Buckle Up! A Summary of Adverse Selection Pressures on Health Insurance Exchanges


For most households, the marginal costs of acquiring health coverage on an exchange are within shouting distance of the annual cost of a new car (Exhibit 1); and, the odds of health costs (if uninsured) exceeding costs of coverage (if insured) are less than 50 pct (Exhibit 3). Among subsidy-eligible households, in many cases net premium costs are higher for younger (and presumably healthier) than for older (and presumably sicker) beneficiaries with similar incomes (Exhibit 4). It follows that many households – especially younger and healthier – may choose not to purchase coverage

Assuming households that do purchase coverage do so optimally, +/- 80 pct of households would buy the cheapest (Bronze) coverage and the remainder (+/- 20 pct) the most expensive (Platinum) coverage. By purchasing the cheapest plan, healthy households (the 80 pct on Bronze) minimize their payment of excess premiums (premiums above their costs of care), and thus minimize the extent to which they subsidize households (the 20 pct on Platinum) whose medical costs exceed premiums paid

Small employers with younger and healthier employees can almost certainly save by self-funding, i.e. by avoiding the exchanges entirely. Stop-loss policies to self-funding employers can be priced to reflect a specific employer’s health risks, where fully-insured policies on the public exchanges cannot. This is likely to result in small group exchanges consisting of significantly worse-than-average health risks

We believe that the Affordable Care Act’s (ACA’s) provisions for limiting adverse selection are too weak (e.g. penalties for being uninsured are too low), or even counter-productive (higher effective premiums for younger than for older subsidy-eligible beneficiaries at a given level of income). The Act’s provisions for risk sharing are relatively strong; however these only serve to ensure equivalent relative exposure to unsustainably high absolute risks

Conclusion: Enrollment in individual and small group exchanges will be much less than originally (and perhaps even currently) expected; sellers of alternatives to full risk policies (ASO services, medical stop-loss insurance) in the small group markets will see accelerating demand; and, additional legislation and/or regulatory rule-making (i.e. further reforms) may be necessary soon after the exchanges begin operating

Cigna (CI) is a notable beneficiary of rising demand for ASO services and medical stop-loss in the small group market. Health Net (HNT) and Aetna (AET) are relatively exposed to small group risk, and stand to lose from a shift by employers (with healthier workers) to self-funding. AET’s acquisition of Coventry, completed last week, increases their exposure

Risks to other insurers have less to do with adverse selection (you can see it coming and price for it; and, the ACA ensures the risks are more or less equally shared), and more to do with the high likelihood that adverse selection forces new – and potentially adverse – legislation and/or rule-making

For our full research notes, please visit our published research site.

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