Health Insurance Markets 101
insurance is a mechanism to pool risk. The insurance business only works if insurance companies can predict their members’ “risk” accurately enough to set premiums to cover their costs. risk is more predictable when membership groups are broad and stable. (1)
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In broad risk groups, low-risk people subsidize high-risk people. this may reduce the perceived benefit of low-risk individuals in purchasing insurance. As a result, low-risk individuals may choose to enroll in lower-cost, lower-benefit plans that are less attractive to high-risk individuals. they can even choose not to sign up for any health insurance.
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If low-risk people refuse to participate in the same plans as high-risk people, the risk group can be segmented. As this occurs, plans that are more attractive and more beneficial to those at higher risk become increasingly more expensive and less attractive to those at lower risk. A cycle can ensue where the risk pools for these plans become so small, unstable, and concentrated in high-risk individuals that insurers refuse to offer these plans altogether. this is often called a “death spiral“.
Insurers and Enrollees Have Opposing Incentives
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When comparing health insurance options, most people probably do some type of cost-benefit analysis, even if it’s informal. Factors considered may include 1) the cost of coverage, 2) the ability to cover those costs based on household income and other expenses, 3) how helpful that coverage will be to an individual based on what you know about their health needs , 4 ) the costs and benefits of any alternatives, and 5) tolerance for the financial risks of not having health insurance. In general, people know more about their own health needs and risks than insurance companies. People’s tendency to use this knowledge to choose plans that are most beneficial to them is known as adverse selection.
Likewise, insurers have a financial incentive to avoid high-risk individuals. Before the Affordable Care Act (ACA) restricted its use, insurers used a number of mechanisms to respond to adverse selection. while actuaries may refer to these practices as risk management, detractors refer to them as cherry picking.
Such practices included denying or limiting coverage for pre-existing conditions (ie, medical underwriting) and canceling policies of individuals who had previously undisclosed pre-existing conditions. Insurers have also structured plans to be less attractive to high-risk individuals with mechanisms such as high cost-sharing requirements, annual and lifetime benefit limits, limited benefit coverage, and exclusions of specific types of drugs from coverage. While these practices limited insurers’ exposure to costs associated with high-risk individuals, they also limited members’ protection against catastrophic health care costs.
how risk pooling differs in individual and employer-based markets
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While there are drawbacks to employment-related health insurance, job-based coverage has generally been an effective way to create broader, more stable risk pools that allow for health premiums more affordable and accessible. For the most part, people do not choose their employer based on their health risk. This means that risk pooling in employer-provided plans occurs more naturally, is less subject to adverse selection, and requires insurers to use fewer risk management practices. Most employers subsidize premium costs and give employees a limited set of plans to choose from. As a result, participation in employer-provided plans is high and employee risks are widely pooled.
However, the individual health insurance market faces many challenges in achieving broad, stable and predictable risk pools. the individual/non-group market is essentially all health insurance not provided by employers or the government. today, that includes both the healthcare.gov marketplace here and the “off-exchange” marketplace. In 2015, employer-provided insurance was the main source of coverage for Tennesseans, with only about 6% of Tennesseans (or 415,000) getting their health insurance through the individual market. by 2017, 234,000 Tennesseans signed up for Marketplace coverage. (2) (3)
Risk Pooling and Insurance Reform
the aca and the proposed alternatives and replacements seek to regulate individual health insurance markets by focusing on various factors that affect the balance and stability of risk pools.
For example, certain provisions of the ACA and the recently proposed American Health Care Act (AHCA) are intended to increase enrollment of low-risk individuals by lowering barriers to coverage. and make alternatives more expensive or non-existent. (4) (5) (6)
- the aca’s individual mandate imposes a financial penalty for waiving coverage, while the ahca includes incentives for continued coverage.
- Provisions such as the essential health benefits of the aca standardize coverage options so that lower-priced, lower-benefit plans are no longer available in the individual market, which can also reduce the adverse selection and selective selection.
- The marketplace mechanism makes it easier to compare and purchase plans, which can help attract lower-risk individuals.
- premium subsidies (based on AHCA income or AHCA age) can help make health insurance more affordable, which can also attract people lower risk.