How Maine Health Insurance is Supposed to Work, and Doesn't

How Insurance is Supposed to Work, and Doesn't

The underlying principle behind insurance is simple: everyone pays a little in order to have funds on hand to pay the medical bills incurred by a few. This principle is dramatically illustrated by the fact that 80% of the costs of care for a large population of people will be incurred by about 20% of the individuals in that population. This principle is described as "pooling" risk for health care expenses and it works best when the risk is distributed across a large population.

This basic concept starts to break down when there is "fragmentation" in the risk pool. Fragmentation means that a population of individuals is divided in one or more subgroups and separate premium costs are calculated for these groups. To the extent that the underlying health risk (and likely costs) for these subgroups is different, the sharing of insurance risk across a large group has been undermined. And, premium costs will vary among subgroups.

There are many examples in Maine (and elsewhere) where fragmentation of the risk pool occurs. Employers that choose to self-insure their employees and dependents effectively fragment the commercial insurance pool. The medical expenses associated with a self-insured group are not blended with other groups. Employers choose to self-insure for a number reasons. First, they believe (usually correctly) that the medical expenses of their employees and dependents will be less, on average, than the general population. Secondly, self-insurance provides greater flexibility for companies to design their medical benefit plans (see The Role of Regulation, below). To the extent that an employer adopts wellness, case management and other cost management programs, a self insured arrangement assures that any realized savings will accrue to the company and its workers. Finally and particularly for a company that has multi-state locations, a self insured plan simplifies administration.

Insurance companies also establish separate risk pools for different segments of the market, usually in response to regulatory requirements and competitive pressures. For example, small businesses may be grouped together with a premium rate that relects the expected medical expenses of this market segment; a "community rate" is established. If the cost of insurance becomes disproportionately more expensive for certain small businesses, these businesses may leave the pool. A small employer with a relatively young and healthy workforce may discontinue coverage, providing additional cash compensation instead. The groups remaining are increasingly less healthy and their costs will increase even faster. This phenomenon is known as adverse selection and more likely to occur among insured individuals and small groups, two market segments which insurance companies are required to community rate. Among market segments that include mid and large employers, there is more stability in the group and virtually no migration due to health insurance costs.

Taken to its logical conclusion, adverse selection will result in a risk pool that contains only very sick people who pay exorbitant premiums. Many argue that adverse selection is happening in Maine today for individuals who purchase Anthem's individual policies and that this will lead to the eventual demise of this product.

One final word on fragmentation: Medicare and Medicaid represent subsets of the general population that have been segregated for purposes of providing health insurance. On one level, this fragmentation of the risk pool has had a positive impact on the cost of private health insurance. Medicare and Medicaid provide coverage to populations who are sicker and consequently more costly. These public programs effectively remove these populations from the general risk pool. However both programs reimburse providers at levels below what providers believe are adequate. In order to recover this shortfall, providers charge commercial insurance programs more than would otherwise be the case. This is referred to as "cost shifting" and is a separate consequence of fragmentation of the State's insurance pools.

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