Adverse Selection

Adverse selection means that one side in a negotiation has more information than the other and can use that difference to their advantage.

The most common way that adverse selection is referred to in health insurance is the rumor that high risk individuals and those with expensive care needs will move to the state or federal insurance programs driving up costs.

An insurance company issues a quote based on a census of the customer company’s employees.  This is the information it holds for the negotiation.  Adverse selection comes into play when the demographics of the company don’t accurately reflect the near-future state of health of the employees due to new hires or a new diagnosis to a current employee.  So, beyond the census information gathering, insurance companies further protect their own financial interest by limiting coverage or raising premiums on everyone.  Of course, these are a negative consequence for the buyers.

For self-insured companies, the same census-to-reality risk factors exist.  Typically large employers or companies with young demographics trend toward self-funding their insurance because of the lower perceived risk.  However, just one or two high value claims can upset the financial apple cart.   And the number of number of $1,000,000+ claims has doubled in just 4 years.  The top diagnosis categories for these claims include cancer, heart disease, neonatal intensive care, and trauma, such as motor vehicle accidents.

Purchasing stop loss insurance is a way for self funded plans to mitigate risk of adverse selection.  High value claims or high overall health costs can be paid by the stop loss carrier if thresholds written into the policy are met.