Tuesday, March 16, 2010

Health Care Underwriting

Health insurance companies use underwriting to evaluate the health insurance risk of an individual or group of individuals. Through this process an insurer estimates the cost of providing health insurance to each customer.

Historically, health insurance underwriting is used to underwrite individuals and employers of less than a 1,000 employees. Large employers are generally excluded from underwriting for two reasons.

First, they often self-insure and use the insurance company or a TPA (third party administrator) to administer the company's health plan, while accepting the insurance risk corporately. They hedge this risk with "stop loss" insurance, which I won't go into since it is not the focus of this article.

Alternatively, because of a large employers size, the insurance company believes that the employees of the company reflect a measurable risk based on the prior year's claims and therefore they do not go through the process of individual underwriting, but rather base their rates on historical claims adjusted for expected future claim trends.

Individuals and small employers are very price sensitive. By excluding individuals that have higher health risk, health insurance companies can offer lower premiums. Historically, 3% of the people in America account for 20% of the nation's health cost and 20% of Americans account for 80% of the nation's health cost.

Given this dynamic, the health insurance company that is better able to identify the 20% of individuals that will represent 80% of the health care claims can offer lower prices to 80% of the target market and still make a reasonable profit.

In contrast, the insurance company that fails to underwrite and uses a "community rating" method (averaging the cost of everyone in the community to price their product) will be more likely to attract the individuals, who are have serious health conditions (since the healthy individuals will seek the lower cost insurance offered by the companies that do underwriting) causing their claims to be higher than the community's average. This is called "adverse selection". These companies will end up losing money regardless of what they charge.

To address this issue some states have mandated that insurance companies use "community pricing" to level the playing field. "Community pricing" prohibits health insurance companies from underwriting risk. When this happens, it becomes imperative that health insurance companies secure a significant market share in order to have an average "risk" pool of individuals and consequently drives smaller competitors out of the market.

At the same time, it makes health insurance more expensive to healthy individuals, who comprise 80% of the market. Demographically, these individuals tend to be younger with lower incomes. As a result, some individuals that could have afforded health insurance with underwriting now find they cannot and drop health insurance.

In effect, we have changed the uninsured pool from those that could not get health insurance to those that cannot afford it. Over time, more and more healthy young people opt out of insurance for cost reasons. As more and more people drop insurance coverage for affordability reasons, the insurance pool loses revenue disproportionately to claims.

This causes insurance companies to raise prices at a much greater rate than inflation to keep the insurance pool financially sound. Eventually, these rate increases are so high, that the news media and politicians are outraged and demand action. The politicians generally fail to acknowledge that past political actions were a major contributor towards the problem.

Massachusetts addressed this problem by mandating everyone have health insurance to keep the "healthy young people" from escaping the insurance pool and thereby keeping health insurance rates lower. Mandating insurance maintains the health of the "risk pool" but does so by effectively "taxing" healthy young people with lower incomes to subsidize individuals with higher health care costs.

By itself this is probably okay, but these same young people are being asked to shoulder and increasing Social Security cost, Medicare cost, and national debt of the nation. How much is to much?

Often as a product of underwriting individuals are offered insurance at standard rates, but have pre-existing health conditions excluded from coverage. Pre-existing exclusions can also apply when underwriting is not done or a health condition is not revealed at the time a policy is issued (this is called point of claim underwriting).

Briefly, "point of claim underwriting" is a term used to describe how an insurance company reviews a claim to determine whether an applicant misrepresented information on a health insurance application.

For example, a woman finds she is pregnant and purchases insurance without disclosing her pregnancy to the insurance company. Six months later she delivers her baby. When the delivery claim comes to the insurance company, the insurance company checks and determines that the woman failed to disclose her condition at application and denies the claim.

Regulations prohibiting insurance companies from limiting coverage for pre-existing conditions increases the cost of health insurance and therefore eliminates access to health insurance to others based on affordability.

So what is the answer.

In my opinion, we should allow insurance companies to underwrite individuals and to "rate" them according to their health risk. In addition, they should be able to issue "pre-existing" condition limitations that apply for up to one year. If as a society, we choose to subsidize individuals that have substandard health risk, then we should do that directly in order to keep the cost of health insurance for healthy individuals affordable.

My recommendation is that we do subsidize health insurance premiums for individuals with substandard health risk. But, the subsidy should be adjusted for income and lifestyle. Insurance companies would go through their standard underwriting process and offer a premium based on the risk rating of the individual. If the insurance rating resulted in the individual paying higher than standard rates, the individual could apply for a health insurance premium subsidy from the government.

The maximum subsidy would be the difference in the individual's insurance premium and standard rates. This subsidy would be reduced based on the individual's income and lifestyle. At some income level, the subsidy would vanish. Likewise, controllable lifestyle factors would be used to adjust the subsidy. This would provide a financial incentive to individuals asking for a subsidy of their health care cost to contribute to reducing that cost by pursuing a healthier lifestyle.

So where am I going with this? I believe we can "reform" the current health care system in America to make health care universally available and affordable at a cost below what our health care system costs today. This blog will continue to examine health care issues and solutions, please continue reading and send me your feedback.


  1. There was one article saying that..if your insurance policy has full medical underwriting then all your medical history will be available to your insurers up front..true..??
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