Community Rating vs. Experience Rating

A "Premium" is the price paid in advance for an insurance policy. With "Community Rating," everyone pays the same premium. An insurer using community rating to set insurance premiums ignores any differences in expected costs among insured groups or people. If an insurer uses community rating, but people know and use their expected costs to decide whether or not to buy insurance, then only the sickest people may wind up signing up for insurance. With "Experience Rating," people pay different premiums based on differences in their demographics, past health care utilization, medical status, and other factors. "Underwriting" is the way in which insurance companies project what the expected covered health costs will be for a particular person of group. "Medical Underwriting" includes assessment of the health or chronic illness of a person or group. The issue of whether health insurance premiums should be based on community rating or experience rating is a complex one involving social concerns, adverse selection, and privacy issues. Community rating was once common, but has been eroded. One result is that higher cost groups (and individuals) are charged higher premiums. Sadly, some employers may not hire people with chronically-ill dependents for fear that it will increase their health care premiums. This is one reason why proposals to reform health insurance often suggest a return to community rating or some other type of premium subsidy from the chronically-well to the chronically-ill. "One Year Lag Insurance" is an extreme form of experience rating in which the insurer increases next year's group premium by the entire amount of this year's group loss. This is almost like having no insurance at all, except for the year lag between a group's loss and the corresponding increase in the group's premium. This is one reason why people want to reform the small group insurance market. One-year-lag insurance creates perverse incentives for game playing between employers and insurers. Sometimes small employers have an incentive to switch insurance carriers each year. Sometimes insurance companies have an incentive to dump small employers. Constant switching is costly and aggravates the already-inefficient nature of the small group market. One type of proposed reform is a limit on how much insurance premiums can be changed from one year to another.

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