In order to shop effectively for health insurance, you need to understand how coverage is priced. Or “underwritten,” in industry parlance.

This is an essential point. But ordinary consumers don’t think much about how health coverage is priced—because they don’t think about insurance like other goods or services they buy. Which contributes to the inefficiencies that sometimes screw up the health insurance markets.

Think about how well you—or maybe your kids, if you have any—understand the pricing of mobile telephone services. People usually know how many text messages or minutes are allowed each month under their phone plans, the costs of exceeding those limits, the speed of their connections, coverage areas and many other fairly technical details.

There’s not much demand for the analogous details about health insurance. And a quick Internet search confirms this: The information available on health coverage pricing at most consumer sites is so limited that it’s not useful.

So, in this column, I’m going to pretend that the pricing of health insurance coverage is something that a precocious 12-year-old would want to understand as well as she does her phone plan. And I’ll try to explain it on those terms.

When an insurance company sets up a health coverage policy, it looks at two things:

1)    the coverage offered by a particular type of health insurance policy, and

2)    the individual (or group of individuals) being covered by that policy.

Some companies refer to these as “primary” (related to the policy) and “secondary” (related to the individual insured) underwriting factors. In industry jargon, a company “prices” the coverage and “rates” the individual insured.

A jargon warning: The terms “underwrite,” “price” and “rate” are used somewhat interchangeably in the insurance industry. Some companies use the terms strictly, separating their slightly different meanings; others use them loosely. In any case, the three terms refer to steps in the process of figuring out how much to charge for coverage.

An insurance company will usually start by pricing the coverage in question. And this is trickier than pricing other types of insurance, for several reasons.

1)    Health insurance policies do not follow industry-standard forms, as homeowners and auto policies do. Most insurance companies write their own health policies, which means there can be big differences between one company’s contract and another’s. It also means that industry-wide payment numbers and trends mean less to a specific company when pricing health coverage than when pricing homeowners or auto coverage. (Though health insurance companies do use industry-wide numbers as a “control” to compare against their own.)

2)    Payments made under an individual health insurance policy can vary dramatically, year to year. And in total. These payments are more difficult to model or otherwise predict than payments made under life or property coverages. Even when a health policy has a lifetime coverage limit (recently prohibited by the federal Affordable Care Act), most claims don’t involve payments that come anywhere near that limit in a given year. But a few do…and it’s very difficult to predict which those few will be.

3)    Government programs—primarily Medicare and Medicaid, but also others—influence the cost of medical care services paid for by private-sector health insurance. While the reimbursement formulas used by the government plans are public information, they can have unintended consequences or other unpredictable effects. And, based on where and to whom a company sells its policies, government programs have a greater or lesser effect on payment histories. In some regions, Medicare sets the market prices for all health care services.

So, there are lots of variables involved in pricing coverage. The best way to account for them all is to keep track of the various payments the insurance company has made under the various types of health policy it offers.

Historically, the most common types of health policy have included:

• traditional indemnity-style coverage
• managed-care coverage
• catastrophic or “high-deductible” indemnity coverage
• major medical coverage
• disease- or condition-specific coverage
• Medicare supplement (a/k/a “Medigap”) or other specialty coverage

Not every company offers all of these coverages; and some companies break one of these categories into multiple sub-categories.

A health insurance company pays actuaries to track its history of payments (sometimes called “losses”) made under each type of coverage. And those actuaries will cross-reference the payment histories by the type of policyholder making claims. So, for example: The actuaries can tell senior management that the company makes an average payment of $6,900 each year on an indemnity policy sold to a 50-year-old woman and an average payment of $3,400 each year on a major medical policy sold to a 30-year-old man.

This sort of proprietary payment (or “loss”) history is extremely important to health insurance companies; it forms the foundation of the company’s pricing formula. From this perspective, it’s easy to see why the insurance company considers its payment history the “primary” factor in pricing coverage.

Next comes the “secondary” factor—namely, you.

In most cases, “you” means a group of individual insureds organized by their employment with one company or entity; in some cases, “you” means an individual buying his or her own coverage. In either case, the “secondary” pricing factors include personal characteristics that are mentioned most often in simplistic consumer-advice columns:

• age
• height/weight
• location of residence
• blood pressure
• smoker/non-smoker
• alcohol use
• other health status (especially any genetic tendencies or chronic conditions)
• personal financial/credit history

If you’re buying health insurance through an employer or other group, these secondary factors are less important but may affect the amount of your monthly premiums or necessary deductibles and co-pays. If you’re buying coverage as an individual, they are more important and may determine whether you’re insurable at all.

So, a health insurance company has its proprietary, “primary” pricing factors in place already when you apply for coverage. It then asks you for information—by means of its policy application form and, in some cases, a blood test or physical exam—to help it gather data on “secondary” rating factors.

If you meet the minimum parameters of insurability, the company uses a formula (also created by its actuaries) that assigns various values to each of the “secondary” factors. For example, if you’re more than 20 percent over average weight for your height, the formula may add X points; if you don’t smoke, it may subtract Y points; etc.

When the total number of points related to all “secondary” factors is determined, this is converted to a secondary rating factor—often between about 2.0 and about -0.5. Then, the primary average payment amount for the type of coverage you’re seeking is multiplied by the secondary rating factor to produce a “working” or “basic” premium.

This working premium is then increased to account for statutory requirements related to required reserves, permitted profit margins, contributions to government-run insurance pools or other costs. (These increases to the working premium are how most so-called “health care reform” schemes generate the funds that they need to subsidize health coverage for the uninsured.)

At this point, the insurance company usually compares the working premium to other premiums it charges insured people or groups; and, if yours is too high or low, the insurance company may bring it back into range by adjusting required deductibles, co-pays or coverage limits.

The result of these several modifications is a final premium which you—or your employer or insurance group—have to pay.