An Overview of Adverse Selection in Health Insurance

Health Insurance

What is Adverse Selection?

Adverse selection in health insurance occurs when unhealthy people or people who are more prone to illness-causing higher risk to insurers but health insurance plan, whereas healthy people don’t buy a health plan. If unhealthy people buy more health plans or more robust health plans while healthier people buy less coverage. Adverse selection puts the insurer at greater risk of losing money through claims than expected. This generally results in higher premiums, resulting in more adverse selection, as healthier people generally not prefer to buy increasingly expensive coverage. Health insurance companies will become unprofitable if adverse selection were allowed to continue unchecked.

How Adverse Selection Works?

Unhealthy people who think they probably might spend more than $500 per month if they had to pay their healthcare bills generally enroll in health plans, thereby resulting in adverse selection. Since the health insurer is only taking $500 a month per insured but is paying more than $500 per month per insured in claims, so they lose money. Thus, if the health insurance companies don’t do anything to prevent this adverse selection, then eventually they will lose so much money that they will not be able to pay claims to the insured.

Insurer’s Ability to Prevent Adverse Selection is Limited by the ACA

Health insurance companies can adopt different ways to avoid or discourage adverse selection but they are prevented from the government regulations from using some of these methods and they are also restricted to use other methods. In an unregulated health insurance market, health insurance companies make use of the medical underwriting to avoid adverse selection, as, during this process, the underwriter checks the medical history, demographics, prior claims, and lifestyle choices of the applicants.

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This is carried out to determine the risk that insurers will face while offering health insurance to that person. As a result, the health insurer might not sell plans to someone who poses a great risk. Besides, the insurers might also charge higher premiums from a riskier person compared to a person who poses less risk. In addition to this, a health insurer might also put an annual or lifetime limit on the coverage amount to reduce their risks. To reduce their risk health insurance companies may also exclude pre-existing conditions from coverage, or exclude certain expensive healthcare services or products from coverage.

Before 2014, most of the health insurance companies were widely using most of these techniques but now they are not allowed to use these techniques any more. The Affordable Care Act has put the following limits on health insurers:

  • Health insurers cannot refuse to sell health insurance to people having pre-existing conditions.
  • Insurers cannot charge more premiums from people having pre-existing conditions.
  • Health insurance companies cannot impose annual or lifetime caps on benefits.
  • Individual and small group health plans should provide a uniform set of essential health benefits and insurers cannot exclude expensive healthcare services or products from coverage.
  • For major-medical health insurance plans, medical underwriting was eliminated.

ACA Help Insurers to Prevent Adverse Selection 

Though the Affordable Care Act restricted health insurers to use to prevent adverse selection in the individual market but has also established the following means to prevent unchecked adverse selection.

Required to Maintain Coverage 

The Affordable Care Act from 2014 through 2018 has required all U.S. legal residents to have health insurance or pay a tax penalty. This encouraged healthier and younger people to enroll in a health plan, because if they didn’t enroll then they will face a hefty tax penalty. However, the penalty is eliminated after the end of 2018, as a result of the Tax Cuts and Jobs Act. It is estimated that the elimination of the individual mandate penalty would result in a 10% increase in the individual market premiums than they would have been, if the penalty had continued. The rise in the premium is a direct result of adverse selection, as it is healthy people who are expected to drop their coverage without the penalty threat, resulting in an unhealthy group of people left in the insurance pool.

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Limited Open Enrollment

To prevent people from waiting to buy health insurance until they are sick, the ACA has come out with a fixed open enrollment window. People are allowed to sign up for health insurance only during the open enrollment period, or during a time-limited special enrollment period triggered due to certain life-changing events. Before 2014, the limited enrollment windows were applicable only for Medicare and employer-sponsored health plans and individual health plans were available throughout the year but after 2014 all the plans were available only during the open enrollment window.

Health Insurance Coverage in most cases doesn’t become Effective Immediately 

As per the Federal regulations, most of the health insurance plans have a short waiting period between the individual enrolling in a plan and the coverage becoming effective. If a person enrolls during the fall open enrollment period that runs from November 1 to December 15, then coverage becomes effective from January 1. If the person enrolls during a special enrollment period, then the coverage is effective either the first of the following month or the first of the second following month, depending upon the circumstances.

Surcharge on Tobacco 

Nearly all the medical underwriting has been eliminated by the ACA in the individual market but still, health insurers in the individual and small group health markets are allowed to charge smokers up to 50% higher than non-smokers applicants.

Older Applicants have Rating Ratio

Though health insurance premiums cannot vary based on gender or health status in the individual and small group market, but the ACA has allowed health insurance carriers to charge older applicants up to three times more than younger applicants. It is mainly because older people usually have more medical expenses compared to younger people, and thus pose a higher risk to the insurer. However, some of the states don’t allow insurers to charge older applicants three times the younger applicants.

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Differences in Actuarial Value 

A uniform tier of coverage is established by the ACA based on actuarial value. It allows health insurance providers to charge higher premiums for plans having a higher actuarial value. As a result, Gold plans cost more than Bronze plans, thus, consumers who want robust coverage of a gold plan will need to pay more to obtain this plan.

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