Why do health insurers suddenly hike premiums?

A reader asks, “Can you please explain why health insurers suddenly hike premiums? I was shocked to see my premium increase by almost 50%. I thought premiums would increase only if we moved from one age band to another.”

An insurance company makes money if its customers rarely make claims. Insurers will do everything in their power not to pay out claims, or at least not the full amount.

Health insurance is unique because the same person(s) can make multiple claims over a decade and sometimes even the same policy year. Now imagine a situation like the pandemic! This is a nightmare for the insurance industry. Although the recent premium hikes are related to a sharp increase in claims seen in 2020 and 2021 for several insurers, many buyers have witnessed such hikes years before.

Why does this happen? Imagine you are a health insurance company. You are just getting started and wish to increase your market share. How do you do this?

• Create a product with frivolous features (e.g. claim restore etc., which have a low probability of kicking in).
• You incentivise your sales force and engage in content marketing.
• How do you price your product? Do you price it appropriately to potential claims outgo, or do you price it lower to entice consumers?

There are two issues here:

(1) An incentivised sales force is a double-edged sword. Sure they will work harder to increase sales, but they may also do it in haste. This could mean customers’ pre-existing conditions (PEDs) can either get hidden or watered down, resulting in a far-from-healthy insured pool. This means the likelihood of claims increases. Several private insurers avoid offering policies to those with PED or offer them only after permanently excluding the PED to build a healthier insurance pool.

(2) At launch, a product could be underpriced (relative to risks) to quickly attain a reasonable market share. However, this assumes not too many claims are paid out (i.e. a healthy-insured pool).

So you can now imagine what happens if the total paid claims increase at a rate comparable to the premiums collected. Profitability decreases. There is a limit up to which this loss can be borne by a new player. Beyond that, the only option is to hike premiums for existing and new customers.

A crude measure of the insurance company’s financial strength can be obtained via the incurred claim ratio (ICR).

The incurred claim ratio (ICR) is defined as net incurred claims divided by net earned premium  (net of all operating expenses, commissions etc.). This should neither be too low nor too high, but how low is low and high is high are quite arbitrary.

ICR has nothing to do with the probability of an insurance company payout. A young private insurer will see violent fluctuations in its ICR from one FY to another. This is because the number of claims received and the amount paid will vary quite a bit.

Even for established players, ICR can fluctuate wildly. Take Star Health, for instance. They have been around since 2006. Their ICR in 2019-20 was 65.91%, and in 2020-21 it increased to 94.44%. This means profits significantly dropped in 2020-21 as almost all premiums collected were lost to claims. Government support is the only reason PSU insurers* survive even after regularly paying more claims than premiums collected. No such luck for private players.

So they have no choice but to hike premiums. Many other players with lower ICR also have recently hiked premiums. So this tells you how fragile the industry is and how difficult the situation is for the consumer. They can’t stop premium payments, especially if their net worth is low. A single big hospitalization can destroy them. Their only choice is to continue. (employer policies have drawbacks and are far from reliable for corporate employees). A catch-22 situation.

* PSU insurers also hike their premiums from time to time.