Be careful what [guarantees] you ask for

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By James T. O'Connor | 14 January 2008


Jan. 14, 2008

Most Americans support a guarantee of health coverage, and some states have enacted guaranteed issue, which has implications for insurance markets.

We asked Milliman Principal Jim O’Connor to provide some perspective on this issue.

Q: Guaranteed issue can lead to adverse selection. Why is this?

A: It's human nature for people to seek out the best deal they can get. People who are young and healthy typically haven't used the healthcare system much and are less inclined to seek health insurance coverage, whereas people who are less healthy are more likely to seek out insurance. Unless there's some kind of screening of health insurance applications and a preexisting condition limitation, people tend to wait until they become sick before actually seeking health insurance. A purely guaranteed issue market, without certain controls, will be selected against because it will attract the sickest—and most expensive—people without attracting healthier—less expensive—populations. This results in adverse selection and spiraling health insurance costs.

This unintended consequence is important to note, because availability of coverage is generally not a problem. Affordability is the greater concern. Simply requiring a guaranteed issuance of coverage will not improve the affordability of coverage and, depending on the other requirements in place, may very likely make coverage even less affordable for most people because of the adverse selection it invites. So guaranteed issue can have the opposite effect of that intended as health coverage becomes less affordable.

Q: Why does the promise of guaranteed healthcare put pressure on the individual insurance market in particular?

A: The majority of the population is currently covered under employer and/or government benefit plans, but there are roughly 17 million people who are in the individual market. It's a growing market, in part because more and more employers are either reducing the subsidies they provide toward their employees' premium or simply eliminating coverage. This is particularly true for dependent coverage and retiree coverage. As a result, those seeking dependent or retiree coverage are increasingly finding better deals from an individual policy than they are from their employer group policy, particularly if they are healthy.

One of the key differences between group coverage and individual coverage is related to selection issues. Because individual insurance involves a person-by-person purchasing decision, the selection issues are far greater than those that occur in an employer group situation where the employer is making the benefits decisions. Because of employer premium subsidies, a group policy is far more likely to include healthier people who help offset the cost of the unhealthy. This is not the case with individual insurance, especially when you remove underwriting.

Without underwriting, individual insurers end up getting an unbalanced share of less healthy people, driving premium costs even higher, which makes individual coverage less and less affordable for those people who view themselves as very healthy. The healthy people thus opt out of the system, further exacerbating the selection issues. And as the cost of individual coverage goes up, those who are looking there for affordable dependent coverage may run out of options.

It should also be noted that the vast majority of applicants for individual medical plans are offered coverage by insurance carriers and health plans. Those declined because of a medical condition can enroll in a high-risk pool, a form of guaranteed coverage that most states already have in place. Or they can get coverage through some other state-provided guaranteed-access mechanism. Only eight states appear to not guarantee access to every individual, although even these eight states have systems or regulations to provide guaranteed access to many, if not most, people seeking coverage in the individual market.

Q: Is there a way to make a guaranteed issue work for the individual market?

A: Yes, but there are certain requirements if you're going to make sure that a viable and competitive individual medical insurance market will continue to operate. First, insurers need to be able to vary rates based on health status and demographic characteristics. Varying rates allows the carrier to recognize differences in health status and expected costs and cover some of the excess costs that are due to the adverse status of less healthy applicants. A second requirement is a meaningful preexisting condition provision, which gives people an incentive to apply for insurance before they get sick. Without such a clause, there is no reason for a young, healthy person to seek coverage, and these are the people you need buying policies in order for the individual market to work. Third, a structure through reinsurance, government, and/or industry pooling is desirable for equitably distributing catastrophic risks.

For example, the state of New York is guaranteed issue, allows only a relatively weak preexisting condition clause, and does not allow carriers to vary their rates by age and gender—everyone gets the same rate, with some variance based on geographic location. Subsequently, New York's rates are perhaps the highest in the country and many individual medical insurance carriers have pulled out of the state or will not sell there. So even though you've got guaranteed issue, the general availability of individual health insurance is more limited than in many other states and it is likely available only at a relatively higher cost. It's a classic catch-22.

Guaranteed issue with an actuarially sound rating structure that allows rating variation in light of individual risks and an adequate preexisting condition limitation provision can potentially work for the individual market, particularly if coupled with a catastrophic risk pool funded by a combination of government and all health plans, including group plans and health reinsurers.

Jim O'Connor is a principal in Milliman's Chicago office.