Saturday, August 01, 2009

A discussion of community rating versus experience rating in health insurance markets

I apologize for the technical title, but I thought readers should be made aware of an issue in US health insurance markets that needs to be fixed.

Community rating means that every enrollee in a health insurance market gets charged the same price based on the health status of the community. In other words, healthy people subsidize the sick. Some definitions of community rating allow insurers to charge based on demographic variables such as age bands, gender or tobacco use (this may be referred to as modified community rating in technical literature).

Experience rating means that individuals have their premiums set based on their own health status (i.e. the experience of the individual or group). For example, if I have diabetes, I would be charged a higher premium - assuming I'm even offered insurance.

In the US, the first health insurers generally offered community rating. When for-profit insurers came along, they used experience rating to offer cheaper premiums to younger and healthier people. This was good for the new entrants. However, the older, community-rated insurance pools had sicker people, and they had to raise prices. This set off a cycle, where sicker people tended to remain in the pool as prices rose and healthier people left. This is an example of adverse selection (link to Wikipedia article on the subject).

Briefly, experience rating basically prices sick people - and any of us could become sick - out of the market. In addition, you cannot have a market where some insurers are using community rating and some are using experience rating. The Democratic health reform proposals in the US Congress would all end experience rating. I am under the impression that many Republican Congresspeople supported an end to experience rating as well. To my knowledge, all the European countries with private insurance markets do not allow experience rating.

Rating bands are a related concept. Generally, a rating band of 2:1 means that the highest premiums in a market could be no more than twice the lowest premiums. This is after considering all factors on which you can rate people, so if a state did this, a (for example) 64 year old obese female smoker who had cancer, diabetes and heart failure would pay no more than twice a 20 year old healthy man.

The health reform proposals would generally impose tight rating bands in the individual and probably small group markets (companies in the large group market, over 200 or so enrollees, generally charge everyone in the group the same premium anyway). I don't think most states don't have rating bands, so if you're a sicker person, if you're even offered individual insurance you could probably pay more than 10 times that of a healthy person. If you impose a rating band where there wasn't one previously, though, younger folks would face significantly higher premiums than they previously did. They'll have to a) be subsidized and b) stop their damn griping.

Back to the concept of experience rating vs community rating. As I said, I thought this was a no-brainer concept that was settled long ago. However, to my dismay, I've recently seen two articles which condemn the move away from experience rating based on the flawed 'skin in the game' argument:

Government could also free up the private market to change the economic incentives to have better health. If people have skin in the game, preventable costs fall. Safeway and other companies have saved a lot of money with wellness programs, and increasing cost-sharing also has a huge effect. Yet Democrats are moving in the opposite direction, prohibiting insurers and employers from designing policies based on health status and limiting the financial involvement of patients in their own care.

Shawn Tumulty, of CNN Money, has an article where he directly condemns moving away from experience rating:

2. Freedom to be rewarded for healthy living, or pay your real costs

As with the previous example, the Obama plan enshrines into federal law one of the worst features of state legislation: community rating. Eleven states, ranging from New York to Oregon, have some form of community rating. In its purest form, community rating requires that all patients pay the same rates for their level of coverage regardless of their age or medical condition.

Americans with pre-existing conditions need subsidies under any plan, but community rating is a dubious way to bring fairness to health care. The reason is twofold: First, it forces young people, who typically have lower incomes than older workers, to pay far more than their actual cost, and gives older workers, who can afford to pay more, a big discount. The state laws gouging the young are a major reason so many of them have joined the ranks of uninsured.

Under the Senate plan, insurers would be barred from charging any more than twice as much for one patient vs. any other patient with the same coverage. So if a 20-year-old who costs just $800 a year to insure is forced to pay $2,500, a 62-year-old who costs $7,500 would pay no more than $5,000.

Second, the bills would ban insurers from charging differing premiums based on the health of their customers. Again, that's understandable for folks with diabetes or cancer. But the bills would bar rewarding people who pursue a healthy lifestyle of exercise or a cholesterol-conscious diet. That's hardly a formula for lower costs. It's as if car insurers had to charge the same rates to safe drivers as to chronic speeders with a history of accidents.

This is all part of their effort to pass “universal” coverage and gradually transition everyone into a single government program like Medicare, thus insulating people even more from the costs of their lifestyle decisions. Don’t expect to win the war on obesity by making the government fatter.

The basis of the skin in the game argument is that people make wiser decisions about their health when they're exposed to costs. If you have a copay for a doctor's visit (meaning that you have to cough up some sum of money, that it isn't covered fully by insurance), you'll be more careful about visiting the doctor for trivial reasons. Similarly, if you're exposed to some sort of financial penalty for being fat or sick, you'll be careful not to be fat or sick. I find the first half of the argument more compelling than the second. However, when insurers charge sick people the full price for their illness, the result is that sick people get priced out of the market.

As to the second, most people don't choose to become sick or obese. It sure sounds like the WSJ folks think obesity can be treated simply by charging obese people more in insurance - and if so, why do those idiots oppose taxing fatty foods? Obesity is not simply a matter of faulty choice. In addition, to my knowledge, you need quite a large financial penalty or bonus to get people to change behavior. Applied to obese folks, that could be viewed as discrimination.

Now, I'll deal with Tumulty's argument. In the first part of his argument, he argues that states which made their individual insurance markets community rated drove up costs for everyone, and drove the younger people out of the plan. He is actually correct. Community rating in isolation is not health reform, and healthy people will be unlikely to buy insurance as it will cost them more than they think it's worth. However, if you mandate insurance, you get everyone into the market, so that the healthy subsidize the sick. If you add marketing and other restrictions that prevent each insurer from attracting a healthier group of enrollees, so that healthy and sick people are evenly distributed among all insurers, you avoid situations where one insurer gets all the sick people. If you add subsidies, you make sure that no one is paying too much. Tumulty forgot to mention that.

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