After several years of more modest increases, 2011 broughtcompanies and consumers sharply higher health insurance premiumincreases—and questions about the factors behind the increasedrates.

A September 2011 Kaiser Family Foundation study showed theaverage annual premium for family coverage through an employer grewto $15,073 in 2011. That’s 9 percent higher than the same premiumin 2010, and a dramatic contrast to the preceding several years,when premium increases of 3 percent to 5 percent were common. Theoverall trajectory, however, has always been up. The cost of familycoverage has nearly doubled since 2001, though wages have increasedby just 34 percent.

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Companies that self-insure and rely on stop-gap policies tocover unexpected expenses saw rate hikes of similar percentages.Those increases were typically similar to those levied on fullyinsured companies in percentage terms, but less in absolute terms,as stop-gap coverage is typically much less expensive than a fullinsurance plan for all a firm’s employees.

The reasons behind the dramatic increase are many and complex.They include industry consolidation, global market pressures,medical costs, Medicare and Medicaid reimbursement rates, and theknown and unknown effects of the federal health care reform law,which has begun to take effect but is not yet fully in place.

A consolidating industry

“In the insurance world there has been a lot of consolidation,and there aren’t a lot of independent carriers,” says Jim Williams,president of Lockard & Williams, a third-party administratorfor employee benefits based in Pascagoula, Miss.

“Companies that are toward the top of the food chain dominatethe market,” he says.

Williams is right, according to the American MedicalAssociation, which reports there were 400 corporate mergers betweeninsurance providers in the dozen years leading up to 2009. In agrowing number of states, a single insurer provides the majority ofprivate health insurance coverage. Insurers in these statesmight feel less competitive pressure to keep rates lower,particularly for small companies, which often lack the resources toself-insure.

Global market pressures

Of course, premiums aren’t the only income source insurancecompanies have. These corporations have other significant investments, and “they’re not making as much money ontheir overall portfolios,” says Tony Steuer, a life insuranceanalyst and financial educator based in Alameda, Calif. “They haveto invest in relatively safe vehicles, and those have been payingreally poorly.”

Highly rated bonds, including Treasury bills, municipal debt, aswell as other offerings pegged to either the Fed Funds rate orLIBOR (the European equivalent), historically have offered lowreturns in years.

Economic upheaval among Euro-zone member countries also has hurtinsurance companies with global investments. Some companies, forinstance, have purchased Greek or Italian debt, which offeredpremiums over bonds issued by more stable countries but are now indanger of default.

Insurance firms have rolling bond portfolios, “so they do havesome older Treasuries at higher rates, which helps when the newerbonds are paying so little,” Steuer says.

No one knows when better yields will be available, however, andinsurance companies pad that uncertainty with premium money.

Medicine: Ever more expensive

Ask a health insurance company why premiums are going up, andthey’ll say that it’s simple: Medical costs are also on therise.

It’s a fair point, says Sandy Walters, executive vice presidentand senior consultant at Kelly & Associates Insurance GroupInc., a brokerage, product distributor, and third-partyadministrator based in Baltimore. “Technologyin phones and computers gets cheaper as the industry gets moremature. Medicine is different. In medicine, technology drives costsup, even as the industry gets more mature. Procedures are moreexpensive because they use more technology,” he says—and they usemore technology because patients demand the quick, accuratediagnoses and treatments they think technology offers.

Once patients have high-tech procedures, they often requiremedication to maintain the results, as with bypass patients whothen need cholesterol-lowering and blood pressure medication forthe rest of their lives.

“We’re prescribing more drugs,” Walters says, adding that thosedrugs are more expensive. “It isn’t unusual for drugs to cost$5,000 a month—for one prescription. Top plan utilizers might spend$50,000 a year on drugs.”

Procedures are also more expensive because hospitals have raisedtheir prices.

“Hospitals have really been ratcheting up their costs,especially on replacement body parts” such as artificial knees andhips, says Fred Hunt, who is active past president of the Societyof Professional Benefit Administrators in Chevy Case, Md. “I’veheard anecdotal stories and seen bills from members, and markupsmight be as much as 1,000 percent. They’re doing it because theycan. It’s a quick rip-off, like when a restaurant buys a bottle ofwine at one price and sells it to you at another.”

A night in the hospital, Hunt adds, might have once cost $1,800.Now it could be as much as $5,000, “When third-party administratorsask, hospitals give a lot of double talk and a lot ofnon-answers.”

Hospitals also play a complicated game of shifting costs,subsidizing uncompensated care, and charging different patients—andbenefit plans—different prices for the same services. Patients withone type of insurance pay one price, patients with a secondinsurance type pay another, cash patients pay a third price, andpatients with government-funded health care pay close to nothing atall.

By reducing or eliminating provider payments for Medicareand Medicaid patients, the federal government has pushed back costsonto the insurance market, Williams says, forcing hospitals to billinsured and cash patients more to cover the costs of treatment thatgovernment reimbursement ignores.

“They’ve expanded eligibility for those programs at the sametime to deal with the uninsured problem. That’s supposed to balancehealth care reform on paper, but really the insured are subsidizingthe uninsured or those in government programs. Doctors can refuseto see Medicare and Medicaid patients, but they run the risk thatthose programs will remove their eligibility,” Williams says.

The Patient Protection and Affordable Care Act ultimately willforce hospitals to adopt pricing transparency, which could drivecosts down. In their view, that’s all the more reason to increaseprices now.

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PPACA: The big question mark

Both insurers and hospitals are raising their rates inanticipation of fully implemented health care reform.

“About three years ago hospitals and doctors thought there wouldbe single payer. They thought they’d better get their money whilethey can. They don’t know if the Feds are about to dictate theirprice, so if cost control shows up, they’ll be negotiating from ahigh point,” Hunt says.

A single-payer health care system isn’t an option right now, buta price increase still makes sense from hospitals’ point ofview.

PPACA means new costs for insurance companies. They’ll have tooffer coverage on parents’ policies for students up to age 26, guarantee policy issuance despitepre-existing health conditions, and provide fully funded wellnessbenefits.

“Insurers know the cost is going up, and they’re going to getthe increases in while they can,” Lockard says.

Of course, insurance companies don’t know exactly how manystudents or patients with expensive pre-existing conditions will end up on their policy rolls, andthere isn’t a good way for them to collect that information.

An individual company could have a very different experiencethan its industry peers, depending on whom it covers. According toHunt, the Agency for Health Care Research recently said that 1percent of the population generates 22 percent of costs, and 5percent generates 50 percent of costs. White, non-Hispanic women inpoor health, the elderly, and users of publicly funded health careare the most expensive populations.

“Get a few more of those and you increase costs by a lot,” Huntsays.

That worries insurance companies. To prepare for the possibilitythat their new plan members will be expensive, “they pad theiruncertainties,” Steuer says.

New rules for medical loss ratios worry insurance companies evenmore than the uncertain medical expenses of a new population. UnderPPACA rules, health care plans serving groups of fewer than 50people must spend 80 percent of their premium dollars on claims,leaving 20 percent for administrative costs and profit. Plans thatserve more than 50 people must spend 85 percent of premiums onclaims, leaving just 15 percent for administration and profit.Plans that don’t spend the required proportion on claims must givethat money back to policyholders.

From a consumer’s point of view, this sounds like a dream cometrue. From an insurance company’s perspective, however, it’s anightmare. Right now, a carrier estimates its claims costs and setsrates for a given year. If it spends less than estimated, thecompany keeps the excess. If it spends more than its estimate, itadjusts rates up for next year. In this system, luck can only workin an insurance company’s favor.

Under the new law, by contrast, insurance companies with fewerclaims than they estimated would give the extra money back, a rulethat caps potential profits. But if an insurance company has a badyear, one in which there are more claims that it estimated, the lawdoesn’t automatically let the firm raise its rates in response.Each state must approve requested increases, with jumps of morethan 10 percent automatically questioned.

Instead, the insurance company must make up the extra from theamount allotted to administrative costs and company profit. In thissecond system, luck can only work against an insurance company.

“It’s hard for me to believe that insurance companies will stayin the business,” Hunt says. “They may say thanks, but nothanks.”

Those who don’t want to stay in the U.S. health insurance markethave other choices, some of them potentially more lucrative.Companies could offer supplemental insurance to Asians, forinstance, tapping a market that Hunt says is larger than the U.S.health insurance market.

Some carriers are leaving the market already, Lockard says.

“It’s harder and harder to find availability, especially forindividual policies,” he says. Other companies are technicallystill in the market, but persuading them to write policies isabsurdly difficult.

“We have carriers now who have made it so difficult to getindividual coverage that we don’t do that coverage anymore,”Lockard says. Even getting a quote is difficult, he says. “Peoplesit here for an hour and a half answering questions just to hear anumber, and then that number is much too high.”

Health insurance costs won’t be coming down anytime soon—perhapsnot until we learn to make some medicine irrelevant by takingbetter care of ourselves.

“Having people take care of themselves in a preventative way isthe answer,” Walters says.

Historically, that’s been a tough prescription to follow.

Ingrid Case is a freelance writer and editor in Minneapolis.She can be reached at [email protected].