Death spiral (insurance)

Death spiral is a term used to describe an insurance plan whose costs are rapidly increasing as a result of changes in the covered population. It is the result of adverse selection in insurance policies where lower risk policy holders choose to change policies or be uninsured. The term is found in the academic literature at least as early as Cutler and Zeckhauser's 1997 paper "Adverse Selection in Health Insurance" which refers explicitly to an "adverse selection death spiral".^[1]

Health Insurance Spiral

When one purchases an individual health insurance policy, one is assigned to a risk pool “group” specifically for subscribers to that policy. The group is not everyone who holds a similar policy issued by the company, rather only a very small portion of subscribers who hold similar policies. A group is typically only open for a set enrollment period, after which it is closed to any new subscribers. The group size never increases after it is closed. It does decrease, however.

Over time, the policyholders in the group acquire health conditions. Hence, the claims costs for the entire group increase, and therefore, so does the average health cost for the individuals in the group. The insurer then raises the rates to cover the higher costs. Subscribers with better health realize that they can re-apply for and obtain other very similar health insurance at low, new-subscriber rates similar to the original rates of the current policy. Often, the insurer will promote the "new" similar health plans. When one applies for the "new" policy, one's health will be reevaluated, one will have to re-qualify and be re-underwritten. However, if one has acquired certain health conditions over the term of the current policy, most likely one will be disqualified for the "new" policy. Or one will be offered the “new” policy at the lower, new-subscriber rate; but acquired health conditions will be excluded from coverage under the "new" policy, even if those health conditions were acquired while covered by the insurance provider under the current policy.

Since they can purchase the same or better coverage for less, the healthy people flee the group. As the remaining less-healthy people who cannot flee (because they cannot qualify for new health insurance) acquire more health conditions over time, and since the group is closed to new healthy subscribers, the total health costs for the group accelerates out of proportion to the number of subscribers in the group, and the average cost for the individual group member increases. Premiums are increased to reflect higher average costs of the group.

As the premiums increase, healthy people increasingly flee, unhealthy people remain, average costs increase, the cycle continues and the premiums are further increased. This cycle continues until no one, not even the sick who may strongly want or need it, can afford the policy. The individual health insurance policy group then goes out of existence. Since the original size of the group was small in relation to the total subscriber base, it is very easy for an insurer to eliminate, or allow to go out of existence, any one group of policyholders.

Advantages for Insurers

In most states, it is illegal for health insurers to engage in individual re-underwriting -- re-evaluating the individual subscriber's health risk after the subscriber files a claim under the policy and adjusting the subscriber's premium accordingly; compare also rescission. The process described so far can best be described as "group re-underwriting" – evaluating the group’s medical costs and adjusting the group’s premium accordingly. It accomplishes the same effect -- purges the companies' risk pool of higher risk individuals or allows the insurer to eventually eliminate any high-risk pool altogether, or excludes individuals' health conditions even though the health conditions were acquired during the terms of the policies with the company and while the premiums were faithfully paid. This has the advantage to the insurer of decreasing their liability without violating the terms of the policy or being accused of (individual) re-underwriting. It also allows the insurer to claim that the policy offers protection against rises in premiums due to the policyholder acquiring health conditions, though that protection is limited.

Disadvantages for Policyholders

Through the process of "group re-underwriting", the insurer is able to keep down the premiums of new health plans for new or healthy subscribers, and offer some limited protection against rises in premiums due to acquiring health conditions. However, once a person acquires certain health conditions, that person may not be able to qualify for other lower-priced health insurance. Yet, the premiums paid for any individual "group" policy will inevitably rise faster than the average rise in health care costs, generally, until the health policy becomes unaffordable for virtually all people.

External links

• Death Spiral or Euthanasia? The Demise of Generous Group Health Insurance Coverage

References

1. ^ David M. Cutler and Richard J. Zeckhauser, "Adverse Selection in Health Insurance", NBER working paper 6107