Health Insurance: A Primer
Updated February 3, 2005
Bernadette Fernandez
Analyst in Social Legislation
Domestic Social Policy Division
Health Insurance: A Primer
Summary
People buy insurance to protect themselves against possible financial loss in the future. Such losses may be due to a motor vehicle collision, natural disaster, or other circumstance. For patients, financial losses may result from the use of medical services. Health insurance then provides protection against the possibility of financial loss due to health care use. In addition, since people do not know ahead of time exactly what their health care expenses will be, paying for health insurance on a regular basis helps smooth out their spending.
While health insurance continues to be mainly a private enterprise in this country, government plays an increasingly significant role. Especially during the latter half of the 20th
century, the government both initiated and responded to dynamics in medicine, the economy, and the workplace through legislation and public policies. For example, the Internal Revenue Service clarified that employer contributions to employee health benefits are exempt from taxation, which encouraged the growth of employment-based health coverage. Given the frequentintroduction of legislation aimed at modifying or building on the current health insurance system, understanding the potential impact of such proposals requires a working knowledge of how health insurance is designed, provided, purchased, and regulated. This report, which will be updated, provides basic information about those topics.
Persons and families without health coverage are more likely than those with coverage to forgo needed health care, which often leads to worse health out come sand the need for expensive medical treatment. Since uninsured persons are more likely to be poor than insured persons, the uninsured are less able to afford the health care they need. Un insurance can lead to health care access problems for communities, such as overcrowding in emergency rooms. Furthermore, individual states and the nation as a whole are affected through increased taxes and health care prices to cover uncompensated care expenses.
Americans obtain health insurance in different settings and through a variety of methods. People may get health coverage through the private sector, or from apublicly funded program. Consumers may purchase health insurance on their own,as part of an employee group, or through a trade or professional association. A small minority of employees get health insurance at no up-front cost because their employer pays the total insurance premium. However, 45 million Americans did not have health coverage for the entire year of 2003.
Health insurance benefits are delivered and financed under different systems.The factors that distinguish one delivery system from another are many, in cludinghow health care is financed, how much access to providers and services is controlled,and how much authority the enrollee has to design her/his health plan. To illustrate,managed care is characterized by predetermined restrictions on accessing services,whereas individual decision-making regarding use of health benefits is a hallmark of consumer-driven health care. And as economic conditions change, a specificdelivery system may gain or lose the interest of affected parties.
List of Tables
Table 1. Health Insurance Coverage by Type of Insurance, 2003...........10
.
Health Insurance: A Primer
Introduction
Health insurance coverage dominates many state and federal health care discussions. As health coverage evolved from an uncommon benefit to a routine one,government’s role in subsidizing and regulating that coverage also changed for workers, employers, and insurers. Although health insurance continues to be mainlya private enterprise in this country, public entities play an increasingly significant role.
Government’s involvement in health coverage expanded dramatically in the
latter half of the 20th century. Public policies and legislation initiated or responded to dynamics in medicine, employment, and other areas.
!
A long-standing rule issued by the Internal Revenue Service (IRS)
stated that an employer’s contributions to employment-based health
insurance could not be included in an employee’s gross income for
tax purposes (Internal Revenue Code, Section 106). This ruling
helped spur the growth of employer-sponsored health benefits. The
IRS also stated separately that employers could deduct such
contributions as part of business expenses.
! Advances in medicine led to escalating consumer demand for newer,
better treatments. At the same time the cost of health care increased,
which was especially problematic for certain groups of care
consumers who lacked health coverage. This led to government
efforts to assist consumers in paying for health care through social
insurance programs.
More and more employees began to work for more than one
employer over their lifetimes. Government was called on to address
a problem many workers faced: keeping health coverage as they
moved from job to job.
Given the frequent introduction of legislation aimed at modifying or building
on the current health insurance system, understanding the potential impact of such proposals requires a working knowledge of how health insurance is designed,
provided, purchased, and regulated. This report provides basic information about
those topics.
CRS-2
.
What Is Health Insurance?
Basic Definitions and Principles
People buy insurance to protect themselves against possible financial loss in the future. Such losses may be due to a motor vehicle collision, natural disaster, or other circumstance. For patients, financial losses may result from the use of medical services. Health insurance then provides protection against the possibility of financial loss due to health care use. In addition, since people do not know ahead of time exactly what their health care expenses will be, paying for health insurance on a regular basis helps smooth out their spending.
The concept underlying insurance is “risk;” i.e., the likelihood and magnitude of financial loss. In any type of insurance arrangement, all parties seek to minimize their own risk. In health insurance, consumers and insurers approach the management of insurance risk differently. From the consumer’s point of view, a person (or family) buys health insurance for protection against financial losses resulting from the future use of medical care. From the insurer’s point of view, it employs a variety of methods to minimize the risk it takes on when providing health coverage to consumers, so as to assure that it operates a profitable business. One method is to cover only those expenses arising from a pre-defined set of services(generally called “covered” services). Another method for limiting risk is to encourage healthier people to obtain health coverage, presumably because health ier people would not need as many medical services as sicker people.
While the methods employed by an insurer differ from those of a consumer,each person or entity has the same goal: to minimize risk in an uncertain future. It is this uncertainty of the future and risk of loss which form the context for insurance,and the strategies to make financial loss more predictable and manageable which drive insurance arrangements.
Uneven Distribution of Health Care Expenses.In health care, a
minority of consumers are responsible for a majority of expenses. According to a study that looked at the distribution of health care spending, 5% of the population accounted for over half of all health expenditures, and 10% of the population accounted for around two-thirds of those expenditures.Such findings were consistent for selected years spanning three decades. Given the unevenness of health care spending and the impossibility of identifying all of the highest spenders before they use medical services, insurers employ various strategies in order to minimize the risk they take on.
CRS-3
Risk Pool and Rate Setting.The main objective of insurance is to spread
risk across a group of people. This objective is achieved in health insurance when
people contribute to a common pool (“risk pool”) an amount at least equal to the
average expected cost resulting from use of covered services by the group as a whole.
In this way, the actual costs of health services used by a few people are spread over
the entire group. This is the reason why insuring larger groups is considered less
risky — the more persons participating in a risk pool, the less likely that the serious
medical experiences of one or a few persons will result in catastrophic financial loss
for the entire pool.
An insurer calculates and charges a rate (i.e., a “premium”) in order to finance
the health coverage it provides. The premium generally reflects several factors,
including the expected cost of claims for using services in a year, administrative
expenses associated with running the plan, and a risk or “profit” charge. The
premium also will vary depending on if it buys self-only coverage or family coverage
(see later discussion). If the insurer accurately estimates future costs and sets
appropriate premium levels, then claims for that risk pool should be reasonably
predictable over time. In other words, the premiums paid by healthy persons in the
risk pool help subsidize the costs of less healthy persons.
Risk Pool Composition and Adverse Selection.As noted above, one
of the ways insurers attempt to make future costs more predictable is by spreading
the risk of high costs for a few people across many people. But the number of people
is not the only significant factor. Equally as important, if not more so, is the
composition of the group
.A consumer’s decision to obtain health coverage is based on a variety of factors,
such as health status, estimated need for future medical care, and disposable
income.Consumers with different health conditions, as well as varying degrees of comfort towards risk-taking, will differ on whether they consider health insurance necessary.
This is a circumstance that insurers will consider when estimating the cost to cover
future health care use. With this in mind, insurers generally will vary the premiums
they charge and the health services they cover (subject to state and federal statues)
in order to attract various segments of the population. This flexibility in rate setting
and benefit determination is particularly important in a competitive insurance market
where insurers try to provide the most attractive rates to increase their market share.However, some risk pools do attract a disproportionate share of unhealthy
individuals. In part, this is because people generally know more about their own
health conditions than any other person or entity, such as an insurer. Health care
consumers typically are the best informed about when they will need medical care
and what kind of services they will need. The “information asymmetry” between
what consumers know compared to what insurers know gives consumers an
advantage when looking for health coverage that will meet their future demand for
health care. This asymmetry is another source of uncertainty which insurers take
into account when developing and pricing insurance products (or health plans)
CRS-4
.
When a disproportionate share of unhealthy people make up a risk pool, a
phenomenon known as “adverse selection,” the average cost for each person in the
pool rises. The higher costs may encourage the departure of healthier members from
the group, and discourage the entrance of other healthy people, since healthier people
may be able to find cheaper coverage elsewhere, or decide that coverage is too costly
and become uninsured. In either situation, it leaves an even less healthy group of
people in the risk pool, which again causes the average cost to rise for the remaining participants. If there is no change in this dynamic, the group may experience a “death
spiral” as it suffers substantial adverse selection leading to an increasingly expensive
risk pool and possibly dissolution of the pool altogether. Therefore, despite the
consumer’s information advantage, it does not guarantee access to affordable and
adequate health coverage.
Group Market, Non group Market, and Medical Underwriting.Health
insurance can be provided to groups of people that are drawn together by an employer
or other organization, such as a professional association or trade union. Such groups
are generally formed for some purpose other than obtaining insurance, like
employment. When insurance is provided to a group, it is referred to as “group
coverage” or “group insurance.” In the group insurance market, the entity that
purchases health insurance on behalf of a risk pool is referred to as the “sponsor
.”Consumers who are not associated with a group can obtain health coverage by
purchasing it directly from an insurer in the individual (or nongroup) insurance
market. Insurance carriers in the nongroup market conduct an exhaustive analysis
of
each
applicant’s insurability. An applicant usually must provide the insurer with
an extensive medical history and often undergo a physical exam. This information is
used by carriers to assess the potential medical claims for each person by
comparing characteristics of the applicant to the loss experience of others with
similar characteristics. Once such an evaluation has been conducted, the carrier
decides whether or not to provide health coverage and determines the conditions for
coverage. This evaluation and determination process is called “underwriting.
”Medical underwriting is standard practice in the individual insurance market,
though a carrier’s ability to reject applicants or vary the terms of coverage are
restricted to some degree by federal and state requirements. In the group insurance
market, insurers forgo underwriting in the traditional sense; i.e., reviewing each
person’s demographics and medical history. Instead, an insurer looks at the
characteristics of the collective group — such as its claims history, demographics
(e.g., industry of firm and age distribution of enrollees), and geographic location —
to conduct the insurance risk and loss analysis. The insurer then charges a premium
based on the analysis of the group’s characteristics. There are exceptions to this for
very small groups. For example, when a firm with only a handful of employeesapplies
for health coverage, the insurer may choose to review the health conditions
of each person in order to establish a premium for the entire group. Or, the insurer
CRS-5
Fully Insured vs. Self-Insured Plans. A common distinction made
between types of health insurance products is whether they are fully insured or self-
insured. A fully insured health plan is one in which the sponsor purchases health
coverage from a state-licensed insurer (also referred to as an insurance carrier). The
carrier assumes the risk of providing covered services to the sponsor’s enrolled
members. In contrast, organizations who self-insure (or self-fund) do not purchase
health coverage from state-licensed insurers. Self-insured plans refer to health
coverage that is provided directly by the organization (e.g., employing firm) seeking
coverage for its members (e.g., employees). Such organizations directly take on the
risk for covering medical expenses, and such plans are not subject to state insurance
regulations. Thus, a large employer that self-funds employee health benefits acts as
both sponsor and insurer for that coverage. Firms that self-fund typically contract
with third-party administrators (TPAs) to handle administrative duties such as
member services, premium collection, and utilization review. TPAs do not
underwrite insurance risk.
Self-only vs. Family Coverage.Another common distinction made in
health insurance is whether the policy covers one person or a family. Under self
only coverage, the holder of the insurance policy is the only person insured. (Self-onlycoverage sometimes is referred to as individual coverage. Individual coverage in this
sense should not be confused with health coverage from the individual insurance
market — see discussion below.) Family coverage applies to the policyholder,
her/his spouse, and children.Self-only and family policies may differ from each
other in terms of the services they cover and the cost-sharing they impose.
Administrative Expenses.Costs for administrative functions encompass
a wide range of operational activities. Administrative expenses include costs
associated with contracting with providers, sales and marketing, enrollment and
billing, customer service, utilization review, case management, and other functions.
The estimate of administrative expenses as a percent of claims often is used as a
measure of operational efficiency. For large firms that self-insure, administrative
costs make up 5-11% of claims, compared with 33-37% for insurers of small firms.
In the non group market, administrative expenses are often higher on a per-person
basis compared to the group market.
CRS-6
Tax Preference
Unlike most industrialized countries, the United States does not guarantee health
coverage to all of its citizens. Instead, it relies on a patchwork approach that
combines private and public means for providing and accessing health insurance and
health care. One of the key pieces of this approach encouraged the growth of
employment-based health coverage via the tax code.
Section 106 of the Internal Revenue Code states that employer contributions to
employment-based health insurance are not included in employees’ gross incomes
for tax purposes. This tax preference encourages workers to sign up for (“take-up”)
health coverage within the work setting. A separate ruling by the Internal Revenue
Service clarified that such employer contributions are business expenses and,
therefore, deductible from employers’ taxable income. Both parties benefit:
employers use health insurance coverage as a means to recruit and retain workers,
while employees typically get access to more services at better rates (see discussion
below). However, employees generally receive reduced wages to compensate for
richer fringe benefits.
The tax exclusion of fringe benefits is one of the primary reason why health
coverage is provided mainly through the workplace in this country. Approximately
two out of three nonelderly (under 65) Americans have employment-sponsored
insurance (ESI). Moreover, of nonelderly persons with private health insurance
coverage, approximately nine out of 10 obtain it through the workplace.
Health Insurance Regulation
Regulation occurs at multiple points in the process of providing health coverage.
Health insurance regulation addresses a wide variety of issues: the benefits that must
be offered, the individuals to whom the insurance is made available, and the
responsibilities insurers have to their health plan enrollees are a few of those issues.
The most common distinction (and one of the most contentious areas) in the
regulation of health insurance is whether it is the responsibility of individual states
or the federal government. This distinction is important because federal and state
laws governing health plans differ on issues such as compensation in courts, access
to care, and mandated coverage for certain benefits.
Responsibility of the States.The regulation of insurance traditionally has
been a state responsibility, as clarified by the 1945 McCarran-Ferguson Act.
However, overlapping federal requirements complicate the matter with respect to
health insurance. Individual states have established standards and regulations
overseeing the “business of insurance,” including requirements related to the
finances, management, and business practices of an insurer. For example, all states
have laws that require state-licensed insurance carriers to offer coverage for specified
health care services (known as “mandated benefits”). Because fully insured plans are
subject to state-established requirements, those plans must offer those mandated
benefits. On the other hand, self-insured plans are not subject to state insurance
regulations so they are exempt from such requirements.
CRS-7
Key Federal Statutes. Regardless of whether health plans are fully insured
or self-funded, they all are subject to a number of federal laws (e.g., the Americans
with Disabilities Act). Two of these federal laws, the Employee Retirement Income
Security Act of 1974 (ERISA, P.L. 93-406) and the Health Insurance Portability and
Accountability Act of 1996 (HIPAA, P.L. 104-191), have significant impact on how
health insurance is provided
.ERISA outlines minimum federal standards for private-sector employer-
sponsored benefits. (Public employee benefits and plans sponsored by churches
generally are exempt from ERISA). Passed in response to pension abuses, the Ac
twas developed with a focus on pensions, but the law applies to a long list of “welfare
benefits” including health insurance. The Act requires that funds be handled
prudently and in the best interest of beneficiaries, participants be informed of their
rights, and there be adequate disclosure of a plan’s financial activities. ERISA
preempts state laws for issues that “relate to” employee benefit plans. (In other
words, the federal law overrides state laws affecting private-sector employee
benefits). This portion of ERISA was designed to ensure that plans would be subject
to the same benefit laws across all states, partly in consideration of firms that operate
in multiple states. However, state laws still apply for issues which involve the
“business of insurance.” Given the ambiguity of the phrases “relate to” and “business
of insurance,” the ERISA preemption is an area of heated debate and active
litigation.
The core motivation behind the Health Insurance Portability and Accountability
Act of 1996 (HIPAA) is to address the concern that insured persons have about
losing their coverage if they switch jobs or change health plans (“portability” of
health coverage). The Act’s health insurance provisions established federal
requirements on private and public employer-sponsored health plans and insurers.
It ensures the availability and renew ability of coverage for certain employees and
other persons under specified circumstances. HIPAA limits the amount of time that
coverage for pre-existing medical conditions can be denied, and prohibits
discrimination on the basis of health status-related factors. The Act also includes tax provisions designed to encourage the expansion of health coverage through several mechanisms, such as a demonstration project for tax-advantaged medical savings
accounts and a graduated increase of the portion of premiums self-employed persons
could deduct from their federal income tax calculations. Another set of HIPAA
provisions addresses the electronic transmission of health information and the
privacy of personally identifiable medical information (administrative simplification
and privacy provisions, respectively).
CRS-8
Why Is Health Insurance Considered Important?
While health insurance coverage is not necessary to obtain health care, it is a
vital mechanism for accessing services in an environment of increasingly expensive
health care. As health care costs rise — at times outstripping the rise in wages —
more people need greater assistance with covering medical expenses. Health
insurance provides some measure of protection for consumers, especially those who
have limited means or greater-than-average need for medical care.
Health insurance is considered important also because of the well-documented,
far-reaching consequences of un insurance. For instance, uninsured persons are more
likely to forgo needed health care than people with health coverage. This includes
forgoing services for preventable or chronic conditions which often leads to worse
health outcomes.Uninsured persons also are less likely to have a “usual source of
care;” i.e., a person or place identified as the source to which the patient usually goes
for health services or medical advice (not including emergency rooms). In 2002,
while only one-tenth of all adults with private health insurance identified no usual
source of care, almost half of all uninsured adults had no usual source.Having a
usual source is important because people who establish ongoing relationships with
health care providers or facilities are more likely than persons without a usual source
to access preventive health services and have regular visits with a physician.
Therefore, to the extent that health insurance coverage facilitates access to medical\services, people without coverage face substantial barriers in the pursuit of the health
care they need.
The negative consequences of un insurance extends beyond the persons directly
involved. The Institute of Medicine found that the insurance status of parents affects
the amount of health care their children receive. In places with crowded emergency
rooms, increasing un insurance rates can add to that problem, since uninsured persons
have fewer places from which they can get general health services outside of
emergency departments (EDs), compared to people with health coverage.
Overcrowding in EDs, in turn, leads to longer waits for all patients seeking
emergency care. Moreover, many uninsured persons forgo preventive health care and
end up developing more serious conditions requiring complex, expensive medical
services. Since health coverage is positively related to income, uninsured persons are
less likely to be able to afford this level of care. In cases where patients are unable
to cover the costs associated with receiving health services, the facilities that
provided those services must take it as a financial loss (i.e., uncompensated care).
These losses can be staggering. For example, one study estimated that health care
No comments:
Post a Comment