Lewis & Ellis, LLC

Adverse selection health insurance

Health Care and Health Insurance
by Chris Bagwell
Adverse selection refers to an imbalance of healthy and high-risk policy holders.
Adverse selection refers to an imbalance of healthy and high-risk policy holders.

Adverse selection in health insurance refers to an imbalance of risky policyholders to healthy policyholders. This is impactful for both insurers and policyholders because the insurers might be forced to raise their prices to protect themselves from losing money. Adverse selection can result in financial risks and an increase in health insurance premiums for the insured.

What is adverse selection?

Health insurance companies strive to strike a balance among their policyholders, including those with low and high levels of current and potential risk. Adverse selection occurs when an inordinate number of people who present as a higher risk to the insurance company purchase insurance policies, while healthier individuals don't. This issue can also arise when people with significant health issues purchase more insurance than their less risky counterparts.

Adverse selection is not desirable because the insurer faces a higher risk of losing money. In turn, the carrier has to charge higher premiums to make up the difference. This higher cost could deter low-risk individuals from buying insurance, thus creating a vicious cycle that leads to more adverse selection. This requires significant risk adjustment.

It may be helpful to look at a simple example to get a firmer grasp of the concept. Let's assume that an insurer offers a health insurance plan with a premium of $650 per month and would give the policyholder the usual insurance coverage for regular health affairs. A high-risk individual with nicotine addiction and a terrible cough who needs frequent medical attention would likely think that this policy offers strong value and may likely purchase coverage. A healthier, low-risk individual may look at the very same policy and find the premium cost to be excessive based on their expected healthcare needs.

How risk plays into adverse selection

If the insurers have too many high-risk consumers, they could potentially go out of business because costs may exceed revenue. Because of this, the company could choose not to insure someone who is too high-risk and they could offer incentives to low-risk people to attract them into buying a policy. In addition, the riskier person could be charged a higher premium due to their risk level. Additionally, insurers may place an annual or lifetime limit on the amount of coverage they provide or exclude pre-existing conditions from coverage. Adverse selection is a major factor in the health insurance market.

While some of these practices are still common, they were far more widespread prior to 2014. Now, most insurance companies do not use these techniques anymore due to the Affordable Care Act (ACA).

The ACA limits insurance companies' ability to adjust rates and number of policies based on consumer details. Those details are also limited in the act. Insurance companies have increased exposure to adverse selection due to these factors. Under the ACA, consumers have the ability to buy individual health insurance and not be denied for any reason, including pre-existing conditions and other medical histories. Since insurance companies can't deny coverage, higher-risk individuals could get health insurance at an affordable rate, which could create adverse selection.

How to curb adverse selection

Despite the negative impact on health insurance companies, there are still ways to curb adverse selection. The ACA has also implemented some mandates to try to mitigate adverse selection as a result of the act. Here are a few and what they aimed to do:

  • Individual mandate: This mandate established a tax penalty for anyone who did not buy a health insurance plan but qualified for one under the ACA. This encouraged healthy individuals to purchase health insurance who might not have done so otherwise.
  • Enrollment periods: This component prevents individuals from acquiring health insurance outside the enrollment periods unless they were subject to a qualifying event. This encouraged people to enroll in a specific time period, not just when they needed it.
  • Premium subsidies: The mandate helps people with low-income secure health insurance who otherwise couldn't afford health care, even if they are healthy and low risk.

Accreditation programs can promote health plan value. You can encourage policyholders to ask if their employer can reimburse individual health insurance premiums because this can boost the number of low-risk people who buy insurance. Contact a Lewis & Ellis consultant today to learn more about reducing adverse selection in your business.



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