Understanding the Spectrum of Health Care Funding

Bringing things back to basics again here to spend some time talking about health care funding.  As Tim Sackett mentioned, it is the time of year when many small and mid-size companies are cringing at their health care renewal costs. So I thought that this would be a good time to drop a little knowledge so that you can hold an intelligent conversation with your broker or insurance carrier.

Components of Health Insurance Costs

There are only three simple components that make up the entirety of health insurance costs. Unless you are Kaiser and try to stick that stupid earthquake retrofitting charges into the renewal year after year – seriously – isn’t 20 years of collecting money for that enough? How much retrofitting could you possibly need? But I digress…




A claim is simply a bill for health care services. Since this is the bulk of what health insurance pays for, claims represent about 72% of the total health insurance costs. However, there are other little charges buried within calculations of claim costs.


When predicting future health costs, for as much statistical work that is involved, it is still just a best guess prediction. So the margin is a little bit of extra padding just in case the calculations are off or some sort of unexpected event occurs. The amount of margin varies quite a bit – financially conservative companies tend to build in a 5-6% margin while larger groups tend to build in 2-3%. Always find out what % margin was built into your rates if you can and try to negotiate it down – the longer you have been insured with a carrier as well as the amount of people you cover will allow you to be more successful in negotiating this. For self-insured companies, make sure you take a look at your margins over time so that you aren’t over or under budgeting.

Reserves (IBNR)

This is also called claims lag. Basically, when someone goes to the doctor, that claim has been incurred. However, it might take awhile for the doctor to get around to submitting the claim to the insurance company and then once the insurance company has the claim, it might take them awhile to pay it. Regardless of when it is paid, there needs to be money available to pay that claim. Most of the time there is about a 1-3 month lag on average. There are three different methods of calculating reserves that are actuarialy acceptable. Other than asking about the average claims lag, you’re not going to be able to do anything to negotiate this part.


Trend is a very nebulous percentage and this is often the best place to negotiate. Trend is a factor that is used to project the cost of healthcare for the future period. All sorts of things get thrown into trend calculations: inflation, utilization, cost shifting from Medicare/Medicaid,Technology, and anything else that might possibly impact costs. Trend also often includes margin as well. The strange thing about trend is that it varies year by year, company by company, and plan type by plan type. Sometimes, when I am annoyed at the inability of an insurance carrier to explain trend, I make them explain every .25% of the increase – it helps negotiate the specific parts.


I don’t know what the actual definition of retention is in the health insurance sense but in plain English, this is administrative overhead and profit. (Maybe a PR person thought retention sounded more pleasant?) Retention is roughly 18% of total health insurance. This is also an area where you can negotiate a little bit.

There are a few different components of retention. There are the fixed overhead costs like: sales, implementation, account management, customer services – you know, the things that have to be done! Then there is the variable costs: interest, non-standard reporting, and anything special you want. There are also: network access fees – the charge for actually getting access to the network of doctors, state premium taxes (these are excluded if you are self-insured), commissions, risk charges, and profit.

3. Pooling/Stop Loss

And then there’s Pooling or Stop Loss. I explain this as an insurance policy that you buy that insures your health insurance plan from suffering from catastrophic losses. It’s essentially reinsurance, a concept that I find somewhat bizarre. Typically, for smaller insured health plans, there will be a dollar cut-off at which the claims cost will no longer count. However, in exchange for this, you are paying additional insurance premiums. It helps mitigate risk. The dollar-cut off is set by the insurance company, unless you are large and can purchase your own stop loss insurance. I’ve never had any luck in negotiating this but it’s generally only about 10% of the total health insurance cost. For larger companies, there are some group arrangements for buying stop loss insurance that can be helpful but on the whole, the stop loss market is unregulated and plays by their own rules.


And those, my friends, are the key components of health insurance funding. May they help you negotiate better rates for 2012!

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