All About Health Insurance: Part 1 - How Insurance Companies Make Money
Good medical billers have the know-how to process claims. But great billers are familiar with who pays the claims...
Health insurance companies sell policies that protect their clients from medical hardships. These policies may include:
- preventative services
- hospital stays
- emergency services
- surgery
- routine care
- healthcare education
- ...and so on.
How do medical insurance companies make a profit?
It's comparable to our lives. We have bills, gas, groceries, kids, our cars break down, our dogs eat shoes, and life all around can empty our pockets and our bank accounts.
In order to take the cruise we have planned for this year's vacation, we have to make enough money to pay for life, plus that little extra to set back for a fun filled week of nothing but sunshine and cocktails.
The money coming in has to be higher than the money going out.
So how do they do it?
The answer: PREMIUMS.
A premium is the cost of an insurance plan.
Health insurance companies may have thousands of clients they collect premiums from every year, but only a few will actually submit claims.
For example, an insurance company receives a monthly premium for an individual of $90 per pay period, plus an additional $300 per pay period from that individual's employer, for a total of $10,140 per year.
If the insurance company has 1,000 clients (and we assume they pay the same amount as the previous client) the insurance company would bring in $5,940,000 a year.
If only 10 of those clients have major claims for a total of $2,500,000 for the year, the insurance provider has a profit of $3,440,000.
Premiums are based on the probabilities of receiving claims and the payout risk of a policy holder. The more money health insurance providers dish out, the higher the premiums are going to be.
How are probabilities and premium prices calculated?
The pricing process is extremely involved, and can be quite confusing. There are many factors insurance companies look at before making any premium rate decisions.
Here are a few key terms for you to know:
Experience rating: this is a rate based on the group's past claims.
Unit of benefit/beneficiary: person(s) covered by the insurance policy.
Manual premium rate: the standard cost quoted in an insurance company's manual for insuring someone.
Expected events: events that are predicted to happen within a certain time frame.
Credibility factor: The weight given to an individual insured's past experience in figuring premiums for future coverage.
Group prices are initially determined on the basis of expected future events. After the period is over, prices may be subject to experienced rating.
Pricing group premiums consists of 2 steps:
The determination of the premium for each unit of benefit (e.g., $1,000.00 life insurance, $1 daily hospital benefit, $1 disability benefit, etc.).
The determination of the total premium that will be paid to the insurance company for all the coverage purchased.
The pricing process for group insurance differs depending on whether manual or experience rating is used.
Manual premium rating determines the cost of insurance separately from a group's claim experience.
For small groups, it's impossible to determine whether experience is actually reflective of the risk exposure or if it's due to a random chance - manual rating is the way to go.
Initial premium rates for larger groups are also configured by the manual rating process.
To obtain a premium for a specific group, manual rates are applied and multiplied by the number of people in the group.
The premium rate necessary to meet the cost of expected claims is referred to as the net premium rate. The net premium rate is calculated by multiplying the frequency of claims by the severity of the claim.
Manual rating also considers the adjustments of expenses, risk charges, contribution to the insurance's surplus, etc.
For larger groups, a formula varying by group size and coverage type is used. It is based on the average claim experience of the insured.
Experience rating factors in a group's claim experience to determine the rate for future premiums. Experienced claims for a given cycle include claims that have been paid or are scheduled to be paid.
The subjective average of experienced claims and expected claims is known as a claims charge. Claim charges are determined by credibility factors based on group size and insurance coverage type.
Credibility factors range from 0 to 1 depending on the estimates of the experience credibility. The experienced claims will be the same as the claim charge when the credibility factor is 1.
If the experience claim turns out to be better than the expected claims for a given period, the surplus is returned.
Individual insurance plans
Gender, age, tobacco use, alcohol use, and medical history are all components used to calculate premium rates for individual plans.
Potential policy holders are required to fill out an application when inquiring about an individual plan. It provides the insurance company with demographic and health history information, and is the main resource used to determine premium rates.
Other factors used by insurance companies to decide upon premium rates include:
- claims history
- medical records
- physician statements
- monthly fees
- policy effective date
- and the policy selection.
Claims history is used to identify any risks for the insurance company by confirming existing conditions.
The criteria used to evaluate a pre-existing condition include:
- what the condition is
- when the condition was present and for how long
- how often symptoms re-occur
- is the condition still being treated
- severity of the condition
Medical records may help clarify reasons for tests and services, and can accurately assess the health status of the applicant.
If a health issue is still not completely understood by the insurance company, they may require the applicant to submit physician statements to further describe the condition.
Group and individual plans differ in the way they processes premium rates, but the overall objective is the same: provide insurance plans that are reasonable, adequate, and equitable.
How do physicians make money?
By the looks of our medical bills, physicians get paid, and get paid well. But how do they make all that money?
They rely heavily on their patients' insurance providers to pick up a great deal of the medical charges.
Insurance providers will only shell out a certain amount for procedures performed. That amount is determined by a resource-based relative value scale (RBRVS).
A RBRVS is an outline used to determine the amount of money a physician will be paid. It assigns a relative value to the procedures performed by a physician, and is adjusted by geographic region. The value assigned is then multiplied by a conversion factor to establish the payment amount.
The RBRVS keeps physicians from charging outrageous fees for their services (although it already seems like they charge an arm and a leg!), but still allows them to earn a fair salary.
Patients' insurance policies provide a large amount of the cash flow within a physician's practice. Without the insurance payments, physicians could see a loss instead of a gain. No cruises for them...
Find part 2 of this article here...
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