Funding Private Insurance: Where Does The Money Come From?

Private health insurance is a contract between an individual and a private health insurance company, which mandates that the insurer pays some or all of the individual's medical expenses as long as they pay their premium. Private health insurance is funded by the individual and the insurer, with the costs split between the two parties. This cost-sharing takes the form of deductibles, copays, and coinsurance. Private health insurance is distinct from public insurance, which is provided by the government.

Employer-sponsored health insurance

There are two main ways in which employers can provide health insurance to their employees. The first is to purchase a health insurance policy from a state-licensed health insurer, which is referred to as an insured plan. The second is for the employer to pay for healthcare for the plan enrollees directly with its own assets, which is known as a self-funded plan.

In 2023, the average employer-sponsored health plan had a total monthly premium of $703 for a single employee and $1,997 for family coverage. Typically, the employer pays the majority of the cost, with employees covering the rest through payroll deductions.

The Affordable Care Act (ACA) includes an employer mandate, which applies to all businesses with at least 50 full-time equivalent employees. These businesses are required to offer affordable, minimum-value insurance to their full-time (at least 30 hours per week) workers or face a potential tax penalty.

There are two types of employer-sponsored health insurance: small-group coverage and large-group coverage. The distinction is based on the number of full-time equivalent employees working for the employer sponsoring the plan. Federal regulation states that employers with fewer than 50 full-time employees are often in the small-group market, while employers with at least 50 full-time employees are in the large-group market. However, states have the option to raise the small-group market limit to fewer than 100 full-time employees.

Employers can also choose to self-insure, which means that they pay employees' medical claims with their own money, rather than purchasing coverage from an insurance company. Most self-insured plans contract with an insurance company to administer the coverage. Employers may also offer an Individual Coverage Health Reimbursement Arrangement (ICHRA), under which they reimburse employees for some or all of the cost of obtaining individual market coverage.

Group health plans, including small-group, large-group, and self-insured plans, must be guaranteed issue, meaning that the plan must cover all enrollees whose employment qualifies them for coverage. Under the ACA, employers cannot impose a waiting period of more than 90 days before new employees are eligible for their health benefits, assuming they meet the eligibility criteria, such as working enough hours.

Employers often provide additional supplemental coverage on top of a major medical plan. This can include dental insurance, vision insurance, life insurance, and short- and long-term disability coverage.

Individual/family health insurance market

Private health insurance is distinct from public health insurance, which is provided by the government. Private health insurance is funded by the individual or family purchasing the insurance plan, with some subsidies provided by the government in certain cases.

In the individual/family health insurance market, there are three types of health insurance for individuals and families to choose from: Affordable Care Act (ACA) plans, short-term plans, and medical indemnity plans.

ACA plans, also known as "major medical" or "Obamacare", meet all the requirements of the ACA and are typically the most comprehensive on the market. They provide benefits for a broad range of health care services, including inpatient and outpatient care, and can save individuals money on routine doctor visits, prescription drugs, preventative care, hospital stays, and more. ACA plans are available to almost everyone, regardless of pre-existing conditions.

Short-term health insurance plans are a more affordable option but provide much less coverage and do not help individuals avoid state tax penalties. They accept applications year-round and can help offset costs in case of a medical emergency. However, they do not meet ACA requirements and may not cover all or any medical needs, so individuals must carefully read the plan details.

Medical indemnity plans, also known as fee-for-service plans, pay a fixed amount for services, regardless of the actual bill for the visit. They can be combined with other insurance to help cover out-of-pocket medical expenses and can be purchased as an individual's only insurance or as part of an insurance package. However, like short-term plans, they do not meet ACA requirements and will not help individuals avoid state tax penalties.

The cost of individual/family health insurance varies depending on factors such as age, location, and income. For those who purchase insurance on the marketplace/exchange, the price depends mainly on income, with premium subsidies offsetting a significant portion of the cost for most enrollees. As of 2022, more than 89% of marketplace enrollees were receiving premium subsidies. For those who earn too much to be eligible for subsidies, the cost of private individual/family coverage will depend on age and location.

Individuals can purchase private health insurance through an employer, the ACA marketplace, or directly from a health insurance company.

Medicare Advantage plans

Medicare pays a fixed monthly amount to the private insurance companies that offer the plans for each beneficiary's expected healthcare costs. This amount covers the costs of Parts A and B, and if prescription drugs are covered, an additional payment is provided. The amount paid by Medicare depends on the healthcare practices in the county where each beneficiary lives and their overall health, which affects the cost in terms of risk.

The funding for Medicare itself comes from two trust funds held by the United States Department of the Treasury: the Hospital Insurance Trust Fund and the Supplemental Medical Insurance Trust Fund. The former covers inpatient hospital care, home health care, and skilled nursing facility care (Part A costs), while the latter covers Part B and D costs, such as visits to a doctor and prescription drug costs. The money in these funds comes from various sources, including payroll taxes, premiums, income taxes from social security benefits, and interest gained from trust fund investments.

In 2023, Medicare spent $454 billion on Medicare Advantage plans, more than half of its total spending. About 51% of Medicare beneficiaries nationwide enrolled in Advantage plans, but this percentage varies by state, ranging from 2% in Alaska to 60% in Alabama.

Premium subsidies and cost-sharing reductions

Premium Subsidies

Premium subsidies are financial assistance provided by the government to help individuals and families purchase private health insurance. These subsidies are available to those who buy private health insurance through the ACA marketplace or health insurance exchanges. The amount of the subsidy is based on income and household information, and it is provided in the form of a tax credit that can be used to lower monthly insurance payments (premiums). Premium subsidies are generally available to individuals and families with incomes up to 400% of the federal poverty level, although the specific eligibility criteria may vary by state.

Cost-Sharing Reductions

Cost-sharing reductions, also known as CSR, are the second type of subsidy available under the ACA. These reductions are offered to lower the amount individuals and families have to pay for deductibles, copayments, and coinsurance. In other words, they reduce the out-of-pocket expenses for healthcare services. To be eligible for cost-sharing reductions, individuals and families must have incomes between 100% and 250% of the federal poverty level. Importantly, these reductions are only available on Silver plans within the ACA marketplace.

The impact of cost-sharing reductions is twofold. Firstly, they lower the maximum out-of-pocket expenses, providing a financial safety net in the event of significant healthcare costs. Secondly, they increase the actuarial value of the Silver plans, meaning that the insurance company covers a larger share of the total healthcare expenses. This increase in actuarial value ranges from 73% to 94%, depending on income level.

Impact of Premium Subsidies and Cost-Sharing Reductions

The availability of premium subsidies and cost-sharing reductions has made private health insurance more accessible and affordable for millions of Americans. According to estimates, more than 9 out of 10 people enrolled in ACA plans as of early 2023 qualified for premium subsidies. Additionally, about 48% of exchange enrollees were receiving cost-sharing reductions during the same period. The impact of these subsidies and reductions is particularly significant for low- and moderate-income individuals and families, who may otherwise struggle to afford comprehensive health coverage.

It is worth noting that the federal government's approach to funding cost-sharing reductions has evolved over time. Initially, the government directly reimbursed insurance carriers for the cost of providing these reductions. However, in October 2017, the Trump administration discontinued direct funding for cost-sharing reductions. Instead, the cost of CSR has been added to Silver plan premiums, resulting in larger premium subsidies. As a result, the federal government is still effectively subsidizing CSR, but through larger premium subsidies rather than direct reimbursement.

Private health insurance laws

Private health insurance is distinct from public health insurance, which is provided by the government. Private health insurance is a contract between an individual and a private health insurance company, which agrees to pay some or all of the individual's medical expenses as long as they pay their premium.

Private health insurance is highly regulated at both the state and federal level. At the federal level, the Affordable Care Act (ACA) has imposed regulatory changes on individual and small-group health insurance plans. For example, the ACA requires that all health insurance plans cover 10 essential health benefits, including:

• Ambulatory care, also called outpatient care
• Mental health and substance use disorder services
• Pediatric services—ACA plans must cover oral and vision care for children
• Pregnancy, maternal and newborn care
• Preventive and wellness care, as well as chronic disease management
• Rehab and habilitative services and devices

Additionally, the federal government requires that private ACA health insurance plans cover birth control services and breastfeeding coverage.

At the state level, each state's benchmark plan sets the minimum requirements for individual and small-group plans within that state. For example, fully-insured group coverage must comply with certain state laws regarding the types of benefits offered, such as covering newborn care.

The specific laws and regulations that apply to private health insurance will depend on the state in which the insurance is purchased.

Frequently asked questions