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California health insurance  -  California Health Reform  -  Adverse Selection and Reform

Adverse Selection and California Health Reform

Many shoppers for California health insurance start to glaze over when they are introduced to the arcane language of the product.

Co-insurance, deductibles, max out of pocket, brand formulary...the list goes on and on.

 We hate to do this but we need to add another term so consumers can make wise decisions for their budget. This term will definitely affect Californian budgets sometimes after 2014 (probably closer to 2016).

The term that will be very very important to everyone's wallet is "adverse selection".

Let's take a look at this purely insurance-related jargon and discuss how it's going to impact not only the pricing but the plans offered on California health insurance market in the coming years.

So what is Adverse Selection?

You're not likely to see it on consumer facing websites because it's a technical term of the industry.

Every industry has their jargon that sounds all toney and insurance is no different. If geeky technocrats with short ties and short sleeve button down shirts issuing warning of Adverse Selection in gray buildings with stacks of data surrounding them...you' re closer than you think.. It's sounds technical enough already but maybe some Latin would be a nice finish. Adverse Selection is a technical term that deals with underwriting and plan design.

Underwriting deals with assigning risk and making sure that the plan and consequently, the carrier doesn't fold under improperly weighted risk to premium.

Adverse selection in layman's terms means this...attracting bad risk. The "attracting" work is key to understanding it. Every carrier gets bad risk since insurance is a future facing concern. Who knows what is to come? In a nutshell, it's a component of insurance plan design that attracts more risky customers than the average. The impending results may come months after the plan launch of years but with time, adverse selection will sink a plan and potentially the carrier that offered it.

We've been directly involved in California health insurance and we've seen many situations where adverse selection has worked its black magic. Let's take a look at one example.

An example of Adverse Selection

Roughly five years ago, a nationwide (very large) health insurance carrier who had a strong showing in the group side of the market decided it was time to enter the individual/family market.

 Individual family is a very different beast altogether since it's very competitive (many carriers) and medically underwritten. At that time, the main carriers on the market were terrified of the rapid health inflation (think double digit increases every 9 months) and where scaling down the benefits (higher deductibles, max out of pockets, etc) to offset the need for further rate hikes as the market was very price sensitive.

This new carrier brought out a very rich plan for the big bills (loosely translated as deductible/ max). If I recall correctly, the deductible was around $250 and the max out of pocket was around $1500/annually which was roughly half of what other carriers offered.

This also pertained to maternity coverage. So how does adverse selection actually work?
Let's say your a 29 year old woman and you're considering maternity in the next 12 months. You need to either get health insurance or you're looking for better options in light of your expecting maternity. You run your quote and there you see a plan which will cap your out of pocket for delivery at around $1500 at a very low rate.

The other plans are all at $3K-4K on the back end and slightly higher. Which way will you go? That's a no brainer.

We warned these shoppers that the plan's rates and or benefits would likely not last but some clients just couldn't budge. The plan imploded so quickly that the carrier left the individual family California health market about one year later. When we got the work that the carrier was leaving the market and closing all existing plans a good 3/4rds of our clients with this carrier were pregnant woman. Think about that...almost 75% and it wasn't just our clients. The carrier had to actually announce a delay in closing the plans since so many of the enrollees were pregnant. Can you guess how long they delayed the closing by? That's right...nine months. That's a curious length of time.

So this was adverse selection in action.

 If a carrier attracts higher risk by a plan's pricing or plan design, the claims versus premium quickly spirals down hill and the whole trend accelerates due to a feedback loop that caused the original issue. So what does adverse selection have to do with the Health Reform changes coming Jan 1st, 2014?

 It's practically baked right into the plan. Let's take a look at a big one that comes to mind. Let's look at the penalty for not buying health insurance.

The ACA law and Adverse Selection

In the first year, the penalty will be $95/annually or a percentage of income. Keep in mind that the uninsured (prior to health reform) break down into three groups essentially. You have those that can't afford coverage (will go on to expanded Medical or received subsidies).

You have those that couldn't qualify for coverage who will probably fall into the subsidy or private camp. Finally, you had those that could afford California health insurance but decided not to purchase it.

The penalty is really geared towards them. They tend to be male and gainfully employed. Let's look at a 40 year old male who is above 400% of poverty (where subsidies end). In the first year, he can either pay $95 for the year or pay $4000 in premium (expected due to rich benefit mandate). Even if the percentage of income kicks him up to $1000/annually, is he likely to get coverage?

Some will but most will not. Keep in mind that they don't have coverage now!
Okay, coverage is now guaranteed issue which means a person can't be declined based on health. We don't know what the rules look like yet for open enrollment (when an uninsured can come on) but California tends to be lenient on this front.

Let's say that 40 year old (or a percentage of this 3rd pool) gets Cancer. They will then go get coverage and probably $40K-80K of medical expenses will hit the risk pool. Premiums will go...significantly. Here's where the feedback loop kicks in. At the next rate increase (partially driven by the adverse selection), more people will entertain going without coverage and guess what...only the healthy people would look at this. We lose more "good risk" and attract "bad risk" with guaranteed issue.

The penalty is designed to offset this adverse selection but it's not strong enough and although it's scheduled to go up over time, the premiums will be going up at a faster clip. Adverse selection is the death spiral of any insurance plan.

The Health Reform bill has built in a re-insurance (help the carriers for very expensive new enrollees) promise but only for the first 2 years of the plan so maybe we don't see the effects of adverse selection in the first two years. Of course, can the penalty ever catch up with the premiums and if there's pressure on the premium, the carriers will have to significantly squeeze the networks (doctors re-imbursement). The law of unintended consequences writ large.
 

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