Are you experienced?

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.

16 replies
  1. 1
    Linda Featheringill says:

    . . or have you ever been experienced?

    [couldn’t resist]

  2. 2

    At the same time, they can also identify the groups full of twenty-four year old marathoners with “perfect” claims history and IUDs.

    Oh, my. Can they tell how much money I have in my pocket right now? My sources say ‘yes.’

    Thank you for this post, and all the others. Your writings have really helped take a lot of the mystery out of something that affects us all.

  3. 3
    Soonergrunt says:

    Once again, thanks, Richard. Every single post of yours has made me smarter.

  4. 4
    I'mNotSureWhoIWantToBeYet says:

    Hi Richard,

    I enjoy your posts on this topic – they’re always informative.

    However, a minor nit…

    At the same time, they can also identify the groups full of twenty-four year old marathoners with “perfect” claims history and IUDs.

    There is almost always an initalism in your articles that makes me stop and scratch my head. For a while I didn’t know what you meant by a “PCP” – until I looked it up.

    Please define your initialisms/acronyms when you first introduce them. Do you mean IUD = intrauterine device here? I guess that fits (to contrast with the previous case of the family with kids), but many/most marathoners have too little body fat to get pregnant anyway, I think. Or do you mean something else? Google isn’t much help without more information.

    Thanks again.


  5. 5
    Richard Mayhew says:

    @I’mNotSureWhoIWantToBeYet: Yes, I mean IUDs as long term and reliable birth control — and the phrase was to illustrate the group with no big claims and a very low probability of pregnancy claims in the next year.

  6. 6
    Richard Mayhew says:

    @Soonergrunt: I’ll fix that shortly :)

  7. 7
    Bobby Thomson says:

    @I’mNotSureWhoIWantToBeYet: Marathoners get pregnant all the time. Maybe not the elite runners who stop having periods, but we’re talking about generalities here.

  8. 8
    Wag says:

    @Bobby Thomson:

    … and elite athletes are actually really expensive, give their proclivity to injuries, and the subsequent trips to the OR (Operating Room), and PT (Physical Therapy) after.

  9. 9

    This just happened: Tennessee’s Republican governor tried to lure Sears corporate HQ to Tennessee by actually giving them an iconic state-owned office tower in downtown Nashville — for free! Like it’s something he owns, not that is owned by the PEOPLE of the state.

    Even the president of the local Tea Party group is outraged.

  10. 10
    rikyrah says:

    Thank you for these. Like others, these should be archived and put in a permanent link in the sidebar.

  11. 11
    JoyfulA says:

    The Blues in Pennsylvania, at least for decades, used strict community rating. Their weeding-out factor was that preexisting conditions were not covered for one year. I’ve had freelance friends move here for the health insurance.

  12. 12
    JoyfulA says:

    @Southern Beale: Really dumber than it looks because Sears has been run into the ground by its nutzo libertarian owner who has set up the company in silos for every line of merchandise, producing enormous management overhead and no cooperation among “competitive” adjoining department store departments. Add to that, chains like Sears and Penneys that traditionally served the working class have run out of customers who can afford to buy anything beyond food, and Sears would be out of business about the time it moved into its new headquarters.

  13. 13
    Duane says:

    So would the underwriting be the reason when I was looking into providing insurance for our small business group of 5 employees, it was much more expensive to go the group route than have all 5 go to the individual exchange? This is before you factor in the subsidies that most of the individuals would receive but not figuring what the employer tax credit would be.

  14. 14
    Chuck says:

    Upwind/downwind of the lead smelter health risk is reversed. Upwind will be healthier.

  15. 15
    Chuck says:

    Upwind/downwind of the lead smelter health risk is reversed. Upwind will be healthier.

  16. 16
    Chuck says:

    Oops, my misread.

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