Question

It has been shown that wide differences in cost exist among insurers for the same type of policy. The three factors used in premium computation are the basis for these differences in cost. Identify and describe the 3 factors and explain which of these 3 factors would contribute to the widest differences in cost.

Answer 1

Ans) Factors Affecting Insurance Premiums:

- The effect of proposals to increase coverage would depend in part on the premiums charged and the value of the coverage provided. In particular, the costs of a subsidy that covers a specified percentage of policy premiums would be affected by the amount of those premiums, whereas the impact of a fixed-dollar subsidy on coverage rates would depend on the share of the premiums it covers. Thus, the factors that determine premiums also affect the impact that a proposal has on insurance cover­age and the federal budget.

- In general, the premium charged for a private health insurance policy is equal to the sum of two components: the average amount that an insurer expects to pay for services covered under the plan; and a loading factor that reflects the insurer’s costs of operating the plan (including administrative expenses and a return on investment). An insurer’s costs for covered services in turn reflect the scope of benefits that are included, the plan’s cost-sharing requirements, and the health status of the plan’s enrollees.

- The aggregate effects of those factors are illustrated by examining current premium levels. Reflecting the choices that individuals and families currently make, premiums for employment-based plans are expected to average about $5,000 per year for single coverage and about $13,000 per year for family coverage in 2009. Premiums for policies purchased in the individual insurance market are much lower—about one-third lower for single cover­age and half that level for family policies.1 In large part, those differences reflect the fact that policies purchased in the individual market cover a lower share of enrollees’ health care costs, on average, which also encourages enrollees to use somewhat fewer services. At the same time, average administrative costs are higher for individu­ally purchased policies. The remainder of the difference in premiums probably arises because people who purchase individual coverage have lower expected costs for health care to begin with. In other words, if both employment-based and individually purchased policies covered the same enrollees, the difference in their premiums would be smaller.

- Those premiums could change under proposals that would modify the health insurance market or extend cov­erage to individuals who are currently uninsured. Some proposals could affect premiums by requiring that indi­viduals enroll in plans that meet certain design specifica­tions in order to qualify for subsidies or comply with a mandate. For example, proposals could require that plans cover certain services, limit the amount of cost sharing that would be required of enrollees, or be "actuarially equivalent" to an existing plan.2 The more comprehen­sive the insurance coverage, the higher the premium would be. Because of the resulting increase in the use of health care services, total spending also would be greater under proposals that reduced cost sharing. CBO has concluded that a 10 percent decrease in enrollees’ out-of-pocket costs would typically cause average spending on health care to increase by 1 percent to 2 percent.

- In addition, premiums could be affected by proposals that changed insurers’ management of covered benefits. Most people who have private health insurance are enrolled in some form of managed care plan. Those plans use various techniques to contain health care spending, including negotiating lower fees with a network of pro­viders, requiring that certain services be authorized in advance by the plan or by the patient’s primary care phy­sician, monitoring the care of hospitalized patients, and varying cost-sharing requirements to encourage the use of less expensive prescription drugs. Proposals that restricted plans’ use of such management tools would tend to yield higher premiums and health care spending.

- Another factor affecting the level of premiums is the cost of administering a health plan. Some administrative costs (such as those for customer service) vary with the number of enrollees in a plan, but others (such as those for sales and marketing efforts) are more fixed—that is, those costs are similar whether a policy covers 100 enrollees or 100,000. As a result of those economies of scale, the aver­age share of the policy premium that covers administra­tive costs varies from about 7 percent for employment-based plans with 1,000 or more enrollees to nearly 30 percent for policies purchased by very small firms and by individuals. Some administrative costs are unavoidable, but proposals that shift enrollment away from the small-group and individual markets have the potential to avoid the added administrative costs per enrollee that are observed in those markets. In other cases, however, trade-offs may arise between reducing administrative costs and limiting overall health costs and insurance policy premi­ums because some administrative costs are incurred when using management tools designed to limit health care spending.