Health insurance arose as a way of shielding people from catastrophic financial loss due to medical expenses and to ensure that people had access to care. By distributing costs equally throughout a community, each member is protected against the financial risks of a serious illness or accident. Critics argue that this principle has been undermined by underwriting, in which insurance companies determine an individual or group's share of costs based on their perceived risk as opposed to that of the larger community.
Community Rating vs. Experience Rating
There are two ways in which insurance companies determine the percent of cost sharing for members of a group health insurance plan. With a community rating, the overall medical expenses of the group are estimated based on the profile of a geographic region and each member pays the same amount. With an experience rating, insurance companies take into consideration the medical history and expected future medical costs of an individual or group to determine their percentage of costs. Members who are expected to have greater medical expenses, pay more in the form of premiums--payments made in advance of medical costs. (See References 4)
In the 1930s, a group of Texas teachers banded together to form a group health plan called Blue Cross. Each member paid a premium which guaranteed them hospital services. This group plan was based on a "community rating"--each member paid the same amount. Blue Cross plans proliferated throughout the country. With the rise of major medical insurance companies in the 1950s, community ratings gave way to experience ratings. In a competitive marketplace, this allowed insurance companies to vie for the healthiest and least expensive members by offering cheaper plans with more generous benefits. However, for the elderly and sick, this had a negative effect on the their ability to receive coverage and their ability to pay for it. (See References 3)
Avram Yedidia, a health care economist, argues that Medicaid and Medicare were passed in 1965, in part due to the rise of experience ratings by health insurance companies. The elderly and poor, who tend to have poorer health and higher medical expenses, could not obtain or afford coverage, leading the government to intervene and provide them with health care. Since the 1960s, the majority of PPO plans invoke an experience rating system. HMOs were required in 1973 to use a community rating system--but since 1988 Congress revised legislation to permit experience ratings. (See References 5)
Experience ratings underlie the common practices of insurance companies of denying applicants insurance based on pre-existing conditions, having a waiting period before pre-existing conditions are covered and dropping members when they suffer an accident or get sick. The rating system has also caused hardship for employers in the small group market as the cost of a member incurring medical expenses can result in widely fluctuating premiums for members. A number of states require insurance companies to use community ratings in the small group market for employer coverage.
President Barack Obama's health care reform legislation tries to counteract some of the effects of experience ratings. Individuals with pre-existing conditions who have been uninsured for at least 6 months are allowed to join high-risk pools with capped premiums to safeguard against exorbitant out-of-pocket expenses. Insurance companies are also banned from denying children insurance based on pre-existing conditions and dropping someone from a policy who gets sick, according to the Commonwealth Fund, a health policy and research foundation.