Private Health Insurance Premiums and Federal Policy

Most Americans are covered by private health insurance, which they either obtain through employment or purchase individually. Insurance premiums—the payments made to buy that coverage by enrollees or by other parties on their behalf—are high and rising. CBO and the staff of the Joint Committee on Taxation (JCT) project that in 2016, the average premium for an employment-based insurance plan will be about $6,400 for single coverage and about $15,500 for family coverage. Average premiums for coverage purchased individually (in what is called the nongroup market) are also high—but not quite as high as average employment-based premiums, mostly because nongroup coverage is less extensive and thus requires enrollees to make higher out-of-pocket payments when they receive care.

Although premiums for private insurance have grown relatively slowly in recent years, they have usually grown faster than the economy as a whole and thus faster than average income. Over the period from 2005 to 2014, premiums for employment-based insurance grew by 48 percent for single coverage and by 55 percent for family coverage. CBO and JCT expect them to grow at similar rates over the next decade—by about 5 percent per year, on average, or about 2 percentage points faster than income per capita. As a result of that growth, average premiums for employment-based coverage are projected to be about $10,000 for single coverage and about $24,500 for family coverage in 2025, nearly 60 percent higher than they were in 2016.

High and rising premiums for private health insurance are a matter of concern for enrollees. They also affect the federal budget, because the federal government subsidizes most premiums—directly or indirectly—at a cost of roughly $300 billion in fiscal year 2016. Lawmakers have therefore expressed interest in examining the factors that affect premiums. This report reviews the available evidence about premium levels and growth; analyzes the major federal subsidies, taxes, fees, and regulations that affect premiums; and examines how insurers’ own actions affect premiums.

How Do Federal Subsidies, Taxes, and Fees Affect Premiums?

The federal government subsidizes health insurance premiums in two main ways. First, nearly all premiums for employment-based insurance are excluded from federal income and payroll taxes. That tax exclusion, estimated to cost more than $250 billion in fiscal year 2016, subsidizes roughly 30 percent of the average premium for employment-based coverage. Second, under the Affordable Care Act (ACA), the federal government offers tax credits to people who buy nongroup coverage through a health insurance exchange and meet various other criteria. Those premium tax credits are projected to cost about $40 billion in fiscal year 2016.

Not only do the subsidies reduce the portion of the total premium that enrollees must pay; they also affect the total amount of the premium. Both subsidies encourage relatively healthy people to enroll, which reduces insurers’ average spending for enrollees’ health care and thus helps to reduce premiums. However, the tax exclusion also provides an incentive for employers to offer, and for employees to select, more extensive coverage than they otherwise would—which raises total premiums. (The tax credits do not have that effect because their value, unlike the value of the tax exclusion, does not increase when people purchase more extensive coverage.) On balance, CBO estimates, the tax exclusion increases average premiums for employment-based coverage by 10 percent to 15 percent.

Various federal taxes and fees also affect premiums. Starting in 2020, a new excise tax on employment-based plans with relatively high premiums is scheduled to take effect; for people who buy those plans, the tax will roughly offset the incentive to obtain more extensive coverage that the federal tax exclusion provides. Consequently, employers and employees affected by the tax are expected to choose less expensive coverage than they would have otherwise—and as a result, the tax is expected to reduce average premiums. Other federal taxes and fees imposed on insurers, by contrast, tend to raise average premiums, because the insurers generally pass the costs on to all purchasers.

How Do Federal Regulations Affect Premiums?

Before the ACA was enacted, many federal and state regulations already affected private health insurance premiums, particularly for employment-based coverage. But the ACA significantly expanded the scope of federal regulations, especially in the nongroup market. This report focuses on regulations resulting from the ACA, because proposals designed to affect premiums often involve changing those regulations rather than the earlier ones.

One key regulation is the individual mandate, which took effect in 2014 and requires most people to obtain health insurance or pay a penalty. Like the subsidies just mentioned, the individual mandate reduces premiums by encouraging relatively healthy people to get coverage. The ACA also imposes an employer mandate, which requires larger employers to offer coverage that meets specified standards to their full-time workers or face a penalty. That regulation, which took effect in 2015, is not expected to change average premiums very much, but it will discourage employers from dropping coverage and thus will keep some workers from shifting to nongroup coverage.

Other ACA regulations apply only to insurance policies newly sold in the nongroup and small-group markets. (Employment-based coverage is sold in two markets: the small-group, which generally covers employers with up to 50 employees, and the large-group, which covers larger employers.) Many of the regulations tend to increase average premiums, particularly in the nongroup market. For example, when they sell those policies, insurers must now accept all applicants during specified open-enrollment periods, may not vary people’s premiums on the basis of their health, may vary premiums by age only to a limited extent, and may not restrict coverage of enrollees’ preexisting health conditions. Insurers must also cover specified categories of health care services, and they generally must pay at least 60 percent of the costs of those covered services, on average.

Together, the ACA’s regulations increase premiums noticeably in the nongroup market and have more limited effects in the other markets. However, the nongroup market represents a relatively small fraction of the total private insurance market, and according to CBO’s projections, it will continue to do so—accounting for about 15 percent in 2025. As a result, CBO expects that premium increases stemming from the ACA’s regulations will have a relatively small effect on the overall average of private health insurance premiums.

How Do Actions by Insurers Affect Premiums?

Insurance premiums depend partly on actions that insurers themselves take. Above all, insurers generally try to control their costs by restraining spending on health care—spending that accounts for about 88 percent of their premium revenues, on average. That restraint tends to reduce premiums. In order to limit spending on health care, insurers use various strategies, such as negotiating lower payment rates for services provided within their networks of doctors and hospitals; managing enrollees’ use of care more closely; and increasing the amounts that enrollees pay out of pocket. Insurers may also try to attract relatively healthy enrollees and avoid less healthy ones, though federal and state regulations limit or prohibit such practices or reduce insurers’ incentives to engage in them.

Competition also affects premiums. On average, premiums are lower in markets with more insurers. The reason is that those insurers have a stronger incentive to keep premiums low, because otherwise they might lose enrollees to their competitors. Premiums are also lower in markets with more hospitals and physicians, because insurers there have an easier time negotiating lower payment rates or excluding high-cost providers from their networks. The available evidence, however, indicates that many insurance markets are quite concentrated; that is, a small number of insurers account for the bulk of enrollment. Many markets for hospital care and some markets for physicians’ services are concentrated as well. As a result, efforts to increase competition among insurers, like other efforts to reduce insurance premiums, may have complex effects.