Where Do Insurance Companies Get Money

With increasing healthcare costs a major concern for many, we take a look at some frequently asked questions about how health insurance companies make money.

There's a lot of confusion among consumers as to why costs are increasing. One key question for some: how do health insurance companies and the people who work with them make money?

We've outlined answers to some commonly asked questions about healthcare costs.

What is the difference between a captive agent that works for an insurance company or an independent agent or broker who works for you?

Depending on the State and/or Insurance Company, Agent/Brokers (individuals or companies that help people choose health insurance) may earn commissions from insurance companies. Sometimes when someone buys an insurance policy from an agent/broker, the insurer who just got a new customer pays the broker a commission. These commissions are built into policies and are equal to a small dollar amount per policy per month. It's unlikely you'll pay an agent/broker a direct fee for their services. However, commission structures vary by insurer, plan, and state. In many states, insurance companies do not pay the agent/broker commission for individual policies.

In addition, definitions and titles vary widely by state. What might be called an independent agent or broker in one State is called a consultant, in another.

How do insurance companies make money?

Insurance companies have two primary sources of revenue: underwriting income and investment income.

Underwriting Income

Anyone with a healthcare policy pays a monthly insurance premium. A health insurance company gathers the premiums it collects from thousands of customers into a pool. When one of those customers needs coverage for medical care, the insurance company uses money from this pool to pay for it in the form of a claim. A health insurer will also use premiums to pay for the costs of doing business. With the passing of the ACA, the law requires insurance companies to spend 80/85% on claims and 20/15% on administrative costs. The law regulates the amount of income based on the premium charged. Other costs that you pay for your health services (such as copayments and coinsurance) are paid to your healthcare provider (doctors and hospitals), NOT to the insurance company.

Underwriting Income = Premiums Collected – Claims Paid – Expenses

Investment Income

Insurance companies take the money that isn't spent on claims or expenses and invests it. The money earned on these investments (stocks, bonds, real estate, etc.) contributes to the company's income.

What is underwriting and what does it involve?

Underwriting is the name given to the act of evaluating the risk of providing coverage and costs of coverage. Prior to the implementation of the Affordable Care Act ("Obamacare"), full medical underwriting included a detailed examination of an individual's medical history. Health insurers put a lot of effort into knowing and trying to predict the cost of claims. That included monitoring guidelines such as eligibility, in-network vs. out-of-network care, medical necessity, and authorization. Underwriting or limiting for pre-existing conditions is not allowed for individual policies due to the ACA.

What money from consumers, specifically, do insurance companies take in as direct profit?

Direct profit from consumers' premiums depends on how much money an insurance company is using. Premiums are collected into a pool. Money then leaves that pool in the form of claims and expenses, whatever is left over is considered profit.

Do insurance companies earn anything or benefit from Obamacare (also known as the Affordable Care Act)?

Obamacare or the Affordable Care Act placed several limitations on insurance companies, but it also tried to set up some buffers so that insurance companies could be protected in a marketplace with less predictability. Examples of both are described below.

Medical Loss Ratio

Obamacare or the Affordable Care Act requires that individual and small group plans spend 80% of premium dollars on claims and efforts to improve the quality of care. The remaining 20% can go to expenses and ultimately to the bottom line For large group plans, Obamacare requires that 85% of premium dollars be spent on claims.

Limited Restrictions on Coverage

Obamacare or the Affordable Care Act limited the restrictions that insurers could place on coverage. As a result, insurance companies can't decline coverage or exclude items in insurance policies because of pre-existing conditions.

Out-of-Pocket Maximum

Obamacare or the Affordable Care Act implemented an out-of-pocket expense maximum, meaning that a customer could only be held responsible for expenses up to a certain dollar amount. After that, all covered benefits are covered by the insurance company.

Risk Corridor Program (2014 – 2016)

In order to help address the uncertainty of a new marketplace, Obamacare or the Affordable Care Act included a three-year risk corridor program. This meant that if one insurance company paid less in claims than what it targeted, it would give money to the program. That money would then be given to an insurance company that had paid more in claims than what it had targeted. While this was a good idea, in theory, it proved very challenging for insurers to estimate their claims and risk in a changing marketplace. It also became harder to pay insurers what they were promised after a new Republican-led Congress voted in 2015 to make the program "budget neutral" (meaning federal funding couldn't be used to safeguard any mismatch of payments in vs. payments out).¹

Why are insurance companies leaving Obamacare or the Affordable Care Act?

A few years ago, some insurance companies argued that financial losses associated with participating in Obamacare or the Affordable Care Act were unsustainable. In addition to the Risk Corridor challenge, companies cited two factors driving losses:

The Consumer Behavior of Healthy People

Insurance pools wound up with an imbalance of healthy, low-cost customers and sicker, high-cost customers. That led insurance companies to charge higher premiums in order to make a profit. In simple terms, healthy people who felt they didn't need insurance, didn't buy it. In order to reduce the risk posed by that imbalance, premiums had to increase. But as premiums rose, even fewer healthy people enrolled in Obamacare, which created even higher premiums and in some cases, led to an insurer's decision to leave the exchanges.

Choices Made by States

States were given two choices:

expand Medicaid to cover more people and/or
offer a state-based exchange or a federally-facilitated exchange.

Medicaid expansion was intended to help lower-income consumers who couldn't afford to buy health insurance but were not eligible for tax credits or subsidies. (Federal funding would initially cover 100 percent of the expenses of new Medicaid patients and would be phased down to 90 percent by 2020 and into the future). Before Obamacare or the ACA, Medicaid only covered children, pregnant women, the elderly, and the disabled. Under Obamacare's Affordable Care Act's Medicaid Expansion, more people could be eligible for Medicaid, but insurers would be shielded from the costs.

Through state-based exchanges, individual states establish their own set of costs, quality standards, and provided-healthcare services. Federally-facilitated exchanges use standard information and requirements regardless of state.

According to data from the Kaiser Family Foundation, those states that set up a state-run exchange and expanded Medicaid fared best when it came to the number of insurers that decided to participate in this year's exchanges.² Among these states, 75 percent had three or more insurance companies continue to participate in exchanges. Those that chose to use the Federal exchange and expanded Medicaid fared worse (with 66 percent of those states with three or more insurers), while those that opted not to expand Medicaid fared the worst (with just 55 percent of such states having three or more health insurance companies participating in exchanges this year).