Question

In health care adverse selection leads to insurance companies wanting to sell plans on the basis of individual members' general level of risk and health history.

What are three methods insurance companies reduce adverse selection? Please explain briefly the reason as to why they use these methods and cite any sources possible.

Answer 1

Adverse selection refers generally to a situation in which sellers have information that buyers do not have, or vice versa, about some aspect of product quality—in other words, it is a case where asymmetric information is exploited. Asymmetric information, also called information failure, happens when one party to a transaction has greater material knowledge than the other party.

Insurers claim that high-risk customers are more likely to take out and charge higher insurance premiums because of adverse selection. When the company pays an average rate but only sells high-risk consumers, by paying out additional incentives and claims, the company takes a financial loss. Nonetheless, the insurer has more money to pay these incentives by increasing premiums for high-risk policyholders. Of example, of race car drivers, a life insurance company pays higher premiums. A car insurance company pays more for high-crime drivers. To tobacco patients, a health insurance company pays higher premiums. By addition, due to increased premium premiums, consumers who do not engage in risky activities are less likely to pay for coverage.

There are several ways to avoid and discourage adverse selection by health insurance companies. Nonetheless, government regulations prohibit the use of some of these methods by health insurers and restrict the use of other methods.

Health insurance companies would use clinical underwriting to try to avoid adverse selection in an unregulated health insurance market. The underwriter reviews the medical history, ethnicity, previous statements, and lifestyle choices of the applicant during the underwriting process. It seeks to assess the risk posed by the insurer in insuring the individual applying for a plan of health insurance.

Most health insurance companies in the United States are no longer allowed to use most of these strategies, although they were commonly used before 2014 on the consumer (non-group) market. The Affordable Care Act forbids those with pre-existing conditions from refusing to sell health insurance.
Insurers are forbidden from charging people with pre-existing conditions more than safe people are charged.
Prohibits health plans to enforce annual and lifetime benefits limits.

The ACA also places restrictions on when people are allowed to participate in an individual market health plan so that people can't wait until they're sick to buy health insurance or know they're going to pay health care costs. Individuals are only eligible to sign up for health insurance during the regular open enrollment period every fall or during a time-limited special enrollment period induced by certain life events such as loss of job-based health insurance, marriage or relocation to a new area

Such short enrollment periods have already been extended for employer-sponsored health insurance and Medicare, but prior to 2014, individual market policies were available year-round — with medical underwriting in almost every country.