Market failure in long-term private health insurance markets: a proposed solution

Recently, private health insurance rates have declined in many countries. In places requiring community rating in their health insurance premiums, a major cause is age-based adverse selection. However, even in countries without community rating, a de facto type of partial community rating tends to occur. In this note, a modified version of Pauly et al.'s guaranteed renewability model, which addresses the problem of age-based adverse selection (Pauly et al., 1995) is presented. Their model is extended from three to 35 periods. Also, probabilities are allowed to increase by age for low-risk types using actual age-based probabilities. This extension of their work shows that private health insurance contracts available stray far from optimal contracts that deal with age-based adverse selection. This suggests that government actions to affect private insurance options are warranted.

Lifetime cover in private insurance markets

In the last few decades, private health insurance rates have declined in many countries. In countries and states with community rating, a major cause is adverse selection. In order to address age-based adverse selection, Australia has recently begun a novel approach which imposes stiff penalties for buying private insurance later in life, when expected costs are higher. In this paper, we analyze Australiarsquos Lifetime Cover in the context of a modified version of the Rothschild-Stiglitz insurance model (Rothschild and Stiglitz, 1976). We allow empirically-based probabilities to increase by age for low-risk types. The model highlights the shortcomings of the Australian plan. Based on empirically-based probabilities of illness, we predict that Lifetime Cover will not arrest adverse selection. The model has many policy implications for government regulation encouraging long-term health coverage.

Lifetime Subsidies in Australian Private Health Insurance Markets with Community Rating

This paper considers the problem of inducing low-risk individuals of all ages to buy private health insurance in Australia. Our proposed subsidy scheme improves upon the age-based penalty scheme under the current "Australian Lifetime Cover" (LTC) scheme. We generate an alternative subsidy profile that obviates adverse selection in private health insurance markets with mandated, age-based, community rating. Our proposal is novel in that we generate subsidies that are both risk- and age-specific, based upon actual risk probabilities. The approach we take may prove useful in other jurisdictions where the extant law mandates community rating in private health insurance markets. Furthermore, our approach is useful in jurisdictions that seek to maintain private insurance to complement existing universal public systems.