Are there federal rules for setting insurance premiums?

The Affordable Care Act (ACA) creates new federal rules that limit how much insurance companies can impose in premiums on individuals and small businesses based on factors such as health status, age, tobacco use and gender. These rules go into effect starting January 1, 2014, and will preempt most existing state laws on premiums.

How do insurance companies set their premiums now?

Many health insurers set the premiums based on the health conditions and risk status of the people they cover. Insurers consider things like how old people are, what kind of jobs they have, their gender, and whether they have been sick before. This assessment helps insurers predict how much money they will spend for those people in the year ahead. Insurers use a variety of methods to set their premiums so they do not lose money on people who are sick or disabled and need a lot of care. Sometimes these methods, called rating practices, can encourage healthier people to buy coverage while discouraging sicker people from doing so by making premiums too expensive for them. Insurer rating practices are currently regulated state-by-state, but various options insurers use include:

• Health status rating. Some insurers charge higher premiums to people who have medical conditions that might increase the chances that they will need health care. This is known as health status rating. For example, an insurer might charge a person who has allergies more for insurance than a person who does not. Health status rating is usually used the first time a person joins a health plan, most commonly for individual and small-group market plans.
• Demographic rating. Some insurers charge higher premiums to people based on their age, gender, or where they live. Typically, insurers charge more for older individuals than for younger ones, known as age rating. Insurers also charge higher premiums to women of child-bearing age because they tend to use more health care services than men, known as gender rating. Insurers also charge more for people who live in areas where medical costs are high, called geographic rating. These kinds of rating practices are used when a policy is first issued and when it is renewed.
• Industry rating. Some insurers charge higher premiums to people who work in industries and professions that tend to have higher health care costs. For example, premiums can be higher for loggers, miners, construction workers, crop dusters, bartenders, taxi drivers, parking lot attendants, hairdressers, and hospital workers. Industry rating is applied mostly in the group market, although individual plan premiums can also vary based on occupation.
• Experience rating. Most insurers charge higher or lower premiums to groups based on their history of insurance claims. Experience rating is common in the large group market and affects a group's premium at renewal, after the insurer analyzes claims actually filed by members of that group in the previous year. Experience rating is also common in the individual market.
• Tier rating. Some insurers in the individual and small group markets charge separate premium levels (or tiers) for people with the same policy based on their health, their use of health care services, and other factors. People can be moved from one tier to another based on these factors each time their policy comes up for renewal. Tier rating is also called re-underwriting.
• Durational rating. A few, very aggressive insurers in the individual and small group markets raise premiums for people who have been in a plan for a year or longer. This is typically due to the expiration of pre-existing condition exclusion periods or the effect of initial medical underwriting wearing off. In other words, the careful screening that people went through to buy the health coverage was a reliable predictor of their health care costs in the first year, but a less reliable indicator of what costs may be in future years. Therefore, insurers may raise premiums to adjust for health changes in the time since the group or individual signed on to the policy.

Each insurance company has its own way of applying rating techniques, and each state has different laws to regulate these practices. Beginning in 2014, the ACA will prohibit a number of these techniques.

Are there any limits placed on insurers' rating practices?

Currently, some states limit insurers' rating practices in the following ways:

• Renewal rate protections. Some states have laws limiting insurers' ability to raise premiums at the time of a plan renewal by placing a cap on annual increases. Usually, these laws limit increases to 10-15 percent above the insurer's "best new business rate" (i.e., the rate they offer to the lowest risk customers and those whose business they are pursuing).
• Rating bands. States have laws limiting insurers' ability to base premiums on health status. The state laws establish a range or "band" of rates that insurers can charge based on an average of the lowest and highest rate than an insurer charges, also known as the index rate. For example, if an insurer sets the index rate for its HMO plan at $100 per person per month and the rating band is 20 percent, then no one can be charged more than $120 or less than $80 for that plan based on health status. In many states with rate bands, however, premiums can also be adjusted above or below the bands due to demographic factors, such as age or gender.
• Community rating. A few states have laws requiring insurers to charge the same premium to everyone on the same plan. No adjustments are allowed.
• Adjusted or modified community rating. Under adjusted or modified community rating, each insurer sets a single rate for all people in a plan; some adjustments are allowed for demographic characteristics, but not for experience or health status.

In states that do not regulate rating practices, studies have found that sicker, older enrollees pay as much as nine times more for the same policy.

What are new federal requirements for insurers to set premiums?

Currently, federal law does not place any limits on the ways that insurers set their premium rates. However, beginning January 1, 2014, insurance companies must meet minimum premium rating rules for health plans for individuals and small businesses. Health plans will be allowed to adjust premiums based only on the following factors:

• Individual vs. family enrollment (i.e., individual + spouse, individual + dependent(s), etc.)
• Geographic area
• Age (but cannot vary by more than three times among adults)
• Tobacco use (the rate cannot vary by more than 1.5 to 1)

Other factors that insurers traditionally use to charge higher premiums, such as health status, use of health services and gender, will no longer be allowed under the ACA. The rating rules in the ACA set a floor, so states can retain or enact a tougher standard than federal law.