What Is Adverse Selection in the Insurance Industry?

One of the reasons that most state governments in the United States mandate that all drivers purchase automobile insurance is to avoid the problem of "adverse selection," or the process by which the most risky insurance customers force out the least risky. If prices cannot adjust based on individual risk, the most expensive insurance customers drive up the average premiums and make it uneconomical for the least risky to buy. Adverse selection is also why American adults are now mandated to purchase health insurance through Obamacare. There are economic arguments for these compelled purchases, but real-life examples show that theory and practice often differ.

How Private Insurance Companies Protect Against Adverse Selection

Adverse selection is a problem of knowledge, probabilities and risk. In most situations, it is fairly easily overcome with differential pricing mechanisms. Suppose two different individuals apply for car insurance through Allstate Corporation (NYSE: ALL). The first applicant is a 22-year-old male, drives to and from work every day, has a history of speeding and has previous accidents on record. The second applicant is a 40-year-old mother who often takes public transit to work and has not had a ticket or accident in over a decade.

From the insurer's perspective, the first applicant is far riskier and far more likely to cost it money. The second applicant is a mild risk. To identify which is riskier, Allstate asks probing questions during the application process and also consults its actuarial tables; it turns out that 20-something men are the most expensive to insure. Thus, Allstate can compensate for the extra risk by charging a higher premium to the first applicant.

Adverse Selection and Other Solutions

Individuals vary in their need for risk protection and in their knowledge of risks and risk tolerance. Insurance companies might have even less knowledge of individual circumstances. If insurance companies fail to distinguish between high-risk and low-risk customers, meaning they are unable to perform effective actuarial processes, then the average premium charged to a consumer might be so high that the low-risk customers drop out of the market.

Life Insurance Settlements: What's New?

 The various types of insurance that consumers purchase are generally viewed as a necessary expense that policy holders don’t think about much in everyday life, except to grumble about the cost of the premiums. But those who hold life insurance policies have some new options to choose from if they decide to forego their coverage. Life insurance settlements now allow seniors to sell only a portion of their policies and keep the remainder as they see fit. This flexible option can make sense in many cases for seniors who no longer need or can afford their current policy.

Morbid Beginnings

The life settlement industry began during the AIDS epidemic of the 1980s, when viatical settlement companies would offer to buy the life insurance policy from a terminally ill policy holder who was expected to die within six months. The owner received cash up front to pay medical bills, and the viatical company collected the death benefit. This industry has matured since those days. Firms now offer policy owners who wish to sell their policies a much more streamlined and efficient program.

The New Options

The life settlement industry now allows seniors who own policies that are no longer needed or affordable a way to get more cash from them than they could by simply accessing the policy’s cash value. The settlement company purchases the policy from the individual, then pays the premiums until the death of the insured and collects the death benefit. This type of arrangement can provide a substantial benefit for seniors who own policies that have become unnecessary, such as if the policy holder gets divorced or a spouse passes away.

Getting Health Coverage Outside Open Enrollment

Open enrollment (OE) for health insurance marks the time period in which individuals can seek coverage in federal exchanges or group health insurance plans. 

A typical employer-sponsored health plan allows individuals to sign up for insurance in a designated time frame prior to the group’s plan year or the annual period in which benefits become effective. 

Employees can utilize OE periods, which may range from a few days to 90 days, to initiate coverage or move from one plan, such as a health maintenance organization (HMO) plan, to other plans, including preferred provider organization (PPO) plans.

OE Rules

The federal marketplace created by the Affordable Care Act (ACA) runs its enrollment period from Nov. 1, 2016, through Jan. 31, 2017. When OE ends, coverage cannot be modified nor can certain dependents be added to a policy. Permissible changes can only be made through the occurrence of a qualifying life event. The following nine situations allow changes in coverage or adding dependents who would normally need to wait until OE periods to obtain coverage.

Minimum Essential Coverage

Group health plans may cease to offer coverage that meets the federal government’s definition of minimum essential coverage (MEC). MEC is determined actuarially by weighing the benefits of a group plan and arriving at a percentage calculation based on the value of said benefits. The federal exchanges apply metal levels, such as bronze, silver, gold and platinum, that correspond to the richness of plan benefits. If a group plan fails to offer MEC, a special enrollment period is enabled.

What Is a Special Enrollment Period, and Why Does It Matter?

A special enrollment period is the opportunity to join a qualified health plan (QHP) offered through the marketplace or to change to a different plan. You qualify for this special enrollment period through certain life events or situations.

Special Enrollment Period

The Obamacare health care plan has an open enrollment period that falls once a year when a person can sign up for health care coverage. You can sign up outside that open window of time if you qualify for certain life events, which include the following three categories.

Loss of Health Coverage

You qualify if you, or anyone in your household, lost health coverage in the last 60 days or expect to lose health coverage in the following 60 days. This may happen through losing a job, losing job-based coverage, losing COBRA coverage or acquiring a job that precludes coverage. It may also happen through losing eligibility for Medicare, Medicaid or CHIP; or through a family member no longer supporting you because of divorce, death, legal separation or because you are no longer a dependent. You may lose insurance because your plan expired, or will expire, within the next 60 days.

Changes in Household Size

You qualify if your household size changed in the interim due to events that may include a birth, adopting or fostering a child, marriage, divorce, legal separation or death. Each of these events drives changes in your original plan. In each case, special provision allows your insurance coverage to start the same day as the impacting event or within that month.