How Much Risk Pooling Is There in the Individual Insurance Market

The potential for adverse selection is a key factor in the individual insurance market where enrollment is voluntary and people have an incentive to purchase coverage when they expect to have health care needs. Insurers in this market try to protect themselves against adverse selection by denying coverage to very high risks or by segmenting risks into groups that can be charged different prices—if they are free to do so under state law. Concern that these practices make individual insurance unavailable or unaffordable to those who most need it have led to efforts to more broadly pool risks in this market through reforms such as guaranteed issue and community rating (Blumberg and Nichols 1996). Risk separation can occur when insurers exclude high risks from the market completely, or when high and low risks are both sold coverage but are separated into different groups by plan design or by price. But the evidence on the amount of risk separation that occurs on either dimension in markets without reforms is somewhat mixed. A recent survey of carriers found that only 12 percent of actual applicants were denied coverage and only about 17 percent of those accepted had riders excluding certain health problems (Musco and Wildsmith 2004). However, this may understate the extent of risk separation if underwriting deters the less healthy from applying. We do not know whether this deterrent effect occurs, but a study of insurance offers to hypothetical insurance applicants with a range of health problems found potential access problems; 37 percent were denied coverage, and 40 percent of those accepted had riders that restricted covered benefits (Pollitz, Sorian, and Thomas 2001). Some studies have shown that those purchasing individual insurance are in better health than those who are uninsured, consistent with underwriting denials or high mark-ups (e.g., Hadley and Reschovsky 2003). On the other hand, even in a market with guaranteed issue and community rating, those participating in a program subsidizing the purchase of individual coverage were healthier than otherwise similar people who remained uninsured (Swartz and Garnick 2000). Among those purchasing individual policies, evidence on risk separation and pooling is also somewhat mixed. Some have said that the diversity of products in the individual insurance market reflects insurers' attempts to separate risks because low and high-risk people will choose different benefit designs (Chollet and Kirk 1998). In addition, there is substantially more variation in the cost of insurance policies than can be accounted for by variation in the benefits, suggesting possible differences in the health of those in different health plans (Cutler 1994). And in some markets that have tried to force risk pooling in the individual market, there are signs that the market is not sustainable (Monheit et al. 2004). At the same time, a number of authors have suggested that there may be more pooling in the individual market than commonly supposed. Pauly and Herring (1999) find that premiums increase with health risk, but that the relationship is far less than would be expected with perfect risk rating. In fact, a 50 percent increase in risk is associated with a premium increase of less than 10 percent (Pauly, Percy, and Herring 1999). Analyses of choices by low- and high-risk purchasers of individual insurance conclude that the two groups do not purchase policies with significantly different benefit designs (Browne and Doerpinghaus 1993). We expect that there may be greater pooling for those who remain enrolled in individual health plans for a period of time, even if there is risk separation at enrollment. Guaranteed renewal, required by the Health Insurance Portability and Accountability Act (HIPAA), means that those who become sick cannot be excluded from the pool and, in practice, they generally are not placed in a new underwriting class.1 This practice provides some degree of protection in the event of becoming sick; for those who remain in the individual market over a period of time there may be greater pooling of long-term risk than of risk at entry (Pauly 1992; Patel and Pauly 2002). But few studies have been able to explore the effect of duration in plan on pooling. The purpose of our study is to further examine how much pooling of risks occurs among potential purchasers in the individual insurance market, how much pooling occurs among those who purchase coverage, and how this varies with duration of coverage using data from an unregulated market.