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For a print-ready PDF of this page, click here. Private health insurance is defined here as insurance that pays for the costs of preventing, diagnosing, or treating an accident, illness, pregnancy, or other health condition requiring medical related services. The definition of health insurance is limited to benefits that are payable contingent on the provision of a medical service, where the service indicates the presence of a health condition. This article excludes those classes of insurance in which payment is not contingent on the provision of medical services, though these are forms of insurance that are legally classified as “accident and health” insurance. Among such excluded insurances are: sick leave or short-term disability, which replaces income lost as the result of a temporary illness; long-term disability, which protects against the risk of an indefinite loss of employment as a result of a health condition; and accidental death and dismemberment, a combination of accidental death insurance and presumptive disability (on the basis of a loss of sight or limb). These coverages have in common that they protect the insured against a loss of income attributable to illness, rather than to provide income intended (at least in concept) to cover the cost of caring for an illness. Although the loss of income is an important component of the cost of illness, it is not considered within the scope of health insurance as discussed in this article or for the data presented in the national health expenditures article. Reimbursement health insurance is the most common form of health insurance. It is designed to either pay providers directly for the cost of providing medical services or to reimburse patients directly for their outlays. Benefits are contingent on the occurrence of the specified medical services for which there is a charge. Patients are normally responsible for deductibles, copayments, coinsurance, and differences between the amounts charged and the limits on reimbursement (for example customary and prevailing charges). An alternative to the reimbursement form of insurance is auxiliary coverage. Among the oldest health insurance policies written are “indemnity” coverages, which pay a fixed fee contingent upon a particular medical event (for example, $50 per day confined in a hospital, $75 if an appendectomy is performed, etc.). These auxiliary policies have been largely replaced by more comprehensive reimbursement coverages, especially major medical insurance which reimburses the actual cost of most hospital and medical services. As described earlier, private health insurance has traditionally been classified into three categories. The two principal categories have been the Blue Cross and Blue Shield Plans and “commercial” insurers, that is, those regulated as insurance companies by State insurance departments.7 The third category, independent plans, consisted of all other private health insurers, including self-insured employer plans, union plans, HMO's and similar organizations, and single service plans (for example, Delta Dental). Administrative-services-only plans and minimum-premium plans were classified as independent health plans. This was consistent with the distribution of risk as defined by the insurance industry, that is, in terms of responsibility for funding the claim payments (the expected outlays of the insurer and employer). However, the traditional classification does not reflect the bearing of risk in terms of an open-ended liability for unexpectedly high-claim payments, because with MPP's the insurer bears the risk in this sense.8 Although the ASO and MPP plans were defined as independent health plans, estimates of them were not included in prior estimates to avoid presumed double accounting. During the past decade, the insurance industry has undergone major changes that affect the proper interpretation of industry data and the adequacy of the principal data sources. These developments have also changed the features of the plans that are most important for industry analysis. As a result, the estimating methods previously used have become biased through omitting important and rapidly growing segments of the industry. The most important of the omitted segments are administrative-services-only contracts, minimum premium plans, and plans administered by third-party administrators.9 Changes in the industry have also rendered the classifications previously used inappropriate for analysis. Questions increasingly relate to the organization of the medical system, especially as to the choice of providers available to patients and restrictions on their use. These are the principal tools of alternative health plans in controlling cost and utilization. They are crucial to the design and operation of competitive systems. Taxation, especially as it affects employee (“fringe”) benefits, and regulation are also receiving increased focus. Among the changes already noted are: a move towards self-insurance; a shift by insurance companies to providing administrative services, rather than insurance, as the primary service offered to large employers; the rise of third-party administrators; conversion of a large proportion of the remaining insured plans to minimum premium arrangements; and the increasing complexity in the industry, including competition among plans and also cafeteria plans with “flexible spending accounts”. Other changes have also tended to blur the importance of some of the traditional classifications used to characterize the insurance industry. The similarity between the Blues and other insurers is growing. In fact, nine of the Blue Cross and Blue Shield plans have converted to a mutual ownership status, and many own for-profit insurance subsidiaries which are regulated by State insurance departments. Both the Blues and the insurance companies now offer similar products in direct competition that differ more from product line to product line than between these two types of insurers. The remaining distinctions between the two relate primarily to taxation, regulation, and market share. The latter allows Blue Cross plans to obtain substantial discounts from hospitals in many States and exempts them from the premium tax in most States. Because of the similarity between the Blues and the commercial companies, a few States make no distinctions between them. The past decade has also been marked by the growth of group model and independent-practice-association (IPA) type HMO's and by the emergence of a number of new types of organized health systems. Notable among the new systems are the preferred provider organizations and the HMO-like provider organizations contracting to provide Medicaid services in States with capitation demonstration programs. For example, all Medicaid services in Arizona are now provided through competing capitated health plans. Only a few of these plans are Federally qualified as HMO's. Cafeteria plans with flexible spending accounts are a further complication to classifying insurance plans. Cafeteria plans offer employees choices among health insurance coverages, usually involving a trade-off between other employee benefits, including additional wages in some cases. Flexible spending accounts (FSA's) are a recent innovation which allow employees to recharacterize wages as medical care reimbursement (formerly a salary reduction), thereby saving taxes. Current regulations for new plans require employees to set aside the dollars to be recharacterized in advance of the receipt of services, and to forfeit any unused amounts. To the extent that the sums set aside may be forfeited, these amounts should be considered to be health insurance. Sums set aside are a prepayment for health coverage and forfeited amounts are similar to paying a premium and then not needing health care services. FSA plans in existence or planned in January 1984 may continue to permit salary reductions through 1985 to pay for health care services without forfeiting benefits. They may be used to fund other tax preferred benefits, such as pensions. Although these benefits are prepaid, they do not represent insurance, but resemble more a direct payment funded by the withdrawal of cash from savings. Some existing plans permit retroactive recharacterization of wages as medical reimbursement. These plans are referred to as zero balance reimbursement accounts, or “Zebras.” These amounts should not be considered health insurance, since no prepayment occurred. While not yet a large dollar item, FSA's are expected to grow rapidly during the next decade, if favorable tax treatment is extended. The health insurance industry has become highly complex. Traditionally, risk-bearing was considered the most important feature. In recent years, however, market share has become increasingly associated with the administrative responsibility, because this function accounts for a much larger portion of insurer net income than the provision of insurance, and employs more people in the industry. Analysts may wish to follow trends in administration or changes in regulations or restrictions to the choice of provider. Some of the most important of these aspects (or “dimensions”) of insurance services, as currently provided, are as follows:
A discussion of the nature of each of these dimensions of health insurance follows. AdministrationThe most important administrative responsibilities concern: determining eligibility of claimants, services covered, and appropriate reimbursement amounts; accounting for the amount spent; and making the financial projections needed to determine the incurred status of a plan and the rates and aggregate funds needed for the next year. The financial analysis is normally supplied by the insurer or by consultants. The other duties are allocated according to the objectives and needs of the employer and for economy of operation. Employer involvement in the important decisions affecting the operation of a health insurance plan and in the day-to-day administration varies widely. Most employers leave all such responsibilities and duties to insurers or TPA's. Others are involved intimately with the details of operating the plans and the decisions concerning the payment of providers and claimants. A common arrangement in large employer plans is for most of the day-to-day operations to be carried out by employees of the company, rather than those of the insurer. In such situations, the insurer provides specialized technical services, such as actuarial support, adjudication of difficult claims, auditing, etc. RiskThe question of which party is at risk in a health insurance arrangement is more complicated than it appears. Unlike most other forms of insurance, employment-based health insurance generally makes each employer pay its own costs over time, at least for employers with 100 or more employees. Insurers have developed a variety of arrangements that adjust the net cost charged to an employer to the sum of the actual costs of paying claims, administering the policy, and a “risk” charge. These types of arrangements include: Experience-ratingThe premium charged is a projection of the claims and administrative charges, plus a margin for safety. The estimate of future claims is a projection from past experience. In non-participating experience-rated plans, the subsequent year's premiums may be adjusted down to pay back a surplus or raised to recoup a deficit. In participating experience-rated plans, dividends (or rate credits) are paid at the end of each policy year equal to the excess of premiums collected over claims incurred and administrative and other charges made according to the insurer's formulas. The insurer agrees to pay a dividend based on the excess of premiums over claims incurred and specific “retention charges” covering all charges other than claims. Interest is usually paid on the cash flow of the policy, and dividends may be accumulated with interest. The terms of the agreement may follow the insurer's normal dividend formulas or be determined by competitive bidding. Administrative services onlyThe insurer pays the claims, issues booklets, and provides other administrative functions. Claims are normally paid from an employer bank account or trust established for this purpose. Otherwise, the insurer bills the employer for the amount paid. Claim charge-backsUnder these arrangements, the insurer has a contractual right to charge the employer for the claim run-off (the liability for claims for services that have been rendered, but for which payment has not been made) if the policy is cancelled. The only premium collected is an estimate of the cash outlays for claims payments and retention charges. This is a form of self-insurance, since there is no risk for the insurer. (There may be supplemental agreements between the insurer and the employer for excess loss reinsurance.) These approaches all have in common that, as long as an employer continues with the same insurer, the accumulated outlays by the insurer will be continually adjusted to reflect the accumulated claims incurred, plus administration and other insurer charges. Less direct mechanisms may be applied to smaller groups, which have the effect that over time employers still pay most of their own costs. Such mechanisms include: Credibility percentageThis is the practice of assigning smaller groups credibility factors, that vary with the size of the group. The most usual arrangement is the assignment of a credibility factor X (between zero and 100 percent) to each group based on its size and, therefore, on the expected variation in claims from year to year. Instead of charging the actual claims, the insurer charges X percent of the actual claims and (100 − X) percent times the expected claims (that is, actuarially forecast claims). The expected claims for this purpose are usually based on the actuarial characteristics of the plan (including a safety margin), just as if the plan were fully insured. Aggregate stop-loss insuranceWith this type of insurance, the insurer reimburses the employer (or pays the excess claims) if claims exceed a designated level. This level may be set in terms of nominal premium rates (i.e., expected benefits with associated administrative charges and margin) per employee and per family to allow for changes in the level of employment and the mix of families and single employees. Normally, excess loss insurance is purchased at a level that protects an employer from an unusually bad year; for example, claims more than 15 percent to 25 percent above what would be expected on the basis of an actuarial projection. Protection can limit the benefit payment level for either the entire plan or an individual claim. Individual stop-loss insuranceThe insurer charges an employer an actuarially determined expected claim amount, rather than the actual catastrophic claims in order to spread risk (e.g., more than $25,000 in a year for an individual). Such charges represent direct risk-bearing by the insurer. PoolingThe experience of a number of small employers is combined, and premiums are determined on the basis of the collective experience of all employers in the pool. Minimum premium planThis is a combination of self-funding and participating experience-rated insurance. The insurer pays the claims from an employer bank account up to an agreed maximum for the year. Any excess claims beyond this maximum are paid by the insurer. The “minimum premium” is the amount charged by the insurer for insuring the excess, any amounts pooled, and for administering the plan. The financial effect of the arrangement is the same as a participating experience-rated policy, except that premium taxes are greatly reduced and the employer has the use of the funds that would be tied up in claim reserves. In some situations, insurers insist on holding claim reserves, especially where the financial capacity of the employer or union to pay the claim run-off is in doubt. The insurance arrangements are usually on a claims revealed basis (that is, the insurer will pay for claims presented for payment by providers or insured persons) beyond an agreed maximum per month or year. Despite technically being at risk for claims, insurers do not normally have to use gains generated from other employer groups to pay for losses where an employer-sponsored plan has a bad year. In the short run, at least as long as the plan continues with the same insurer, the lag between the dates of service and payment permit payment of all claims presented without drawing on insurer funds. The insurer will raise the premium rates for the next year by enough to cover both future costs and to make up the deficit. Insurer funds are only needed when an employer cancels with an accumulated deficit. Thus, as long as the insurer does not change, the insurance mechanism serves to spread the costs of unusually high claims over a period of years, rather than to spread it across other insured groups. To reduce the chances that an employer will cancel with a deficit, insurers include margins in their rates proportional to the risk of loss. This risk diminishes as the size of the group grows. Thus, one dimension of any classification based on risk should be the magnitude of the risk of adverse fluctuations, and this varies principally with the size of the insured group. Variance is also affected by the design of the plan (for example, a large deductible increases the variance of claim aggregates), the demographic composition of the group, and other features. Insurers have many ways to protect themselves against cancellation with a deficit. First, a deficit must be substantial for there to be an adequate financial incentive to change insurers. In addition, a bid from a new insurer must be increased for the cost of installing a new administrative system, acquiring the basic enrollment data, enrolling dependents and employees if contributions are required, issuing booklets, and other start-up tasks. Further, the incumbent insurer will have more information to define the risk, and can prepare more accurate projections of future claims (for example, claim files showing the nature of existing health conditions in the group). In contrast, a prospective new insurer will usually resolve most uncertainties by increasing the premium rates to reflect the worst cases, and will perhaps add a further margin to cover the possibility of other unpleasant surprises. Further, a prudent insurer will charge a higher margin to an employer who has canceled with a deficit with a previous insurer. Substantial deficits should occur relatively infrequently if the insurance is managed prudently. In addition, insurers often persuade employers with deficits to continue, or they encourage employers to accumulate dividends in a “claim fluctuation reserve” that effectively removes all risk of loss. They may also have other business relationships with the employer that discourage cancellation. For this article, risk is assumed to rest with the insurer where the insured group's liability is set at a level that represents the expected claims plus a normal margin (5 percent to 10 percent of expected claims). This is, in effect, assumed to occur under all regular group insurance contracts and all minimum premium plans. Contracts with excess loss insurance are treated as being self-insured, despite the presence of full or partial protection against catastrophic losses. These coverages occur primarily under ASO, TPA, and self-administered contracts. This classification reflects the limitations of the data available concerning how much risk is present and how it is actually borne. A substantial market share is held by insurers that are not reported by the HIAA (for example, Lloyd's of London). RegulationHealth insurance plans are regulated under a number of different State and Federal laws, and through State and Federal agencies. The laws and regulations differ widely by State, and may be implemented by different State agencies. Each State has an insurance department that regulates the “commercials” (that is, those insurers other than the Blues, HMO's, and single service plans). The commercial insurers consist of stockholder and mutual (policyholder-owned) companies, and are regulated in two distinct groups: the life and annuity companies and the property and casualty companies. All may write both group and individual insurance policies. The terms “individual” and “group” insurance as used in the insurance field relate to the type of regulation, not necessarily the relationship of the insured to the insurer. Different sets of rules are applicable, depending on the State laws, pertaining to the filing of rates, required policy provisions, loss ratios, and other important matters. In most States, the Blue plans are regulated by the State insurance department. In a few States, no distinctions are made between the Blues and other insurers. Most States, however, have separate laws governing the Blues and any other service plans operating in that State (e.g., Delta Dental plans, Vision Care, Paid Prescriptions). The insurance departments of most States regulate HMO's with respect to insurance functions, especially financial solvency. Federally qualified HMO's are also regulated by the Federal Government. Those participating in Medicare and Medicaid must conform to HCFA regulations. All employer and union plans are potentially regulated by the Department of Labor. In fact, the regulation of self-insured plans is preempted by the Federal Government. States may not regulate self-insured plans covered under the Employee Retirement Income Security Act (ERISA). This regulation, however, is limited to the disclosure of certain data such as the benefit plan, premiums, claims, commissions paid, etc. Employer plans are also regulated indirectly by the Treasury through approval of deductions from Federal taxes. Federal and State tax policies also affect the operations of insurers. Different taxes are imposed on the different types of insurers, and may vary with the mix of insurance policies sold and other details of the businesses. The nonprofit Blues, single service plans, and HMO's are largely untaxed at either the State or Federal level. Provider choiceThe restriction of benefit payments to purchases of the services from a panel of “preferred providers” is important for the potential control of health care costs. Health maintenance organizations exemplify one of the earliest forms of such restrictions in provider choice. Many reimbursement insurance plans are now including restrictions or incentives to use a preferred provider organization, or PPO. The current interest in introducing competition into the purchase of services under group insurance programs has attracted great interest in the potential for these plans. Prototype PPO's vary widely in features, and many more variations may prove to be feasible. Typical characteristics include: simplified billing and prompt payment; provider discounts and agreement to accept payment as full compensation; competitive advantages for preferred providers, ranging up to exclusive contracts (EPO's), in return for higher patient volume; prior selection of restricted panel with cost-sharing advantage and/or reduced employee contribution; agreements for precertification of admissions and to abide by the results of utilization review; formal gatekeepers (for example, a single physician must approve all nonemergency care for any patient); and acceptance of risk sharing by providers. It is too early in the development of PPO's to determine appropriate classifications. The list above suggests several important dimensions according to which PPO's may be classified: type of sponsor, reduction on provider choice, methods of provider compensation, approach to utilization management, degree of risk sharing (if any), and choices provided to employees. Other dimensions of interestAnalysis of private health insurance involves other dimensions, although these have less direct impact on estimating total spending for insurance. For example, the specific features of individual insurance contracts are of obvious relevance to policy analysis. These include such matters as the specific types of services covered, the definitions of eligible providers, the payment provisions, and cost sharing. The demographic, economic, and health characteristics of the persons insured are also of vital-importance. These microeconomic aspects of private health insurance are, however, beyond the scope of the current inquiry. Also, no attempt is made here to classify the various approaches to the control of the utilization of services. Table 4 summarizes the classification of private health insurance plans according to the dimensions previously discussed. It shows, for example, that Blues nonexperience-rated standard contracts are administered by the insurer, entail risk borne by the insurer, are regulated by the State, and provide unrestricted provider choice. It shows, moreover, that while nearly all Blues plans are identical with respect to provider choice and administration, there are important differences with respect to regulation and risk. Thus, if either regulation or risk is the key variable of interest, it would clearly be inappropriate to categorize all Blues plans as a single entity. This observation reinforces the need, expressed earlier, for an expansion of the traditional method of classifying private health insurance. Private health insurance plans, by type of classification
The primary intent of Table 4 is to demonstrate relationships and to convey a sense of the complexity involved in measuring private health insurance. If each of the X's in the table were to be converted to a numeric estimate, one could derive the volume of private health insurance for which the insurer bears the risk versus that which is self-insured by summing down the appropriate columns; similarly, one could derive the split among modes of administration, regulation, and provider choice. Caution must be exercised, however, for certain types of plans, indicated by the footnotes. Self-insured plans, for example, often purchase some degree of catastrophic protection. Similarly, plans which are administered by insurers sometimes involve a sharing of administrative functions, and so on. Page 2Revised and previously published private health insurance estimates for premiums1 and benefits, and difference: United States, selected years 1965-83
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What type of health insurance policy states that the insurance company may not cancel the policy but they may increase the rates on a specified class of insureds?
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