ve outlined answers to some commonly asked questions about these important market players.
What are health insurance brokers and how do they make money?
Brokers (individuals or companies that help people choose health insurance) earn commission from insurance companies. Every time someone buys an insurance policy from a broker, the insurer who just got a new customer pays the broker a fee. These fees are typically built into policies and are equal to a small percentage of premiums. It’s unlikely that you’ll pay a broker a direct fee for their services. However, commission structures vary by insurer, plan, and state.
How do insurance companies make money?
Underwriting income and investment income.
1. Underwriting Income
Anyone under a healthcare policy pays a monthly insurance premium. A health insurance company essentially pools that money together from its customers. When one of those customers needs cost coverage for some medical care, the insurance company uses money from this pool to pay for it in the form of claims. A health insurer will also use premiums to pay for costs of doing business. What’s left in the pool of premiums is income. Other costs that you pay for your health services (like copayments and coinsurance) are paid to your healthcare provider (doctors and hospitals), NOT the insurance company.
Underwriting Income = Premiums Collected – Claims Paid – Expenses
2. Investment Income
Insurance companies put money into financial investments. The money earned on these investments contributes to the company’s income.
What is underwriting and what does it involve?
Underwriting is evaluating the risk of providing coverage and costs of coverage. Prior to implementation of the Affordable Care Act (“Obamacare”), full medical underwriting included a detailed examination of an individual’s medical history. Health insurers put a lot of effort into knowing and trying to predict cost of claims. That includes monitoring guidelines such as eligibility, in-network vs. out-of-network care, medical necessity, and authorization.
What money from consumers, specifically, do insurance companies take in as direct profit?
Direct profit from consumers’ premiums depends on how much money an insurance company is using. Premiums are collected into a pool. Money then leaves that pool in the form of claims and expenses, whatever is left over is considered profit.
Do insurance companies earn anything or benefit from Obamacare?
Obamacare placed several limitations on insurance companies, but it also tried to set up some buffers so that insurance companies could be protected in a marketplace with less predictability. Examples of both are described below.
1. Medical Loss Ratio
Obamacare requires that 80% of premium dollars be spent on claims and efforts to improve quality of care. The remaining 20% can go to expenses and ultimately the bottom line.
2. Limited Restrictions on Coverage
Obamacare limited the restrictions that insurers could place on coverage. As a result, insurance companies can’t decline coverage or exclude items in insurance policies because of pre-existing conditions.
3. Out-of-Pocket Maximum
Obamacare created an out-of-pocket expense maximum, meaning that a customer could only be held responsible for a certain amount of expenses. After that, all costs are covered by the insurance company.
4. Risk Corridor Program (2014 – 2016)
In order to help stabilize the uncertainty of a new marketplace, Obamacare included a three-year risk corridor program. This meant that if one insurance company paid less claims than what it targeted, it would give money to the program. That money would then be given to an insurance company that had paid more in claims than what it targeted. While this was a good idea in theory, it’s been very challenging for insurers to estimate their claims and risk in a changing marketplace. It also became harder to pay insurers what they were promised because in 2015 a new Republican-led Congress voted to make the program budget neutral (meaning federal funding couldn’t be used to safeguard any mismatch of payments in vs. payments out).
Why are insurance companies leaving Obamacare?
Some insurance companies have stated that the financial losses associated with participating in Obamacare are unsustainable. In addition to the Risk Corridor challenge, two factors, that contributed to these losses are consumer behavior of healthy individuals and choices made by states.
1. Due to Consumer Behavior of Healthy People
The imbalance of healthy, low-cost customers and sicker, high-cost customers led insurance companies to charge higher premiums. As premiums rose, fewer people enrolled in Obamacare, which created even higher premiums and in some cases, led to an insurer’s decision to leave the exchanges.
2. Due to Choices Made by States
States were given two choices: 1.) expand Medicaid to cover more people and/or 2.) offer a state-based exchange or a federally-facilitated exchange.
In addition to increasing coverage, Medicaid expansion was intended to help insurance companies because of its ability to insure more high-risk customers (federal funding would initially cover 100 percent of the expenses of new Medicaid patients and would be phased down to 90 percent by 2020 and into the future). Before Obamacare, people who weren’t eligible for Medicaid and were denied coverage by insurance companies were left uninsured. Medical conditions left unattended because of a lack of insurance are ultimately more costly to the system. Under Obamacare’s Medicaid Expansion, those individuals could be eligible for Medicaid and insurers would be shielded from the costs.
Through state-based exchanges, individual states establish their own set of costs, quality standards, and provided healthcare services. Federally-facilitated exchanges use standard information and requirements regardless of state.
Looking at data from the Kaiser Family Foundation, states that set up a state-run exchange and expanded Medicaid fared best when it came to the number of insurers that decided to participate in this year’s exchanges. Among these states, 75 percent had 3 or more insurance companies continue to participate in exchanges. Those that chose to use the Federal exchange and expanded Medicaid fared worse (with 66 percent of those states with 3 or more insurers), while those that chose not to expand Medicaid fared the worst (with just 55 percent of states with 3 or more health insurance companies participating in exchanges this year).