Does where you live affect health insurance premiums?

To understand how insurance premiums are set, for health insurance or otherwise, it helps to understand the concept of risk and reward. It’s something you hear about a lot but what it basically means is that taking on increased risk is only worthwhile if doing so increases your reward. In a health insurance context, that means the riskier you are, the more the insurance company has to charge you in premiums for the risk of insuring you to be worth their while.

That said, the way risk management people think about risk is different from the way most of us think about it. In the insurance context, risk is calculated by multiplying frequency (how often you are likely to file a claim) by severity (how bad the loss is likely to be when you do). But how does this apply to the topic of health insurance?

Well, if you’ve bought health insurance before, you should already know what kinds of tests they run and the questions that are commonly asked: your age, whether you smoke, how many drinks you have a week, whether you have any pre-existing medical conditions. This is all to determine your frequency – your probability of getting sick and filing a health insurance claim.

Next up is severity. The insurance company doesn’t calculate the severity of a claim the same way a patient would. For the insurer, severity is just a number: how much will they need to pay out for the claim.

This is also where geography comes in. Where you live mainly comes into play when factoring in the likely severity of a claim. Cost of living and salaries differ from region to region, and it’s the same with healthcare services. If you live in an expensive part of the country, your healthcare services will be more costly. That means the insurance company will need to pay more if you file a health insurance claim. So, to make up for taking on the added risk (paying bigger claims), they will need to raise your premium (for advice on keeping your costs low, see How to Lower Your Health Insurance Rates).