December 1, 2016


Key materials

Insurance, broadly speaking, is the financial mechanism by which individuals pool risk in order to protect themselves against the costs associated with uncertainties. A well-functioning insurance market allows people—at a relatively small cost per person—to live their lives, pursue their goals, and carry out their business with mitigated risk.

For insurance to function properly, certain basic conditions are necessary. For example, for a risk to be insurable, the potential loss cannot be infinitely large, immeasurable, or certain to happen, and the question of whether the loss occurred cannot be indefinable. In a market-oriented society, health insurance would be like other insurance. Individuals would purchase coverage for some portion of their medical, surgical, or pharmaceutical expenses, and the price of the coverage would reflect the risk.

Unfortunately, as governments continue to expand their role in regulating health insurance, health insurance operates less and less as true insurance. For example, in contrast to casualty insurance suppliers, health insurance companies are not fully free to design their products to meet the demands of their customers. The prices the companies set typically do not reflect the actual expected costs associated with any given buyer, based on that buyer’s actual risks and characteristics. Furthermore, pricing on a health insurance product from one year to the next often requires the approval of a state board. Consequently, as many commentators have pointed out, health insurance bears much greater resemblance to a prepaid healthcare plan than to an actual insurance product.

While federal regulation of private health insurance markets has been the main focus of policy debates in the past few years, state regulation remains influential. The HOAP index’s Insurance Subindex evaluates state laws and regulations in five areas: (1) mandated health insurance benefits, (2) mandatory rate review, (3) age rating, (4) tobacco rating, and (5) geographic rating. 

The first indicator scores the states according to how many benefits state law requires to be included in health insurance policies sold in the state. (These are requirements over and above federally mandated health benefits, which are required in all states.) Some researchers have estimated that mandated benefits can increase the cost of basic health insurance by an amount between 20 percent and as much as 50 percent of what it would have been otherwise. Others have noted that the cost increase is likely smaller because many people receive coverage through their employers, and employers likely would have elected to include most mandated benefits anyway. But these researchers still find that mandated benefits have a negative effect on openness, access, and consumer choice.

The second indicator evaluates whether states allow health insurance companies to set their own prices as they see fit without external review or approval. In an open market, insurers would be able to set their prices at a level they believe is efficient, just as other producers do. However, some states have laws that empower state insurance departments to review and reject price increases. Some researchers have found that required approval of rates is not necessarily correlated with fewer rate increases, which challenges the assumption that the practice protects consumers. In this indicator, states that do not have mandatory rate review score the highest, followed by states that require review in either the individual or the small group market but not both. States that score the lowest require review in both the individual and small group markets.

The third, fourth, and fifth indicators pertain to various types of community rating. According to federal law, despite the importance of accurate risk assessment, insurers may not sell coverage to people at different prices based on their actual health-related behaviors and other relevant characteristics. Under statute, insurers are only allowed to take into consideration a limited number of factors when pricing coverage for an individual. These include the person’s age, whether the person smokes, and where the person lives. Premiums may be higher for certain individuals only by certain ratios, such as 3 to 1 for older adults compared to younger adults. States that impose no more restrictions than the applicable federal law does are leaving their insurers as free as they can in this regard, so they score the highest in these areas. Some states, however, go beyond the federally defined ratios and impose narrower ranges that, in effect, intensify the community rating effect. These states score lower. States that prohibit insurers from using these variables altogether score the lowest.