Healthcare Town Hall

What follows is excerpted from the recent healthcare reform briefing paper, “Adverse selection and the individual mandate”:

Proposals for individual mandates usually incorporate an incentive (a carrot) to purchase coverage and a penalty (a stick) for not purchasing coverage.

• The carrot is a subsidy, voucher, or other financial mechanism to help make insurance more affordable and put uninsured people of limited means in a position where the cost/benefit decision bears a more realistic relationship to their respective income levels. This would reduce the cost component of the cost/benefit decision described above, and thereby encourage more people to purchase health insurance.
• The stick is a financial penalty of some sort on individuals who fail to purchase coverage. This changes the cost/benefit decision in that it makes the alternative to purchasing health insurance more expensive and therefore less attractive financially.

The strength or weakness in any mandate lies in the level at which these incentives and penalties are set. For example, an insufficient subsidy for healthy but lower-income individuals, even if paired with a tax penalty, may not be enough of an incentive, especially if the tax penalty doesn’t create an imperative to purchase insurance.

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What follows is excerpted from the new healthcare reform briefing paper by Tom Snook and Ron Harris, “Adverse selection and the individual mandate.”

Community rating refers to a health insurance premium rating structure with limited or no variation in the premium rates among insureds. Under community rating requirements, health plans have a reduced ability to vary premium rates so as to be consistent with an individual’s risk characteristics, such as age and gender. Current industry practice in the individual and small group markets is to develop premium rates commensurate with an individual’s actuarially expected costs; for example, younger people have lower rates than older people. A community rating requirement would limit the degree to which a carrier can do this. Limiting the range of rates means raising the lower end and reducing the top end of the rate scale, so that rates are no longer proportionate to expected costs. This creates a cross-subsidy where younger individuals pay more for health insurance to reduce the premiums for older policyholders. The fact that community rating requirements will make insurance more expensive for younger and healthier individuals could serve to undermine the efficacy of the mandate, especially if the mandate is not highly aggressive in terms of penalties for non-compliance.

Click here to see the full paper.

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What follows is excerpted from the new healthcare reform briefing paper, “Adverse Selection and the Individual Mandate.”

The purchasing or enrollment decision that an individual makes when deciding whether to obtain health insurance coverage and, if so, what plan of benefits to select, typically represents an exercise of consumer self-interest. It involves consideration of anticipated personal or family needs, price, doctors and hospitals available, other benefits or services, health plan reputation, and various other factors. Adverse selection is the natural process of individuals making insurance purchasing decisions that reflect their own personal circumstances and healthcare needs and desires. Such decisions are generally informed ones, leading to maximization of the cost/benefit tradeoff; and the decisions that maximize this tradeoff favorably for the individual consumer generally have the opposite impact on the insurance program (i.e., lead to higher costs relative to the premium level charged). In recognition of this informed consumer behavior, insurers have developed time-tested underwriting and rate-structuring techniques for mitigating and managing the resulting healthcare risks and costs.

A selection spiral is a worst-case result of adverse selection that can quickly make an insurance program insolvent. The dynamics of a selection spiral work like this: A health plan gets worse risks (higher-cost individuals) than it anticipated in its original rate setting, and so has to increase premium rates to provide adequate revenue to cover these higher costs. However, raising the rates changes the entire cost/benefit equation, and so the rate increase will cause some individuals to drop their coverage—and those who do drop are more likely to be the lower-cost individuals in the pool. As a result, the health plan winds up with a pool of risks even worse than the one it started with, with premiums that again need to be increased to cover the new, higher costs. This sort of spiral can quickly get out of control and lead to the collapse of the insurance pooling mechanism. 

Click here to see the full paper.

Cost, Reform, Universal coverage adverse selection, individual mandate, Ron Harris, Tom Snook

Several of the reform bills in Congress share a common theme: A move away from the rating and underwriting techniques that are used to manage adverse selection, and a move toward an individual mandate where all people are required to obtain health insurance. A new paper by Thomas D. Snook and Ronald G. Harris focuses on these reforms, and how adverse selection will impact premiums rates in the post-reform world.

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One of the core concepts in healthcare reform is the effort to minimize adverse selection. An effective mandate is key to this effort.

In order to better understand adverse selection, it may be helpful to look beyond healthcare to other kinds of financial products with distinct selection issues. We were reminded of one such product—private unemployment insurance—over the weekend in the New York Times. Quoting from the article:

It turns out that the biggest problem with private unemployment insurance is something that industry insiders refer to as adverse selection. That is a fancy way of saying that the people who take out this sort of policy are the ones most likely to need it.

“The potential set of policyholders are selecting against the insurance company, because they know their situation better than an insurance company might,” said Michael Schmitz, a principal and consulting actuary for the Milwaukee office of the consulting firm Milliman.

As a result, there is not the sort of risk sharing that occurs when insurance is mandatory, as it generally is with auto insurance.

This dynamic is made more complicated when it comes to healthcare because, unlike auto insurance or private unemployment insurance, healthcare in America is not just insurance but also an employee benefit. An article in the Washington Times this weekend referred to this latter factor as “a baroque form of third-party prepayment.”

Another way of thinking about it is to look at utilization trends, which can be major drivers of healthcare costs. Which brings us back to a delicate question: How do you encourage a system where everyone has insurance coverage without creating a system that encourages overutilization?

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What follows is excerpted from the new health reform briefing paper, Understanding Healthcare Plan Costs and Complexities.

Selection is the notion that people will make economic choices to their own benefit when they choose an insurance plan. In this context, to their own benefit refers to the person’s need for insurance. Typically, people with high morbidity—that is, people with relatively higher expected claim costs in the coming year—are more inclined to select richer plans. They do so because they anticipate significant healthcare spending and they want to choose the plan that costs them the least out of pocket. Conversely, people who expect a lower morbidity—that is, people who don’t think they’re going to spend much on healthcare costs because of their age, health, etc.—usually choose relatively less rich benefit plans. This pattern is not absolute, but it holds up over a large population of insured.

For most healthier people, the cost sharing is not a large concern, although the share of health insurance premium that they are required to pay may be. These people may seek savings with a plan that requires them to pay a lower premium. This becomes important when considering plans like the most popular FEHBP plan and the Milliman Medical Index plan. The availability of a relatively rich benefit program, as is the case with these two examples, is more likely to attract sicker people, while healthier people are more likely to choose a less rich plan with lower associated premium costs. (This dynamic is discussed in more detail in an interview published last year.)

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The Los Angeles Times published an editorial today about the growing consensus among health insurers over the need for universal coverage. While some might find this puzzling, there are sound insurance principles that support the broadest possible coverage.

This interview with Bruce Pyenson offers a primer on adverse selection, a topic germane to the question of broad coverage.

Q: How do you define adverse selection?

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