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Insure.com FAQ: How does the health insurance company determine our group's premium?

Small business group health insurance: Frequently asked questions

Question:
How does the health insurance company determine our group's premium?

Answer:

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Health insurance companies use one of three methods to calculate your group's premium: medical underwriting, adjusted or modified community rating, or rating bands. The method used depends on the rules in your state.

Medical underwriting is used primarily in the individual and small business health insurance markets. It is used in the large group market only at the time of purchase and rates are based on the number of employees participating in the plan, and a review of the company's claim history.

When an individual or employee is asked to provide their medical history, it means their insurance application is being medically underwritten. Insurance companies use medical underwriting to establish eligibility, set premiums or deny coverage. For very small employers, premiums can increase if you have one employee with a history of chronic illness (such as diabetes) or with a catastrophic illness.

The good news is that a group cannot be turned down because of the health of one individual, nor can one person be denied coverage when the rest of the group has been accepted. The Federal Health Insurance Portability and Accountability Act of 1997 (HIPAA) prevents insurers from charging different rates to individuals in the same group based on their health status and other factors. Under HIPAA's nondiscrimination requirements, "group health plans may exclude coverage for a specific disease, limit or exclude benefits for certain types of treatments or drugs, or limit or exclude benefits based on a determination that the benefits are experimental or medically unnecessary — but only if the benefit restriction applies uniformly to all similarly situated individuals and is not directed at individual participants or beneficiaries based on a health factor they may have."

The second method, adjusted or modified community rating, is the standard for setting health insurance premiums in some states and eliminates health status from the list of factors insurers consider when they set premiums. The rate charged is based on limited factors such as ages, gender mix and lifestyles (i.e. if the employee smokes) of the group's members. Pure community rating, rarely used, means that everybody in a particular geographic area pays the same premium for health insurance.

The basic principle of adjusted or modified community rating is that a single rate applies to all small or large groups in the market, with limited "adjustments" permitted for specific "case characteristics," such as the average age of the company's workers, according to the National Association of Health Underwriters (NAHU). When adjusted community rating is applied, the ZIP code of the employer is used to determine the group's premium. In most cases, insurers use the employer's ZIP code, unless there are employees who live far away or completely out of state. In that instance, they'll use the employee's ZIP code.

States that use adjusted or modified community rating include New York, New Jersey and Pennsylvania. The only state that still uses "pure community" rating is Vermont. The New York State Insurance Department notes that adjusted community rating is still being used in the individual, small group and direct pay insurance market, but the department is considering moving from community rating to experience rating. Experience rating uses historical data to set rates based on the amount of claims made during a given time, the information is then used to predict the potential for claims in the future.

The more common rating system is "rating bands," where an insurer sets a base rate or the lowest rate that can be charged for a group with the same case characteristics. Case characteristics generally include age, gender, industry type, geographic area, family composition and group size. Then the insurer "rates up" for the group's health status. For example, if the only case characteristics are age and gender in addition to the state's limit on variation in rates (between the highest and lowest premiums allowed), the small employer that has an aging workforce with health problems and is mostly comprised of women (women are charged higher insurance premiums than men) might be charged $1,200 per person per month. At the same time, a small business in the same industry that has younger folks, a more balanced number of men and women and better best health status could only pay $200 per person per month for the same coverage.

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