Adverse selection is not a new term and has been a big part of the insurance industry for decades. With the introduction of the Affordable Care Act (ACA), there was a new element of risk assessment involved with health insurance. Here, we'll take a look at how adverse selection plays a part in the ACA and overall insurance development.

Adverse selection in health insurance

Adverse selection is when there is an imbalance of high-risk policyholders to healthy policyholders. This can happen because more sick or ill people tend to buy health insurance due to their health care needs being more pressing. Healthy people may not buy insurance in the first place or have less coverage in general, which is what leads to the imbalance.

Adverse selection inherently puts the insurer at risk of losing money through a high level of claims being made from sick people. This causes the company to charge higher premiums. If left unchecked, this relationship can lead to what is called a health insurance death spiral. This is when insurance premiums increase so quickly that healthy people can no longer afford them, so they drop their insurance coverage. When many people cut their coverage, the insurer is forced to raise premium prices even more. This spiral continues until the insurance company is forced to shut down because they have lost so much money.

As an insurance company, adverse selection is not the most ideal. It can lead to particular financial risks based on the risk associated with having so many sick people buying insurance. This is where the ACA came into play in an effort to maintain fair premium costs. We will go into more detail about the impact of policies on adverse selection in America. Keep in mind that adverse selection was not completely eliminated by these initiatives.

How ACA impacts adverse selection

ACA limits the ability to adjust higher premium rates and availability of policies on a customer-by-customer basis. Some insurance companies feel that this has caused them to have a higher level of exposure to adverse selection because they can no longer adjust costs as freely. Before the ACA, each policy could be tailored to the specific policyholder more easily. Now, it's not as simple due to the fact that Americans can buy insurance policies on state insurance marketplaces.

This means insurance companies cannot refuse coverage to any one policyholder based on their health or other determining factors. Consumers are more free to pick what kind of coverage they prefer. Even if they have pre-existing conditions and a long medical history, they are guaranteed insurance coverage. Because insurers can not deny coverage, those who are considered high-risk are obtaining more health insurance. In turn, insurance companies are more exposed to adverse selection.

When health insurance companies were freer to be selective in who they supply coverage to, they could protect themselves from the effects of adverse selection because they had more background information about the consumer.

Ways to limit adverse selection

The ACA inserted policies to control who could be denied healthcare insurance coverage. Let's take a look at the policies that the ACA implemented to reduce adverse selection in insurance.

Individual mandate

One of the main issues that contribute to adverse selection is the lack of healthy enrollees buying insurance. ACA encourages a healthy individual to buy coverage by imposing a tax penalty on anyone who was eligible for insurance. This persuades more low-risk people to counterbalance the high-risk consumers.

Enrollment periods

Individuals are not encouraged to buy health insurance outside open enrollment periods unless they qualify to do so. Previously, some people would only buy coverage when they got sick or injured, which added a disproportionate amount of high-risk people. The enforced enrollment period ensures that an enrollee who want insurance will have it at all times, just not when they need it the most.

Premium subsidies

Those with low income may not have the funds to buy health insurance, even if they are low-risk and healthy. The subsidies help this demographic of consumers get health insurance, who would otherwise go without.

ACA insurers and risk assessment

Risk adjustment

There are also risk adjustment programs that strive to level the playing field for insurers and consumers across the board. In the beginning, there were three additional premium stabilization programs included in the ACA. The main purpose was to compensate insurers who have more high-risk clients. In 2023, these programs will be adjusted in all states.

So how are risk assessments and adjustments determine the liability of the insured? Most enrollees are ranked based on individual risk scores. There are several different factors that go into creating these scores:

• Age.
• Sex.
• Diagnosis.
• Hierarchical condition categories (HCCs).
• Health history.

Keep in mind that risk scores are calculated differently based on which age group they fall into. This is mostly based on the fact that the health cost differs depending on age.

In 2023, the proposed risk adjustment user fee will change. The fee will be about $0.22 per member per month, which is less than the current fee of  $0.25 per member per month. The U.S. Department of Health & Human Services (HHS) reports that it will cost about $60 million in the benefit year 2023 to operate the risk adjustment program.

When it comes to risk assessment, the ACA programs have patient-centered health risk methods. In order to be compliant with ACA and avoid penalties, insurers need a partner that knows the program inside out. Insurers still have resources that will reduce their vulnerability to adverse selection. Each year, the rules and mandates are changing to reflect the changing health landscape.  As a result, insurance companies may be forced to raise the price of premiums to counterbalance the potential loss.

For example, the individual mandate federal tax penalty does not exist in its previous state. This means that healthy, low-risk people may not face a tax penalty, depending on their state of residence. If the consumer decides not to have health insurance coverage, they can more easily drop their individual health plan if they are low-income individuals. This has its own impact on adverse selection, and considerations must be made.