Underwriters are the key people in an insurance company. They are the people who look at applicants, apply a system of equations and probability trees and figure out what a reasonably close price for the risk adjusted projected cost of an individual. If the underwriters guess too low, the insurance company won’t collect enough premiums to pay all claims. If they guess too high, customers will leave as they can get better deals elsewhere.
PPACA has introduced a paradigm shift in underwriting health insurance products. The change has primarily occurred on the very large group and individual markets right now. Small and medium sized employer sponsored group health insurance will be underwritten in a different fashion this summer and next fall as the 2013 policies expire and new business is written.
There are three different flavors of underwriting for health insurance. PPACA uses modified community rating. Most small and medium sized groups are currently underwritten by either experience or statistical underwriting that incorporates dozens of variables. Before we look at the implications of the underwriting change, let’s understand what these systems do.
Experience underwriting occurs when an insurance company has been insuring a group for a while and has built out a claims history. The insurance company knows the health conditions of the members in that group. Underwriters can look at claims and make a very good guess at what a person will cost an insurance company over the next year. Underwriters can look at a group and identify the three cancer survivors, or the five heavy smokers with oxygen tanks or the diabetic cluster, or the family with two kids who are on the autism spectrum. At the same time, they can also identify the groups full of twenty-four year old marathoners with “perfect” claims history and interuterine devices (IUDs).
Statistical underwriting is underwriting based on playing twenty questions (actually more like 90 questions.) It is used when the insurance company does not have a deep claims history on a group or a set of individuals. The insurance company finds out about where people live, what their past medical history looks like and what their recent utilization profiles as far as costs. Statistical underwriting leads to people getting rejected because they are sky divers, or female because women tend to use more than similar age and health men plus they have pregnancy risk.
The final major underwriting system is community underwriting. Pure community underwriting gives the same rate to everyone within an area irrespective of current or historical health status. A 22 year old male with no medical issues will pay the same rate as a diabetic cancer surviving 64 year old female.
Obamacare uses modified community underwriting. Insurance companies are allowed to consider three factors in setting rates. The first is age. 64 year old individuals can pay no more than three times the rates of a 21 year old. This is roughly actuarially fair with a minor subsidy up the age ladder. The second factor is smoking status. Smokers can be charged 50% more of the base premium. The final factor is location. Some insurance companies will price adjoining zip codes differently. For instance, a zip code that is traditionally upwind of a lead smelter will probably be cheaper to insure than the zip code downwind. Other companies will price at the city or county level.
Modified community underwriting is the only form of underwriting on the Exchange and qualified individual market right now. It is the only form of underwriting allowed for any new policy with an effective date of service of January 1st or later. Grandfathered plans and otherwise compliant plans that were written before January 1st can continue to have either statistical or experience underwriting.
Most small and medium group health insurance policies will need to be renewed at some point in 2014 and their underwriting will change. The implications of this change will be in another post.