Death spiral (insurance)
|This article needs additional citations for verification. (May 2011) (Learn how and when to remove this template message)|
Death spiral is a condition of the insurance market in which costs rapidly increase as a result of changes in the covered population. It is the result of adverse selection in insurance policies in which 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 1998 paper, "Adverse Selection in Health Insurance," which refers explicitly to an "adverse selection death spiral."
When one purchases an individual health insurance policy, one is assigned to a risk pool “group” specifically for subscribers to that policy. That group is not everyone who holds a similar policy issued by the company but only a very small portion of subscribers who hold similar policies. A group is typically open for only a set enrollment period, after which it is closed to any new subscribers. The group size never increases, after it is closed, but decreases.
Over time, the policyholders in the group acquire health conditions. Hence, the claims costs for the entire group increase and 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 reapply for and obtain other very similar health insurance at low rates for new subscriber that are 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 re-evaluated, and one will have to requalify and be re-underwritten. However, if one has acquired certain health conditions over the term of the current policy, one will most likely will be disqualified for the "new" policy. It is possible that one will be offered the “new” policy at the lower rate for new subscribers, 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, who are less healthy, cannot flee (because they cannot qualify for new health insurance) but acquire more health conditions over time, and 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, less healthy people remain, average costs increase, the cycle continues, and the premiums are further increased. That 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.
Other insurance types do not experience the death spiral presumably because they are much more affordable. Catastrophic health insurance would probably not experience the death spiral.
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: purging companies' risk pool of higher risk individuals or allowing the insurer to eliminate any high-risk pool altogether or excluding 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. That has the advantage to insurers to decrease 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 because of the policyholder acquiring health conditions even 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 still offer some limited protection against rises in premiums from acquiring health conditions. However, once one acquires certain health conditions, one may not be able to qualify for other lower-priced health insurance, but 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.