Speaking to a number of actuaries (professionals who specialise in risk management) has shown me how important risk profiles are. These profiles are a fundamental tool in the practice of premium pricing. From data relating to your age, occupation, lifestyle, pre-existing conditions, and many more factors, you are categorised into a certain subgroup. The expected dollar value in claims an individual within a particular subgroup will make in an average year is then computed. Your premium is then based on this figure, with a margin added for administration costs and profits.
What makes the above process so remarkable is the difficulty for the insurance company to obtain all the information that they need. The health insurance market suffers from two major problems.
‘Asymmetric information’ is the first hurdle that creates pricing difficulties. This relates to the fact that, no matter how many questions the insurer asks, the individual will always know more about the status of their own health than the insurance provider. This adds a layer of complexity to assigning premium prices.
On top of this, the insurance market gets stung by a form of ‘moral hazard’. Once people are insured, they are inclined either consciously or subconsciously to take more risks and take less care of their own health, as they know in the event of something going wrong; they will be covered.
This leads to the crux of the situation. Health Insurance providers attract a disproportionate amount of unhealthy people to their products. This sees a healthy individual pay a higher premium to compensate for this uneven number of healthy to unhealthy individuals. So for an unhealthy person, their health insurance premium will be a great deal. But from a healthy person’s perspective, they are paying a bit more than they would have needed too if their subgroup was full of other individuals like them.
Despite this, insurers have come a long way over the years, mitigating the effects of asymmetric information and moral hazard. Through intensive research they are now able to ask more and more appropriate questions, gathering more data about the individual than ever before. In addition to this, most insurers have initiated a co-payment or deductible system to reduce the impact of moral hazard.
Deciding the dollar value to charge a client for a premium is a difficult process, that requires analysis from specially trained actuaries. This process is made even more difficult through the gaps in knowledge an insurer will have in relation to the client. Combining these understandings with the knowledge gained in part one of this series regarding the reasons why health insurance premiums continuously go up, can lead to some useful conclusions.
When contemplating whether or not to renew your policy due to an annual premium hike, ensure to compare the increase to the national medical inflation rate. If the rates are reasonably similar you can be confident your premium hike is of fair value. In addition, ensure you thoroughly read the product disclosure statement (PDS) of your policy to make sure you have adequate coverage. This knowledge allows you to accurately compare the cost of insurance provided by the various insurance providers, making sure you get a competitive offer.
This article is written by Chandan Hegde, Hive Up.