How insurance rate increases really work–and why they are so high!

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By Consumers Union on Thursday, March 11th, 2010

News of double-digit rate increases for individuals and families who don’t have employer-based coverage continues to roll in from around the country – with a recent report showing rate hikes as high as 60% in Illinois, with the majority of increases in the 15% to 40% range.

The Illinois report provides some further clues as to why some of these rate hikes are so astounding. (Insurers are required to file their increases with the Illinois Department of Insurance, but the agency has very little legal authority to regulate rates.) The state has reported that, in 2008 and 2009, rate hikes on “closed blocks” (insurance policies that are no longer being sold to new customers) were almost all in the double-digit range, with a majority of increases at 20% or higher. However, many rate hikes on “open blocks” (insurance policies that are still being marketed to new customers) were less than 10%, with a majority of increases at 15% or less.

So what does that mean? If you buy an individual health insurance policy, you still end up in a “group” that includes all the people who purchased that policy (or similar ones as determined by the company). The insurer will raise your premium based on how much it costs to cover medical services for the policyholders in your group. So far, that sounds just fine.

But insurance companies can only keep the rates for that group down if they keep selling that policy to new, healthy people. They well know that once they “close” a group by pulling that policy from the menu marketed to new customers, then that group will simply grow sicker over time. Because we all get sick eventually.

As medical costs increase for the group, and with no new low-cost healthy people paying in, insurance companies can justify significant rate increases. As the rates go up, the healthiest people shop around for another policy and buy into an “open” group somewhere else. The sick people now have a pre-existing condition and can’t go anywhere.

The effect of this practice is that people who most need medical care face premium increases of 20 to 60 percent. They pay until they can’t pay anymore, and then drop the plan. Most state laws prohibit insurers from canceling sicker customers outright, but in this system they don’t have to.

Pennsylvania’s Insurance Commissioner, Joel Ario, recently told state legislators that the Blue Cross and Blue Shield plans in his state sought rate increases of 30 to 40 percent for some individuals. He allowed only an average of 10% increases, and explained why in a letter to lawmakers:

Many of the proposed increases…exceeded 20% and some exceeded 40%, not because medical trend was running that high for all customers but rather because the filings were more aggressive in discriminating between good and bad risks. When the companies pointed to medical inflation as a reason for seeking increase, we pointed out that medical inflation, while still unsustainably high, is running under 10% on average. We also pointed out that the requested rate increases were based more on reducing or eliminating past practices that spread risk broadly across product lines rather than on broad increases in utilization. Finally we found other actuarial problems on a case by case basis.

So when we hear insurers howling about medical costs driving up premiums, we need to look closely at whether they are fairly spreading risk among their policyholders or whether they are merely trying to get rid of those who actually need their product.

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