Coping with Risk Segmentation

A factor that complicates almost all proposals to extend health insurance coverage is how to cope with risk segmentation in the small group and individual insurance markets. Experience in these markets shows that if market forces are left to operate unfettered, people seeking private health insurance will be segregated into small risk pools that reflect their expected risk of incurring medical expenses and charged premiums accordingly. Premiums will vary widely across the spectrum of expected risk and risk will not be widely shared. These are problems that generally do not plague large employers because they are large enough to form their own risk pools and self-insure; that is, costs are sufficiently spread among higher-risk and lower-risk employees within the group. So the discussion that follows applies to health insurance for small employers and individuals buying coverage on their own. Risk segmentation and the consequent wide variation in premiums create at least two kinds of problems.

First, some high-risk people are not able to afford coverage. Second, the wide premium spread requires some people to pay much more than others for identical coverage, which many would consider inequitable. Both of these points will be discussed in more detail later, but to clarify the problem it is useful to begin with a discussion of the purpose of insurance.