Health Insurance: Who Takes the Risk?

Dec 23, 2011 by

Health insurance is fundamentally a product designed to help share the risk of medical expenditures. (While it also serves the purpose of negotiating discounts, that is outside the scope of this article.) All of the elements of a health insurance policy are put in place to influence how risk is distributed.

Part of what makes health insurance confusing is that it often tries to distribute risk both at the time a transaction occurs and across all the transactions.

Sharing Risk at the Transaction
Unless the “Maximum Out Of Pocket” (MOOP) has been reached, when people receive care covered by insurance, they typically have to pay either a copay or coinsurance, if not the entire cost of the care. A copay is a way to make the insured person liable for a fixed amount of the cost of care, while coinsurance is a way to make the insured person liable for a fraction of the cost of care at the time of use. While copays and coinsurances are typically only a small amount of the cost of the expenses they are associated with, they are put in place to discourage unnecessary use.

Sharing Risk Across Transactions
Deductibles, the amount that must be paid before coinsurances and copays apply, are put into place to share risk between the insured and the insurer. As the average person uses a few hundred dollars of care a year, the average premium cannot be less than that to accomodate the costs of average users. Since there is no point in charging people what they expect to spend (as that is not really a risk), insurers institute deductibles through which they protect people from very large expenses. That way, the cost of everyday use is not built into the cost of the insurance policy. Instead, only extraordinary use is covered. (One caveat is that some policies do cover routine check-ups to prevent people from becoming very ill and needing catastrophic care; the cost of this is built into premiums.)

Employers sometimes offer to step in and take some or all of the risk, particularly if they are large or believe that they have a healthier than average set of employees. They may do this in one of two ways. The most typical method, which is used by very large companies, is to simply ask insurers to bill them directly for the claims “billed to the insurer”. The employer then pays those claims directly, and is charged by the insurer only for facilitating the process. (This is called “Administrative Services Only”.) Alternatively, somewhat smaller employers may choose to create health insurance plans with two deductibles: a low one for the employee, and a moderate one for the employer. In these situations, the employee is responsible for payments until their deductible is reached, perhaps at $1,000. After that, the employer pays the claims for the person until a second, higher deductible is reached, perhaps at $10,000. If the particular employee spends over $10,000, the risk of additional spending is then handled by the insurer. (This is called a “Group Health Reimbursement Arrangement”.) This method of reimbursement allows an employer to save money on health insurance by getting high deductible plans, while offering employees the benefit of a low deductible. In situations in which the workforce is healthier than average, the employer may save money over the cost of simply buying a lower deductible insurance policy.

To conclude, health insurance policies share risk both associated with the transaction using coinsurance and copayments, and across transactions through the use of deductibles. All the risk has to go somewhere. People pay higher premiums when the insurance company takes more of the risk, and lower premiums when they take on more of the risk themselves. This is a mathematical necessity, as the money to cover the additiona risk has to come from somewhere.

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