Imagine you’re in a meeting with your benefits consultant discussing the upcoming medical renewal. Your company offers more than one type of plan to employees so employees can choose what they want based on their needs. However, your consultant warns you about “adverse selection” and talks about how careful steps will need to be taken to avoid it, but what is adverse selection in the first place?
Sick in Need is Sick Indeed
Adverse selection occurs in insurance when there is an imbalance of high-risk, sick individuals to low-risk, healthy individuals enrolling in benefits. This can lead to an atypical distribution of high utilizers of an insurance plan compared to low utilizers. Left unchecked, it increases financial risks for insurance companies and causes higher health insurance premiums for employers and employees. Adverse selection can occur in all types of insurance, but for the sake of today’s question, we’re focusing purely on medical insurance.
For example, imagine you offer two medical plans. One is a high deductible health plan that is fairly inexpensive to enroll in, and the other is a traditional plan with a lower deductible that is a little more expensive to enroll in. An employee who hardly ever needs medical services is very likely to pick the high deductible health plan because it results in less money coming out of their paycheck. Meanwhile, an employee who is managing a chronic condition or taking expensive medications is more likely to sign up for the traditional plan, despite it being more expensive because they want a lower deductible or need prescription copays.
If this example is repeated through the entire employee population, you will likely end up with all of your healthy employees enrolled on the cheaper high deductible health plan and your high-utilizing employees enrolled in the traditional plan. The claims spend on your traditional health plan will quickly outpace the amount of premium that is being put in and the insurance company will need to raise costs the following year to compensate.
How to Avoid the “Death Spiral”
When adverse selection is allowed to continue unchecked, it results in a “death spiral” that causes insurance companies to lose money on certain plans and consequently no longer offer them as a result. So how can an employer situation their benefits to avoid adverse selection?
- Work with your benefits consultant to create financial incentives for high-utilizing employees to enroll in other plans
- Work with your benefits consultant to create a contribution model that helps prevent adverse selection
- Educate your employees on the difference between deductible and out-of-pocket maximum, as other plans may have less exposure for employees without them realizing it.
- Ask your benefits consultant if claims reports are available for your plan. Note: there is usually a minimum company size before the insurance company will share claims data with you.
Author: Arwyn Robinson – SHRM CP
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