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The Power of Positive Selection

We have always known that those who purchase health insurance products know more about their own risk than the insurance companies who issue such products. Now, in the aftermath of the pandemic, we are gaining further confirmation of this basic truth.

Medical loss ratios certainly hit an all-time low in the second quarter of 2020. One very effective way of reducing healthcare utilization is to close the hospitals and doctor offices. Loss ratios went up in the fourth quarter with a bit of catch-up work being done. However, it seems that they have come back down a good bit in the first quarter of 2021. We may be seeing that some of the work that was postponed in the second quarter of 2020 will never be done at all.

Of more interest are three market developments that seem to be attracting insured populations with low utilization. They are short-term medical, small-group self-insurance, and reference-based pricing.

Short-term medical plans received special treatment in the Affordable Care Act (ACA) because their market was perceived not to be broken. Specifically, these plans could retain their pre-existing condition exclusions. Thus, prospective insureds who had pre-existing conditions were best advised to stay away from short-term plans and purchase the new individual plans on the exchanges.

Those who had pre-existing conditions and did purchase short-term plan found their claims to be denied under the contract. As one would expect, short-term plans have attracted a healthier group of insureds (positive selection), and their loss ratios are running lower than expected.

Self-insured medical plans also received special treatment under ACA. Again, their market was perceived not to be broken. As a result, they were exempted from requirements for guaranteed issue and modified community rating. Smaller groups were soon attracted to self-insured plans, particularly those with healthy covered members.

Stop-loss arrangements were quickly adopted to the risk dynamics of smaller groups. Groups with less favorable risk characteristics were more attracted to the fully insured plans under ACA. We are now seeing favorable claim experience (positive selection) for small groups who are self-insured.

The final market development is reference-based pricing. Under this arrangement covered charges for medical services are defined as a percentage of those allowed under Medicare. Since Medicare generally imposes very low fee schedules on healthcare providers, reference-based pricing often results in very substantial discounts from billed charges. The challenge is that healthcare providers have not agreed to accept these fee levels. Some providers are sending balance bills to patients covered by plans that use reference-based pricing.

Most plans will work with providers to resolve the situations, and reference-based pricing is becoming more common. However, prospective insureds who are expecting to incur medical expenses soon are likely to shy away from plans with reference-based pricing. Again, the net result is low loss ratios (positive selection) in plans sold with reference-based pricing.

Insurance companies will never know as much about the health status of prospective insureds as those insureds know about themselves.

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