How Do Health Insurance Companies Determine Employer Costs?

Age, gender, tobacco use, family size, claim history, business size — understand which factors impact health insurance costs.

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Studies show that 56% of small businesses offer health insurance to at least a portion of their employees. Whether you’re part of that group — or intend to be at some point — you should know the factors that drive employer premiums. This will help you effectively manage your costs.

Assuming the health insurance plan is fully insured, how does the insurer arrive at the employer’s rates?

The first thing to understand is that if your business is a small employer/group, the insurance company must follow the Affordable Care Act (ACA), plus applicable state regulations when calculating the cost of health insurance.

Defining small employer/group

For ACA employer mandate purposes, a small employer is a business with fewer than 50 full-time (or full-time equivalent) employees. These businesses are exempt from the employer shared responsibility provisions of the ACA.

However, the ACA’s small group market reforms impacting premium rates defines a small employer as a business with 1-100 employees. For plan years starting before Jan. 1, 2016, the state can choose to define a small employer as a business with 1-50 employees.

Most states regard businesses with 1-50 employees as a small group. Several other states, including California and New York, define small groups as a business with 1-100 employees.

The bottom line is that for employers in the small group market, the ACA permits insurers to calculate health insurance rates only according to:

  • Employees’ (and their dependents’) age
  • Tobacco use
  • Business location
  • Family size


Employees’ (and their dependents’) age is usually the biggest factor in figuring a group’s health insurance premiums. Under the ACA, premiums for older people can be up to 3 times higher than the rate for younger people. Since the base rate is the cost for a 21-year-old, older people can be charged up to 3 times the rate for a 21-year-old.

States are allowed to create their own small group rates based on age, provided the amount does not exceed the 3:1 ratio.

Premiums tend to rise as group members get older, with the biggest increases occurring after age 55.

Tobacco use

The ACA allows small group health plans to charge tobacco users up to 50% more than non-tobacco users if the employer provides a tobacco cessation program and the employee declines to participate in the program. Certain states, including California, Connecticut, Massachusetts, New Jersey, and New York, forbid tobacco use surcharges.

For surcharge purposes, the ACA defines tobacco use as “use of a tobacco product or products four or more times per week within no longer than the past six months.”

Note that some insurers do not take tobacco use into account when determining employer premiums.

Business location

Insurers can establish small group health insurance premiums according to the employer’s geographic location. Further, when calculating the cost of health insurance, the insurer can consider different geographic factors, such as the region’s healthcare expenditures. For this reason, different regions in the same state can have different rates.

However, insurers are not allowed to vary premiums because of differences in health status. This means your insurance company cannot charge higher premiums in your region just because the residents there tend to have more serious health conditions.

Circumstances under which the insurer can modify geographic factors — and by extension pricing — include:

  • The healthcare provider has changed its pricing
  • The region is undergoing unique changes in medical management
  • There’s been an increase or decrease in the number of regions in which the health plan will be offered

Family size

The ACA lets insurance companies vary premiums by family size — which means they can charge more for spousal and dependent coverage. On average, premiums for single coverage rose 4% and premiums for family coverage increased 5% over the past year, according to a 2019 survey by the Kaiser Family Foundation (KFF).

Factors that cannot influence small group rates

The ACA prohibits insurers from establishing small group insurance premiums based on:

  • Enrollees’ medical history
  • Enrollees’ gender
  • The group’s industry
  • The group’s medical claims history


Type of plan and level of coverage

Whether the ACA applies to your business or not, the type of plan and level of coverage play a role in your health insurance rates.

Type of plan

The most common types of health insurance plans are:

  • Health Maintenance Organization (HMO): With low premiums and deductibles, HMO is one of the cheapest forms of health insurance. Enrollees must use doctors within the HMO network.
  • Point of Service (POS): Premiums for POS plans are usually a bit higher than for HMO plans. Enrollees can visit doctors outside of the network but must pay more for that service. To see a specialist, they must get a referral from their primary care physician.
  • Preferred Provider Organization (PPO): With a PPO plan, premiums are normally higher than HMO and POS plans. Enrollees do not need a referral to see out-of-network doctors and specialists.

Per the 2019 KFF survey, 75% of companies that provide health insurance offer only 1 type of plan. (Large companies are more likely to offer multiple plan types.) Also, many insurance carriers limit very small employers to only 1 plan type until more people are enrolled in the plan. Once the number of enrollees grows, more than 1 plan can be extended.

Level of coverage

Employees’ needs differ when it comes to health insurance. Some may hardly ever visit the doctor and may require only catastrophic coverage to help pay for accidents or unexpected illnesses. Others or their dependents may have chronic illnesses, such as diabetes or asthma.

You can offer different levels of coverage to suit the needs of your employee population and your budget. However, more extensive coverage and lower out-of-pocket costs generally yield higher premiums.

Your premiums will also increase if you include bundled add-ons, such as dental and vision insurance or extra health coverage outside of the ACA’s 10 essential benefits.

Midsize and large employers

If you’re a larger company with 51 or more employees, the insurance company can base your premiums on your group’s claims history, your industry, enrollees’ occupation type, the gender of your workforce as well as enrollees’ age, your business location, and the level of coverage.

For example, large claims caused by lengthy hospital stays and expensive surgeries can trigger higher premiums. Further, premiums for construction workers may be greater than premiums for employees in a retail clothing store.

Note that some states define a large group as a business with 101 employees or more.

Typically, large employers can offer their employees lower premiums because they tend to have a bigger risk pool — meaning the risk is spread out across everyone in the plan. However, a large employer can incur inflated costs if their risk pool has a disproportionate amount of high-cost claims and no offset mechanism. For example, high-cost claims might be offset by enrolling a significant number of lower-cost individuals, thereby lowering premiums.

In the end, your health insurance costs depend on the insurance company’s calculation. What goes into that calculation varies by company size, business location, type of plan, level of coverage, and whether ACA rules apply.

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