How do insurance companies make money?

How do insurance companies make money
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A common question among consumers is how health insurance companies can be profitable when prices keep going up? The two major income streams of health insurance companies are as follows:

  1. Underwriting Income
  2. Investment Income

Related Articles:

Underwriting Income:

According to law, health insurance companies must spend 80 – 85% of premium income on claims and 20-15% on administrative costs. Nearly all people with insurance pay a monthly premium.

A health insurer gathers the premiums it collects from thousands of customers into a pool. Then uses money from this pool when one customer needs coverage for medical care in the form of a claim.

In case, If an insurance company needs more funds to pay for their business’s overhead expenses like marketing campaigns or administering dental plans as per new governmental requirements. This additional requirement has been bolstered since President Obama signed Obamacare (the Patient Protection and Affordable Care Act).

Health Insurance Companies Make Money Through Underwriting

Investment Income:

Some insurance companies invest the extra money that isn’t used on medical services or administrative costs. Investing this earned income contributes to their profits.

Health Insurance Income Through Investment

What does underwriting involve?

Although the Affordable Care Act has prohibited insurers from turning potential customers down, health insurance companies still invest time into learning about an individual’s medical history and predicting costs.

In addition to monitoring guidelines like:

  • Eligibility
  • In-network care vs. out-of-network care
  • Medical necessity
  • And authorization 

Some health insurance providers also assess risk factors such as age and pre-existing conditions when determining premiums for individual coverage plans.

Insurance companies take in money from consumers to fund their businesses.

Insurance companies make money in two ways. They make money when they charge people more than it costs them to provide the required health care benefits . They also earn interest on what is left over after insurance claims are paid out of the pool.

Do insurance companies earn benefits from the Affordable Care Act?

Obamacare placed several limitations on insurance companies, but the Affordable Care Act also tried to create a buffer to protect insurers in an unpredictable marketplace.

Here are some examples for better understanding:

1. Medical Loss Ratio

Affordable Care Act (a United States federal statute also called Obamacare) requires that individual and small group plans spend 80% of premium dollars on claims.

They can allocate the remaining 20% to administrative expenses and the company’s bottom line. According to law, large group plans must allocate at least 85% for claims with 15% left for administrative expense and company profits.

2. Limited Restrictions on Coverage

Under the Obama administration’s Affordable Care Act, health insurance companies must cover any pending pre-existing conditions. As a result, they can’t opt against insuring someone because of their condition history.

3. Out-of-Pocket Maximum

Obamacare or the Affordable Care Act changed healthcare coverage for citizens, allowing them access to a larger range of treatments without paying out-of-pocket costs.

4. Risk Corridor Program (2014 – 2016)

The Affordable Care Act, or Obamacare as it is sometimes called, was a good idea in theory. In order to assure continued coverage for those who need it the most, and as an effort to keep costs down, this legislation included a three-year risk corridor program.

According to this risk-corridor program, insurance companies would give money to the program if they paid less out on claims than what they had targeted. The program will then pay that money to those insurance companies that exceed their target. While that sounds like an excellent strategy at first glance, there were two big problems with this plan:

  1. Being how difficult it became for insurers to estimate their risks when changes constantly happened in the marketplace
  2. And another being that all those payments could only take place after Congress gave up its power of the purse strings, which allowed Republicans to cut off funding

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

According to a few experts, insurance companies have been struggling under the financial burden of participating in Obamacare or the Affordable Care Act. These organizations identified two factors that have compounded their losses:

1.The Consumer Behavior of Healthy People

Insurance pools consist of a variety of people with different health problems and needs. This imbalance leads to high-risk patients needing care from insurance companies. It means higher premiums are eventually passed on to consumers.

When healthy people see the insurance premiums increase because some sicker and more unusual patients are joining their pool, they realize it doesn’t make sense to pay for a service they don’t need.

2.Choices Made by States

States were given two choices:

  • Expand Medicaid to cover more people
  • Offer a state-based exchange or a federally-facilitated exchange

Before Obamacare, Medicaid only covered children, pregnant women, the elderly, and the disabled. Under Obamacare’s Affordable Care Act Medicaid Expansion, more people could be eligible for Medicaid. Still, insurers would not bear the extra costs.

Through exchange models, individual states establish their own costs and standards for coverage. Federally-facilitated exchanges use standard information and provisions based on this baseline of minimum requirements.

Official Links:

 Affordable Care ActAffordable Care Act
 Medicaid.govMedicaid.gov
 Pre- Existing ConditionsPre-Existing Conditions
 Young Adult Coverage Young Adult Coverage 

Insurance Explained – How Do Insurance Companies Work


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