[FoRK] Adverse selection in insurance

Stephen Williams sdw at lig.net
Sun Oct 18 20:49:45 PDT 2009

Benjamin Black wrote:
> Gordon Mohr wrote:
>> But what if, instead of buying health insurance at going rates, some
>> individuals are spending several times the cost of insurance on
>> discretionary pleasures like first-run movies, cable television, video
>> games, leisure travel, live events, or designer clothes -- or even
>> gambling, tobacco, alcohol, or other drugs? What if others with the
>> exact same income allocate it to health insurance instead?
>> *Then* can we economic tricksters and market religion true-believers say
>> these individuals "choose not to pay those rates"? Or is there still an
>> objection?
> Certainly!  Now you just have to prove that is what is going on.  That
> they are not properly insured we know.  That they are _choosing_ that
> state (by deciding health insurance is useless, by buying luxuries,
> etc.) we do not know.
> b

There is more nuance than that they just don't choose to buy insurance.  
For one thing, if you are not able to buy into a good group insurance 
plan at your employer, health insurance may look drastically less 
attractive and less rational than it does for most of us most of the 
time.  It is a fairly large step function.  Add to that the fact that 
most companies at least partially subsidize health insurance.    
Additionally, few insurance companies will agree to insure an individual 
who is middle-aged or beyond or who has practically any pre-existing 

Anyone not working for a company or agency large enough to have a 
reasonable negotiated group plan is pretty much completely left out of 
the insurance market unless they are young and have never had any issue 
in any of a large number of categories.  This especially includes 
self-employed entrepreneurs, which is ironic since the GOP likes to go 
on about how health-care reform would hurt small business.  In truth, 
the current system benefits large companies much more.

I will use myself and my current state, California, as an example.  I'm 
in probably the top 5% or better of my age group for healthiness, being 
in shape, having the lowest risk factors for cancer of any kind, heart 
disease, diabetes, etc.  I ran a 5 hour marathon earlier this year, and 
a couple more in the last few years.  I periodically go for 9-12 mile 
kayak trips in big waves on the bay or off the coast of Oahu.  I can 
keep up with the Oahu hiking club for very strenuous mountain hikes.  
Low to optimum blood pressure.  Etc. Etc.  I have no detectable medical 
issues that are severe, might get worse, or could be expected to cause 
any significant expense, ever.  And I have an FAA medical certification 
to prove a lot of that.

Earlier this year, while on COBRA and a self-employed consultant / 
entrepreneur, I found that I could not qualify as an individual for any 
health insurance plan in California (or anywhere in the US apparently).  
My last company had paid my insurance at 100%.  If I could have 
qualified, a substantially worse (much higher deductables, copays, 
limitations, etc.) plan than my old employer was paying $450/mo. for 
would have cost me about $800/mo. (with some quotes at $1200/mo.)  Since 
I did not qualify, my only option after 18 months of COBRA was to try to 
get a HIPAA / MRMIP plan, which seems unlikely: [1], or to go to work 
for another larger company.  So, I now work for a larger company and pay 
about $185/mo. after ~$400 subsidy.  (All my rates are adult+children, 
but not family (i.e. 2 adults + children.))

If someone doesn't have health insurance, they generally cannot afford 
it and often cannot get it anyway.  Since they can get emergency 
coverage in most counties most of the time, sooner or later, it only 
takes a little fatalism or general avoidance of medicine to make health 
insurance seem like a bad idea.  Additionally, if you have health 
insurance, you are presumed by the medical system to be able to pay 
whatever you may incur.  If you can barely afford health insurance, you 
are likely to then incur copays and deductables that are then beyond 
your remaining budget.  If you had not had health insurance or any 
reasonable income, you would have been put in the destitute bin and not 
had an issue.  If you have health insurance, you'll have bill 
collection, credit, and other issues pretty much forever.  The net 
result is that unless you have substantially more income than just 
covering health insurance premiums, it may not appear to make sense to 
pay for your own health insurance.

So, back to:

The "June report" says:
> To address adverse selection risks, most insurers use medical 
> underwriting and incorporate a risk premium into the actual price of 
> coverage. As a result, the price of health insurance that a typical 
> person would face in the individual market greatly exceeds the average 
> cost of covering him or her. Moreover, a significant proportion of 
> individuals may be uninsured because they are denied coverage as a 
> result of medical underwriting.

> The first sentence says that adverse selection is not just a, but the, 
> most important market failure. But then the next three sentences deny 
> that adverse selection is a problem: under adverse selection, people 
> of different risks tend to be charged the same premium--that's what 
> leads to adverse selection. But the CEA notes correctly that insurers 
> are not so ignorant--they use medical underwriting.

The report is not denying that adverse selection is a problem: they are 
saying that the presence of that problem led the insurers to charge 
higher rates to lower risk people to counter the problem.  Does he not 
understand or is he being willfully ignorant to try to make a biased and 
unsupported point?  The report's usage of "incorporate a risk premium" 
is indicating that they are charging more for people than underwriting 
would indicate is appropriate without the presence of adverse selection 

Henderson doesn't get it: The insurance companies are preventing adverse 
selection by charging all individuals high risk rates on the assumption 
that only high-risk individuals would pay those rates.  Since they 
screen out high-risk individuals to begin with, it is only the high risk 
that might slip through that they are trying to prevent being gamed by.

Why does auto insurance not have this problem very much?  A) Everyone 
driving has to have insurance and B) much of insurance is for things 
that other people do to you, and C) the potential losses are much more 
limited and predictable.

Note: California has 55 million residents, but an MRMIP high-risk pool 
cap of 7,100 enrollees, which is often closed.
> California has ousted Blue Shield, the state's second-largest 
> not-for-profit health plan, from the state's high-risk medical 
> insurance pool because its premiums were too high.
> The pool, known as the Major Risk Medical Insurance Program, or MRMIP, 
> insures more than 6,700 Californians who have been shut out of the 
> private health insurance market because of pre-existing conditions.
> Through MRMIP, such people are able to buy coverage from private 
> insurers at premiums that are supposed to be 25% higher than the 
> market rate for a comparable policy. The state reimburses the insurers 
> for any losses they incur.
> ...
> High-risk pool officials said they put Blue Shield on notice last year 
> over concerns about its high premiums. And the insurer's participation 
> slipped to about 80 enrollees this year.
> Blue Shield's "rates continue to be at a level far higher than the 
> other plans' rates," PriceWaterhouseCoopers said in a recent report to 
> the MRMIP board. For single subscribers, the report said, Blue 
> Shield's 2010 proposed rates would have been "1.5 to nearly 3 times 
> higher than those of the other plans."

> MRMIP, the high-risk pool, is capped at 7,100 enrollees and is often 
> closed. But, as of its last count, the program had room for about 200 
> new enrollees.

Therefore, I have first-hand proof that the current arrangement is 
severely broken.  Adverse selection should be addressed, and it will 
probably only be addressed by new regulation.  Probably by requiring 
everyone to be covered, possibly by assigning high-risk individuals 
randomly as a fair percentage of every company's pool.  I really don't 
like the latter, however if high-risk were defined with a much higher 
threshold, it might not be bad.


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