Adverse Selection - Why Insurance Costs What It Does

[Scott 2]

I stumbled across this lay accessibe discussion of adverse selection:

https://yalebooks.yale.edu/book/9780300 ... -business/

It's a good explanation of why insurance costs what it does and how the pitfalls arise. With medical care being such a large financial consideration, it's worth understanding.

The healthcare challenge is keeping non risky people in your insurance pool. If everyone participates, prices stay low and subsidizing the risky is affordable. When prices climb, the healthy leave, causing prices to climb further. This creates a spiral that eventually collapses the risk pool.

One way it manifests is healthy insurees fleeing to lesser quality plans. See the loss of PPOs in some states. This is an early symptom of a collapsing market.

Counter intuitively - subsidizing the healthy participants is a way to stabilize the risk pool. You give money to the young and healthy - those who least need it. Mandates also help, though they need some sort of enforcement. The ACA originally had a financial penalty. It still has the fixed enrollment period, which is a form of mandate.

What's especially interesting to me, is the implication for early retiree healthcare. By maxing out premium subsidizes and cost sharing, I felt like I was beating the system. If someone called me a free loader, I wouldn't argue. But the system, is working as designed. The money is there to incent me into the risk pool, keeping prices down for the least healthy.

Given how nuanced maintaining a risk pool can be, it's a little astonishing the ACA has survived. I found a market driven discussion of the process interesting.

Understanding it all helps in deciding what other insurance products to consider. I know dental is nothing more than a pricing plan, but this book explains why. It makes obvious why certain products just don't work.

[suomalainen]

I didn't read the article, but have read articles in the similar space over the years. Adverse selection / healthy people fleeing the health insurance pools is just a sliver of the problem. Some of the reasons they are fleeing the pools is: 1) they can. I believe the ACA attempts to address this by taxing you if you don't have a health plan, but perhaps the tax isn't all that material. I don't recall the specific number. 2) health insurance is getting more expensive because a) health care itself is getting more expensive, largely driven by pharmaceuticals which is itself driven by americans' obsession with pills and easy fixes, b) there is a very small number of very unhealthy chronically ill patients that consume an enormous percentage of available resources. Some (much? most?) of that is lifestyle diseases such as from smoking, drinking and eating shit food. and c) americans are not culturally (generally and specifically in medicine as well) attuned to the idea of quality vs quantity. More healthcare is obviously better, right? Just like everything else? Supersize me! In any event, no real thought is put into the quality of an extended life; the default assumption is that a doctor's job is to extend life at all costs. It's up to a patient (who has no cultural or personal training to do so) to decide for themselves at their own initiative whether it's "worth it" and so very few will turn down even a small percentage chance at an extended life even if the prognosis is for that life to be of shitty quality. and d) mixed in to both b and c is the poor interface americans have with the health care system. The entry point for the vast majority of care is the emergency room. Emergency rooms by law must take in and care for patients regardless of ability to pay. Hospitals/emergency rooms know the default rate, if you will, and so their prices are inflated because they have to account for the number of folks they actuarilly know will be unable to pay. Call it ... stealth insurance. Geddit?

In short, health care would be much cheaper if we let the super sick die, but that's a conversation no one wants to have, which is dumb, because if we had the conversation, we could just agree as a society that "well, it's super expensive, but our values are that we can't let people die if we have even the smallest chance of extending their life, no matter how shitty it is." Instead, we make that agreement implicitly while, incidentally, also forcing people to live shitty lives even when they want to die. I think having both is fundamentally cruel. If you're going to value an individual's life no matter the cost to you (society), fine, but you can't also value an individual's life no matter the cost to them individually. Small government indeed.

[Sclass]

Timely you brought this up. I just cancelled my dental (ACA) after a few days because I realized it cost a few dollars more than paying cash. DOH! Good teeth are cheaper than insurance.

How do they know you are healthy enough to incentivize you? Just age?

I try to self insure for the most part. The underwriters aren’t fools. They’re going to make money at the end of the day. So who is left to pay?

After retiring I realized the insurance for the most part is for people who are forced to keep things they cannot afford to lose. The people with money provide guarantees to those without money for a small recurring cost. It’s a form of banking. Or gambling. Once you have money then you can focus on reducing liability and limiting the need for underwriting.

Health is trickier. Stay healthy. Brush and floss.

[Frita]

There seems to be no incentive for older healthy people with the ACA. It is assumed that increased age means a host of medical issues. That is not necessarily true. There is no discount offered.

Our denial is massive. Every living thing dies. Sometimes that living thing has a genetic, environmental, or self-imposed condition that is not conducive to life. Being able to die with awareness, love, and peace is the next frontier. IMO The insurance, medical, and consumer-orientedness mine for and maintain fear.

[Scott 2]

@sclass - The incentives don't consider my personal health status. They make assumptions about the market as a whole, including age. The set of balancing factors is too complex to articulate well in a post. Even the book I linked above is only a starting point, that obfuscates a lot of complexity. Which is precisely why it becomes such a regulatory challenge. Managing public sentiment on something a small handful of people truly understand? Not easy.

Rather than attempting to solve the global problem, I find value in informing my personal strategy.

I choose to insure against only those risks I cannot afford. That should have a cost. Because the reduction of risk is valuable to me, it's possible I can benefit while the insurer profits. Even better though, if I can get into a "superior" pool than my true risk. Hence underwriting. The book talks about the impact of information asymmetry and how both parties attempt to mitigate it.

Providers also decide which risk pools to join, when they choose which insurance networks to accept. Due to associated pricing rules, this can influence personal choice of insurance. My dentist does not offer a discounted cash price. I assume this maximizes his insurance reimbursements. So my most affordable option for his services, is a specific dental plan. His cash price of preventive care, equals my insurance premiums plus deductible. Only now I also have the benefit of insurance. And I've prepaid my commitment to preventive care, which encourages compliance.


@suoma - I agree there are many flaws with the existing system. And they are confounded by societal factors.

I appreciated the explanation of how they manifest into pricing. A robust risk pool can absorb some faults. Rather than expect perfect behavior, it mitigates and dampens bad behavior. My motivation is optimizing personal strategy, rather than solving the global problem. I've evolved my strategies through trial and error, but there are underlying reasons they work. I favor a VC backed hospital system, specifically their offices in a wealthy county. I'll bemoan the profit seeking, but they are great at pruning the risk pool. It's my best option with good reason.

Of course there's a global social cost. The public hospitals experience adverse selection of their risk pool. More ER freeloaders. A higher percentage of under insured and uninsured. Patients less likely to engage in preventive care or comply with prescribed treatment. Hence the bifurcated healthcare system many now experience. All the more value in optimizing personal strategy.

The book uses this fictional example. As a health insurer - put your agents on the 5th floor of a walk up, with no elevator. By excluding anyone who won't climb those stairs, you'll get a better risk pool.

Opportunities like this abound in life. They aren't limited to our health insurance. We make choices that pool risk daily. Even something as simple as when to drive. Too bad I can't buy car insurance that's only in effect on weekdays from 10am to 2pm. I'd save so much money.


@Frita - I agree, the current system does not incentive healthy older people. It's a symptom of attempting to optimize the global risk pool. As one makes the transition into Medicare, understanding how risk pooling works again becomes valuable. The books talks about interplay between Medicare Advantage and Medicare Original plans, and associated costs. TLDR - If you can afford it, locking in Medicare Original plus a Plan G at initial enrollment is likely optimal.

[theanimal]

The healthcare challenge is keeping non risky people in your insurance pool. If everyone participates, prices stay low and subsidizing the risky is affordable. When prices climb, the healthy leave, causing prices to climb further. This creates a spiral that eventually collapses the risk pool.

Well, yes and no. Everyone participating in health care means that insurance companies have to take on everyone regardless of their conditions. The equivalent would be like a mandate for home insurers to insure coastal homes in FL that get hit by a hurricane every other year. ACA made the risk pool significantly worse because they have to take on everyone.

What's especially interesting to me, is the implication for early retiree healthcare. By maxing out premium subsidizes and cost sharing, I felt like I was beating the system. If someone called me a free loader, I wouldn't argue. But the system, is working as designed. The money is there to incent me into the risk pool, keeping prices down for the least healthy.

The interest of insurers is to have a good risk pool that will result in lower losses and profitable business. But that is not the interest or purpose of ACA. Its purpose is to provide everyone the option of affordable health care who otherwise wouldn’t be able to afford it. While the insurers would be happy to have a healthy person like you as part of their pool, the subsidies usually don’t go to someone like you and that is not what they are designed to do. Pricing for plans is tied to income, with the most subsidies and incentives going to those who have the least amount of money. As you mentioned, this class of people also tends to have more health problems than those higher on the income scale, meaning more costs for the insurers. If it was an unregulated market, they would not subsidize this group. There aren’t many people in your position that are healthy, with money and can qualify for subsidized plans. So yes, you are beating the system, as am I and many others on here.

Counter intuitively - subsidizing the healthy participants is a way to stabilize the risk pool. You give money to the young and healthy - those who least need it.

My mom’s health care plan has offered financial incentives the past few years for walking. She has 3 metrics she needs to hit each day- total steps, activity every few hours and another I can’t remember. For each of those she can earn $1 per day. The past 2 years she earned over $900 each year which she can put directly into her HSA.

It seems like its easier to reward healthy behavior rather than trying to figure out who is healthy, at least from my perspective. In auto insurance, we reward “healthy” policy holders (no accidents/claims) with lower renewal rates. It’s hard for me to imagine how you would be able to do the same in health care.

Given how nuanced maintaining a risk pool can be, it's a little astonishing the ACA has survived. I found a market driven discussion of the process interesting.

It has survived because it is a financially subsidized government mandated program. Take out the subsidies and I’m sure a few of these companies enter the death spiral that you mentioned above.

[Scott 2]

Fair points on the global design of ACA. Siphoning people off to Medicaid helps make the premiums more palatable as well.

The book talks about how condition based reimbursement was attempted to discourage insurers from adverse selection. A patient with high blood pressure gets the insurer an extra $100 per month from the government, for instance. This leads to a cat and mouse game, where the insurer now includes those reimbursements in their profit strategies. Especially as treatments and drug pricing change, there are inefficiencies to exploit.

My mom’s health care plan has offered financial incentives the past few years for walking.

This is a form of adverse selection. As is my insurance company's fitness program. Healthy people will favor plans with such features. We see it as a way to "win" insurance. That improves the risk pool, making more money for the insurer. Beyond whatever health benefits the individual gets.

Eventually every insurer has to offer the programs, or their risk pool becomes unsustainable. Then a new game begins.

[Sclass]

There aren’t many people in your position that are healthy, with money and can qualify for subsidized plans. So yes, you are beating the system, as am I and many others on here.
.

Thankfully we are outliers.