The Relatively Small Size of the Private Health Insurance Marketplace

There are 328 million people in the United States. Of these, 27% (87 million) have insurance provided by a private health insurance company as defined here. This is a significant number, but not an exceptionally large market share. As of 2018, 44% of the population (around 146 million people) are provided health insurance through programs run by federal or state governments. According to Centers for Medicare and Medicaid Services (CMS) data, as of 2018, 59.1 million people were enrolled in Medicare (federal health insurance for the elderly or disabled);⁹ and 80 million people were enrolled in Medicaid (combined federal and state health insurance for low income people) and CHIP (a federal program for children of families with low income).¹⁰ Additionally, 9.4 million people receive coverage through Tricare (federal health insurance for active duty military and their families)¹¹ and more than 9 million people are cared for by the Veteran's Administration (VA) (federal health insurance for military veterans).¹² The coverage numbers above are then reduced by the people who are enrolled in both Medicare and Medicaid (known as dual coverage), which totaled 11.7 million people in 2016¹³ thus totaling 146. Additionally, as of 2016, around 28 million people had no health insurance, meaning they were not currently enrolled in any program.¹⁴

Almost half of the country receives health insurance through a family member's or their own employer (49%,¹⁵ 161 million people as of 2018) but, due to efficiency concerns and federal law incentives, a large number of employer insurance plans are “self-insured,” meaning that the company is responsible for paying all healthcare costs rather than purchasing group coverage from an existing insurance company.^{Reference Korobkin16} Overall, 60% of all employees (96.6 million people) with employer-sponsored coverage are in self-insured plans, the majority of them in large companies.¹⁷ While these self-insured companies often hire health insurance providers to manage the benefits offered, the health insurance companies are not insuring the beneficiaries.

Widespread Use of Stop Loss Insurance and Reinsurance

Private insurers carry relatively little risk of having to pay for expensive medical care due to their widespread use of stop loss insurance. This can be provided by governments, as in the example from Wisconsin given above, purchased from reinsurance or stop loss companies, or provided through complex financial transactions with sophisticated investors. The idea that health insurers are not actually insuring is counterintuitive, but in fact they often function as middlemen, bundling and selling risk.¹⁸

For purposes of this discussion, it is helpful to think of a typical health insurance policy as allocating risk of loss. The funds insurers use to pay health-care expenses come from premiums that are put into a pool. Purchasers of insurance are the beneficiaries of this pool. Beneficiaries who require care also have additional expenses in addition to their premiums. A policy generally has a deductible (the amount the beneficiary must pay before the insurance company pays anything). There is often a co-payment (a small amount paid for every doctor or hospital visit) and co-insurance (the set percentage of costs that the beneficiary will pay after paying the deductible), as well. Finally, most insurance policies have a cap on beneficiary payments, past which the insurance company covers the full cost of care for the rest of the calendar year. A typical plan might have a $1000 deductible for an individual, a $20 co-payment, 20% co-insurance, and a cap of $12,000.¹⁹ There might also be separate deductions and co-payments for pharmaceuticals.

Looking at the arrangement described above, the risk of loss in the plan is transparently broken into a few tranches (or segments). The beneficiary has the risk of loss for the first $1000 of care they might need in any given year. They are, in effect, self-insured for this. Once they exceed $1000, they share the risk with the insurance company, 20/80, until they have spent $12,000 and then bear no risk of loss for medical costs until the next year. Their total self-insurance liability is $12,000. With no reinsurance, an insurance company would then bear the risk of loss for any expenses that exceed the amount paid for by the beneficiary. That loss, in turn, would be paid from the pool of all beneficiaries' premiums.

Given that health insurance companies divide risk into the tranches described above in most insurance contracts, it is not surprising that they also purchase reinsurance for specific levels of claims or costs from numerous companies. Simply put, the money to purchase the reinsurance comes from the pool of premiums and is used to insure the pool. This behavior is commonplace in the insurance marketplace and not nefarious. However, it highlights how health insurance companies often do not actually function as traditional insurers in that they generally do not bear the risk for larger and/or catastrophic costs, instead purchasing coverage from other entities.

The use of reinsurance and stop loss coverage for both private insurers and self-insured employers highlights the risk exposure benefits of large health insurance pools and its corollary, the increased exposure of smaller ones. It is extremely difficult to devise an insurance product that can cover a small population for a small chance of an extremely expensive event. It is possible, even likely, that the expensive event will never occur, but if it does, the cost is beyond what a small group can reasonably collect by pooling their resources. In a bigger pool, it is far more likely the event will happen, but the cost is spread out.

An example would be if a small community decided to create its own fire insurance pool. Accounting for the chance of the occasional fire would be fairly easy. A fire that spread across an entire neighborhood would be catastrophic, rare, and most likely drain the insurance resources. Multiple neighborhood fires would be even more rare and more financially unbearable. If the pool contained thousands of diverse small communities, however, the larger pool could flatten that spike of risk exposure. Having multiple communities in the pool increases the likelihood of a spreading fire, but the risk would be spread across many more people.

The same logic that applies to the fire insurance example above applies to health insurance, but with healthcare many more potentially catastrophic events have to be considered, making it more complex to predict for a small group.^{Reference Karlamangla20} Premature births, motorcycle accidents with brain injuries, and multiple organ transplants happen, but rarely. The larger and more diverse the pool, the easier it is to flatten all risk spikes across all participants because a small chance of something happening becomes a known cost if the population is big enough and those costs can be accounted for.

For both self-insured employers and private insurers, these spikes are managed by purchasing reinsurance from large reinsurance companies. There are two main types of reinsurance, ones that protect an insurer from excessive claims overall (generally referred to as reinsurance), and ones that function, like the Wisconsin waiver, to cover expensive claims (known as stop loss insurance for self-insured plans and as excess medical reinsurance for health insurers). Little data exists regarding the dollar amount of individual claims for which insurers or self-insured plans purchase rein-surance. However, it is possible to deduce common levels by examining laws seeking to limit exceptionally low stop loss coverage (also known as the “attachment point”). Maryland, for example, recently temporarily raised its limit from $10,000 to $22,500.²¹ In 2002, the National Association of Insurance Commissioners proposed a model law that prohibited the sale of stop loss insurance with an attachment point below $20,000.²² In addition, 60% of reinsurance of this type sold in the United States has an attachment point “less than” $150,000 per covered individual.^{Reference Khoja and Milliman23}

Revisiting the typical insurance contract described above, the beneficiary has the first $1000 of risk, and then has some share of risk up to $12,000. Using the co-payments outlined above, a patient would have $56,000 of medical bills by the time they reached their maximum out of pocket costs. The insurance company would have $44,000 of liability. It is plausible, given the availability of stop loss insurance products with low attachment points, that the beneficiary could be bearing a share of the risk while a different company bears the rest.²⁴

It is unclear how commonplace these contracts are with private insurers, as there is no reporting requirement and the companies, themselves, rarely acknowledge this system apart from within filings required from publicly traded, for profit companies. The products, however, are widely available and the reinsurance marketplace reports consistent growth in healthcare.

Federal and State Subsidies in the Individual Marketplace

The individual health insurance marketplace is a relatively public and transparent area where one can clearly observe the limitations of the private insurance companies. Close to 12 million people purchase their insurance on a health insurance exchange²⁵ created by the Patient Protection and Affordable Care Act (ACA).²⁶ The ACA also created a series of temporary risk management programs to help smooth spikes of cost in small, new, and/or untested pools as the individual insurance market expanded. These programs, known as the Three Rs, included risk adjustment (shifting money from insurers who had less risky populations to those with riskier populations), reinsurance (collecting money from all health insurers and using that finite pool of funds to offset relatively expensive claims histories), and risk corridors (a method of redistributing outsized insurance company profits to companies with higher costs).²⁷ The Three Rs, in a limited manner, combined the pools of all insurers in an area, using the combined funds to offset spikes that any one individual insurer had in its smaller pool and did so to encourage insurers to enter these marketplaces.

As the Three Rs wind down, the 1332 waivers such as Wisconsin's are now appearing, offering direct federal subsidization through stop loss coverage under the theory that this will reduce the cost of insurance overall, rendering the subsidies budget neutral. It should be noted that the Congressional Budget Office (CBO) does not necessarily agree with HHS and Wisconsin projections regarding the cost of this type of program, as it predicted a similar nationwide stop loss program would cost the federal government $6.8 billion each year.²⁸

Wisconsin's waiver is important because it shows that a national taxpayer-based funding mechanism is uniquely situated to spread risk across the broadest possible population and that this is likely to reduce insurance costs. The waiver also shows that private insurers are not functioning well in the insurance marketplace, given that such a subsidy is required.

Looking at the insurance contract example again, with Wisconsin's waiver, the beneficiary would stop paying co-insurance when their care reached a cost of $56,000. The federal government would begin paying for their care when it reached $50,000. Assuming a prudent insurance company that has purchased reinsurance for claims that exceed $250,000 (the end of the federal subsidy), the insurance company would have a maximum risk of loss of $38,000 for that beneficiary.