Risk Selection and Risk Adjustment: Improving Insurance in the Individual and Small Group Markets

Article excerpt

Insurance market reforms face the key challenge of addressing the threat that risk selection poses to the availability of stable, high-value insurance policies that provide long-term risk protection. Many of the strategies in use today fail to address this breakdown in risk pooling, and some even exacerbate it. Flexible risk adjustment schemes are a promising avenue for promoting market stability and limiting insurer cream-skimming, potentially providing greater benefits at lower cost. Reforms intended to increase insurance coverage and the value of care delivered will be much more effective if implemented in conjunction with policies that address these fundamental selection issues.

The individual and small group markets for purchasing health insurance in the United States are widely acknowledged to function poorly. Several features of these markets undermine the pooling of risks, expose people to premium increases if they fall ill, cause job lock, and reduce insurance coverage among those most in need of health care. Furthermore, insurers engage in a variety of costly and welfare-reducing activities designed to attract healthier enrollees and to avoid attracting the ill.

These are issues both of equity and of efficiency. These insurance market failures are broadly inefficient because they make it more costly to obtain the valuable financial protection that insurance affords, and result in resources being devoted to socially wasteful activities that do not improve health or economic well-being. They are also a matter of equity because the burden of the market failures is likely to be borne disproportionately by the sick and poor, who must spend extra for their insurance or become uninsured. Many people regard this as particularly inequitable since most modern societies choose to redistribute resources toward those in poor health. The issues of equity and efficiency are intertwined: if society has a strong interest in ensuring that all of its members have access to at least basic health care and financial protection, then promoting the lowest-cost solutions to market failures, and finding a way to redistribute resources that does not exacerbate these market failures, will also make providing a social safety net more affordable.

There are many possible government interventions to address these problems; some are in use now and others figure prominently in health system reform proposals. These interventions have varied goals. Many seek to reduce the ranks of the uninsured, promoting insurance that people obtain when healthy and that is stable if they become sick or change jobs. This kind of stability would lower uncertainty about individual future premiums and reduce volatility in market-level pools. A second goal is fostering high-value insurance. This implies both minimizing distortionary risk selection activities (such as when insurers structure policies to avoid enrolling high-risk populations) and fostering competition among insurers to offer innovative and efficient policies (so that profits depend on improving value, rather than avoiding high-risks). A third goal is cost containment. One strategy for minimizing utilization of care with low value among the insured (moral hazard) is increased use of cost-sharing--the challenge is to do so without creating an incentive for inefficient skimping. Cost containment is particularly important when much of health care spending is financed by public revenues that impose a drag on economic growth.

Unfortunately, many interventions progress toward some of these goals at the expense of exacerbating other problems. One of the key threads that connects these outcomes is the effect of policies on risk selection and pooling. Premium regulations intended to make insurance affordable for high-risk populations, for example, may increase insurance coverage of the sick, but decrease coverage of the healthy (Herring and Pauly 2006). In evaluating policy choices, it is thus essential to consider the incentives they generate for individuals, employers, and insurers to manage health risks and health spending. …