Health Insurance – Part 1
Eric Jacobson
Employer Health Benefits
2004 Annual Survey
Kaiser Family Foundation
www.kff.org
The Determinants of Health Insurance Premiums
Health Insurance Premiums
Claims Experience
90%
Loading Charge
10%
The Determinants of Health Insurance Premiums
Health Insurance Premiums
Claims Experience
90%
Loading Charge
10%
Determinants of Claims Experience
 Benefit Coverage
 Government Mandates
 Demographic characteristics of the insured
 Industry
 Region
 Medical inflation rate
Cost-containment policies
•Co-payments
•Deductibles
•Utilization review
•Etc…
The Determinants of Health Insurance Premiums
Health Insurance Premiums
Claims Experience
90%
Loading Charge
10%
Determinants of Loading Charge
 Administrative costs
 Marketing costs
 Risk premium
 Reserves
 Profits
Risk Premiums:
Primary vs. Secondary Risks


Group insurance reduces “secondary risk.”
Two kinds of risk . . .
•
•
Primary risk: calculated odds that a bad event
will occur ($6000 expected value of health costs
for an adult.)
Secondary risk: chance that the actual payout
doesn’t equal the calculated expected value. (The
calculation proves to be wrong.) Larger numbers
reduce secondary risk.
Secondary Risk (Variability) Declines as the
Size of Risk Sharing Pool Increases
$8,000
Expected Value of Claims
99% Confidence Limit
$7,000
$6,000
Expected Avg Loss = $5,000
$5,000
$4,000
$3,000
$2,000
200
500
1,000
2,000
5,000
Number of People in Risk Pool
10,000
20,000
Typical Loading Fees by Group Size
As a Percent of Benefits (Phelps, p. 343)
80
70
70
Percentage
60
50
35
40
25
30
17.5
20
11.5
6.5
201-1000
1000+
10
0
Individual
1-10
11-100
100-200
Rising health costs take bite out of
small biz – USA Today 10/5/03
“Small-business profits are getting pinched because
of price increases for employee health insurance.
Among small companies that posted lower earnings
in August vs. a year ago, 18% blamed higher
insurance costs, says a survey of 544 firms by the
National Federation of Independent Business trade
group. In a similar survey a year ago, 11% blamed
health insurance costs for their earnings dip.”
Why is Small Group Health Insurance
So Expensive?

Per capita loading costs decrease as firm group
size increases – econ of scale.
Loading costs = (risk premium + administrative
costs + marketing costs + profits)


Small group purchasers have less bargaining
power.
Adverse selection.
Key Definitions



Adverse selection – Enrollees may seek to join a
health plan at a premium that reflects a lower level of
risk than their own.
Risk selection (cream skimming) – Occurs when
insurers attempt to attract more favorable risk group.
Moral hazard – Any change in individual behavior due
to insurance that increases expected losses, such as
higher utilization of covered services. (Seat belts,
Lipitor, low copayments)
Adverse Selection

Sicker individuals more likely to:
•
•


Demand insurance
Demand more generous insurance, given a choice of
plans
Largely due to “asymmetric info” (individuals
vs insurers).
This process, called adverse selection (or selfselection), complicates the issue of how much
choice to offer consumers in the health care
market.
Consequence of Adverse Selection and
Community Rating:


Persons with poorer-than-average health status
apply for, or continue, insurance coverage to a
greater extent than do persons with average or
better health expectations.
Experience Rating?
An Example of Adverse Selection
100 People
1 Person
30% chance of needing
$100k treatment
Pure Premium = ?
1% chance of needing
$100k treatment
Pure Premium = $1,000
(asymmetric info)