Overseeing and Preventing Adverse Selection

States try to assure that the health insurance market does not separate healthier individuals into some plans and sicker individuals into other plans, a process known as “adverse selection.” When adverse selection does occur, premiums for plans with a disproportionate number of unhealthy enrollees may go into a “death spiral,” becoming ever more expensive as healthier people go elsewhere for insurance. States attempt to control adverse selection by overseeing plans’ marketing practices and by prohibiting insurers from increasing the premiums they charge to individual policyholders or from moving policyholders into different plans when they become sick, a practice known as re-underwriting.

Example: In Florida, an insurer reportedly moved individuals from one block of business to another and then raised their premiums by as much as 200 percent when they tried to renew their policies. In 2002, the Florida Department of Financial Services suspended the company’s license.¹  

Florida now prohibits the following: 

 “(10) Any pricing structure that results, or is reasonably expected to result, in rate escalations resulting in a death spiral, which is a rate escalation caused by segmenting healthy and unhealthy lives resulting in an ultimate pool of primarily less healthy insureds, is considered a predatory pricing structure and constitutes unfair discrimination as provided in s. 626.9541(1)(g). The Financial Services Commission may adopt rules to define other unfairly discriminatory or predatory health insurance rating practices.”

To further guard against adverse selection and encourage plans to accept groups and individuals with all levels of health care needs, some states have established “reinsurance pools” that assist insurers in paying claims for the highest-cost enrollees. In these situations, an insurance carrier pays an assessment (sometimes the state also contributes) to a reinsurance carrier, who pays any of the insurer’s claims that exceed a certain dollar threshold. Thirty states either allow insurers to voluntarily participate in a reinsurance pool or require that they participate in a reinsurance pool. The states that do not use reinsurance are as follows: Alabama, Arkansas, Georgia, Hawaii, Illinois, Kentucky, Louisiana, Michigan, Mississippi, Missouri, Montana, Nevada, New Mexico, Pennsylvania, South Dakota, Virginia, Washington, West Virginia, and Wisconsin.²

Example: In the Idaho Small Employer Health Reinsurance Program, in 2006, insurers are responsible for the first $13,000 in claims for each worker that they reinsure. Under the “standard” plan that small employers most commonly purchase, for the next $87,000 in claims, the insurer pays 10 percent, and the reinsurer pays the remaining 90 percent. The level of reinsurance coverage may be changed at the recommendation of the program’s Board to reflect increases in costs and utilization within the standard market in Idaho. Insurers pay premiums to the reinsurance carrier and, in addition, all small-group insurers can be assessed a fee if the premiums fall short of actual reinsurance expenditures.³

Example: The Healthy New York program uses reinsurance to make coverage more affordable to employers of low-wage and middle-wage workers and more affordable to low-income individuals who purchase insurance on their own. Employers of low- and middle-wage workers, sole proprietors, and low-wage individuals can buy coverage through participating HMOs. The HMOs are responsible for the first $5,000 of each enrollee’s claims. After that, the HMOs pay 10 percent of claims, and the reinsurer pays 90 percent of claims, up to $75,000 for any enrollee in a calendar year. The state itself pays for the reinsurance.⁴

[Return to top]