Ever wondered why health insurance costs more than other types of insurance products? It's because health insurance involves complex actuarial science, assessing the likelihood of falling ill and incurring substantial medical bills based on medical and family history
Under such circumstances, underwriters responsible for computing premiums calculate the probable risk of payout and shield the insurer’s financial stability by proposing a suitable premium. But, what happens to the premium you pay for the years when you are not making claims?
This is where risk pooling in health insurance comes in.
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What is Risk Pooling in Health Insurance?
The insurer creates a pool of policyholders with a permutation and combination of high-risk payouts and low-risk payouts. They collect the premium from everyone and when required, pay off the claims of even those who have just purchased the plan (and thus have a low premium paid to amount claimed ratio).
This process is called risk pooling in health insurance.
Here’s an example. Say
CASE 1: Ajay has a 5-year-old health insurance policy requiring a premium of ₹25k a year (no pre-existing conditions). He hasn't made a single claim yet. The total premium paid towards his policy = ₹1 lakh 30 thousand (considering the slight inflation in policy premiums for the last 5 years). (unclaimed premium = ₹1 lakh 30 thousand)
CASE 2: Cheeni has a 7-year-old health insurance plan requiring a premium of ₹35k a year. (she has a history of high blood pressure) She had made a sole ₹75k claim in her 3rd year. Her total premium paid totalled ₹2 lakhs 65 thousand (considering the slight inflation in policy premiums for the last 7 years). (unclaimed premium = ₹1 lakh 90 thousand)
CASE 3: Samay just purchased a health insurance policy fetching a premium of ₹25k per year (he has an issue with Asthma). 4 months into purchasing a plan, he faces an accident that requires hospitalisation and incurs a bill of ₹3 lakhs 5 thousand. The total premium paid towards his policy = ₹25k (claim lag of ₹2 lakh 80 thousand).
Now, in the case of Samay, since he has made a claim involving an accidental injury, which only has a waiting period of 30 days, the insurer has to pay off his claim. And yet he has only paid ₹25k towards his policy (the claim is for ₹3.05k). The residual amount for the claim is pulled out of the premiums paid by Cheeni and Ajay. The insurer thus didn’t need to dig into his own pockets for the amount risking its financial stability.
Why is Risk Pooling important in Health Insurance?
The answer is simple: to minimize the risks of financial instability among health insurers.
The underwriting team's primary task is to ensure the insurance company's stability and reputation as a lasting health insurance provider. If the company pays a significant share of claims, impacting its Incurred Claim Ratio (ICR), it reflects financial instability and deters policyholders.
To address this, underwriters rely on risk pooling for accurate premium calculations based on actuarial science, reducing the risk of excessive payouts before clients contribute substantially to their policies.
How Does Risk Pooling Work in Health Insurance?
STEP 1: The insurer's underwriting team selects a group of diverse policyholders who differ in their age, gender, health conditions, and thus, risk levels.
STEP 2: Each member of this group/pool pays their premiums towards their health insurance plans. This creates a pool of funds.
STEP 3: In case any individual requires funds for medical reasons (as per the coverage offered by any health insurance plan), the finances are pulled from this pool of funds.
Since the risk of payout is spread thin across the group, those who pose a high risk of payout don’t have to pay excessively high premiums. This pool of policyholders creates a financially stable insurance ecosystem where
- The policyholders are not discouraged from availing of healthy insurance plans despite posing very high risks of payout over multiple hospitalisations due to deteriorating health conditions.
- The insurers are guarded against bankruptcy by avoiding excessive claim payouts and also by avoiding losing potential policyholders over exorbitant premiums.
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Conclusion
The accuracy of premiums and the financial future of a health insurance provider - both of these depend on an accurate insight drawn from risk pooling in health insurance. Now, it’s true that you don’t require such a detailed idea about risk pooling before you purchase a health insurance plan. However, when you pay off a health insurance premium and feel that the charges are too high considering you rarely make a claim, this understanding can come in handy!
