Risk equalization
Encyclopedia
Risk equalization is a way of equalizing the risk profiles of insurance
members in order to avoid loading premium
s on the insured to some predetermined extent.
, risk-rated premiums are observed to differ across subgroups of insured people, which are defined by rating factors such as: age
, gender
, family
size, geographic area (because costs of care may be higher or lower in some coverage areas than others) occupation
, length of contract period, the level of deductible
, health
status at time of enrollment, health habits
(smoking
, drinking
, exercising) and — via differentiated bonus
es for multi-year no-claim — to prior costs. Some nations that encourage private insurance for health care nevertheless seek to prevent insurers from engaging in risk minimizing actions to load the premiums of people with certain high risk profiles, typically the elderly, the sick, and to some extent, women. To achieve this, financial transfers are needed in order to prohibit any discriminatory practices against these sub-groups without increasing costs on insurers. This is done by arranging for a third party to organize a regulatory system of risk-adjusted premium subsidies.
The financial transfers are then channeled via a so-called Subsidy Fund. In Europe
an countries such as The Netherlands, Belgium
, Germany
and Switzerland
the Subsidy Fund is run by a government agency
which assesses risks
for individual policy holders. In all countries that apply risk-adjusted premium subsidies in their health insurance market, the sponsor organizes it in the form of risk equalization among health insurers: the risk-adjusted premium subsidies for the insured are channelled to the insurers. In this case, the Subsidy Fund is called a Risk Equalization Fund (REF). An insurer receives a relatively large sum of subsidies via the REF if the risk profile of their members is relatively unhealthy and vice versa.
Although premiums can be rated across many subgroups of insured people, a sponsor may not want to subsidize all observed premium rate variation in practice. The total set of risk factors that insurers use to rate their premiums can be divided in two subsets: the subset of risk factors that cause premium rate variation which the sponsor decides to subsidize, the S(ubsidy)-type risk factors; and the subset that causes premium rate variations which the sponsor does not want to subsidize, the N(on-subsidy)-type risk factors.
Gender, health status and (to a certain extent) age will, in most countries probably, be considered S-type risk factors. Examples of potential N-type risk factors are a high propensity for medical consumption, living in a region with high prices and/or overcapacity resulting in supply-induced demand, or using providers with an inefficient practice-style. The sponsor determines the specific categorization of S-type and N-type risk factors. When the government
takes up the role of the sponsor, this categorization is ultimately determined by value judgment
s in society. Note that, because the premium subsidies are risk-based, price competition will not be distorted by these subsidies and therefore incentives for efficiency are not reduced.
This system operates in countries such as Australia, Germany, the Netherlands, Belgium, Switzerland, and Ireland. The system of risk equalization plays a crucial role in order to reduce the incentives for risk selection in this new Dutch market of regulated competition. (See Health care in the Netherlands
) Dutch insurers are not allowed to risk-rate their premiums. In practice, the sponsor often encounters difficulties to find adequate measures of the S-type risk factors (e.g. health status) to include in the risk equalization model.
Insurance
In law and economics, insurance is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for payment. An insurer is a company selling the...
members in order to avoid loading premium
Risk premium
A risk premium is the minimum amount of money by which the expected return on a risky asset must exceed the known return on a risk-free asset, in order to induce an individual to hold the risky asset rather than the risk-free asset...
s on the insured to some predetermined extent.
Health care
In unregulated competitive markets for individual health insuranceHealth insurance
Health insurance is insurance against the risk of incurring medical expenses among individuals. By estimating the overall risk of health care expenses among a targeted group, an insurer can develop a routine finance structure, such as a monthly premium or payroll tax, to ensure that money is...
, risk-rated premiums are observed to differ across subgroups of insured people, which are defined by rating factors such as: age
Ageing
Ageing or aging is the accumulation of changes in a person over time. Ageing in humans refers to a multidimensional process of physical, psychological, and social change. Some dimensions of ageing grow and expand over time, while others decline...
, gender
Gender
Gender is a range of characteristics used to distinguish between males and females, particularly in the cases of men and women and the masculine and feminine attributes assigned to them. Depending on the context, the discriminating characteristics vary from sex to social role to gender identity...
, family
Family
In human context, a family is a group of people affiliated by consanguinity, affinity, or co-residence. In most societies it is the principal institution for the socialization of children...
size, geographic area (because costs of care may be higher or lower in some coverage areas than others) occupation
Profession
A profession is a vocation founded upon specialized educational training, the purpose of which is to supply disinterested counsel and service to others, for a direct and definite compensation, wholly apart from expectation of other business gain....
, length of contract period, the level of deductible
Deductible
In an insurance policy, the deductible is the amount of expenses that must be paid out of pocket before an insurer will pay any expenses. It is normally quoted as a fixed quantity and is a part of most policies covering losses to the policy holder. The deductible must be paid by the insured,...
, health
Health
Health is the level of functional or metabolic efficiency of a living being. In humans, it is the general condition of a person's mind, body and spirit, usually meaning to be free from illness, injury or pain...
status at time of enrollment, health habits
Habit (psychology)
Habits are routines of behavior that are repeated regularly and tend to occur subconsciously. Habitual behavior often goes unnoticed in persons exhibiting it, because a person does not need to engage in self-analysis when undertaking routine tasks...
(smoking
Smoking
Smoking is a practice in which a substance, most commonly tobacco or cannabis, is burned and the smoke is tasted or inhaled. This is primarily practised as a route of administration for recreational drug use, as combustion releases the active substances in drugs such as nicotine and makes them...
, drinking
Drinking
Drinking is the act of consuming water or a beverage through the mouth. Water is required for many of life’s physiological processes. Both excessive and inadequate water intake are associated with health problems.-Physiology:...
, exercising) and — via differentiated bonus
Bonus
The word Bonus refers to extra pay due to good performance.Bonus may also refer to:- People :* Lawrence Bonus, a Filipino basketball player* Petrus Bonus, a physician* Bonus , a Byzantine general, active in the reign of Justin II...
es for multi-year no-claim — to prior costs. Some nations that encourage private insurance for health care nevertheless seek to prevent insurers from engaging in risk minimizing actions to load the premiums of people with certain high risk profiles, typically the elderly, the sick, and to some extent, women. To achieve this, financial transfers are needed in order to prohibit any discriminatory practices against these sub-groups without increasing costs on insurers. This is done by arranging for a third party to organize a regulatory system of risk-adjusted premium subsidies.
The financial transfers are then channeled via a so-called Subsidy Fund. In Europe
Europe
Europe is, by convention, one of the world's seven continents. Comprising the westernmost peninsula of Eurasia, Europe is generally 'divided' from Asia to its east by the watershed divides of the Ural and Caucasus Mountains, the Ural River, the Caspian and Black Seas, and the waterways connecting...
an countries such as The Netherlands, Belgium
Belgium
Belgium , officially the Kingdom of Belgium, is a federal state in Western Europe. It is a founding member of the European Union and hosts the EU's headquarters, and those of several other major international organisations such as NATO.Belgium is also a member of, or affiliated to, many...
, Germany
Germany
Germany , officially the Federal Republic of Germany , is a federal parliamentary republic in Europe. The country consists of 16 states while the capital and largest city is Berlin. Germany covers an area of 357,021 km2 and has a largely temperate seasonal climate...
and Switzerland
Switzerland
Switzerland name of one of the Swiss cantons. ; ; ; or ), in its full name the Swiss Confederation , is a federal republic consisting of 26 cantons, with Bern as the seat of the federal authorities. The country is situated in Western Europe,Or Central Europe depending on the definition....
the Subsidy Fund is run by a government agency
Government agency
A government or state agency is a permanent or semi-permanent organization in the machinery of government that is responsible for the oversight and administration of specific functions, such as an intelligence agency. There is a notable variety of agency types...
which assesses risks
Risk assessment
Risk assessment is a step in a risk management procedure. Risk assessment is the determination of quantitative or qualitative value of risk related to a concrete situation and a recognized threat...
for individual policy holders. In all countries that apply risk-adjusted premium subsidies in their health insurance market, the sponsor organizes it in the form of risk equalization among health insurers: the risk-adjusted premium subsidies for the insured are channelled to the insurers. In this case, the Subsidy Fund is called a Risk Equalization Fund (REF). An insurer receives a relatively large sum of subsidies via the REF if the risk profile of their members is relatively unhealthy and vice versa.
Although premiums can be rated across many subgroups of insured people, a sponsor may not want to subsidize all observed premium rate variation in practice. The total set of risk factors that insurers use to rate their premiums can be divided in two subsets: the subset of risk factors that cause premium rate variation which the sponsor decides to subsidize, the S(ubsidy)-type risk factors; and the subset that causes premium rate variations which the sponsor does not want to subsidize, the N(on-subsidy)-type risk factors.
Gender, health status and (to a certain extent) age will, in most countries probably, be considered S-type risk factors. Examples of potential N-type risk factors are a high propensity for medical consumption, living in a region with high prices and/or overcapacity resulting in supply-induced demand, or using providers with an inefficient practice-style. The sponsor determines the specific categorization of S-type and N-type risk factors. When the government
Government
Government refers to the legislators, administrators, and arbitrators in the administrative bureaucracy who control a state at a given time, and to the system of government by which they are organized...
takes up the role of the sponsor, this categorization is ultimately determined by value judgment
Value judgment
A value judgment is a judgment of the rightness or wrongness of something, or of the usefulness of something, based on a comparison or other relativity. As a generalization, a value judgment can refer to a judgment based upon a particular set of values or on a particular value system...
s in society. Note that, because the premium subsidies are risk-based, price competition will not be distorted by these subsidies and therefore incentives for efficiency are not reduced.
This system operates in countries such as Australia, Germany, the Netherlands, Belgium, Switzerland, and Ireland. The system of risk equalization plays a crucial role in order to reduce the incentives for risk selection in this new Dutch market of regulated competition. (See Health care in the Netherlands
Health care in the Netherlands
Healthcare in the Netherlands is financed by a dual system that came into effect in January 2006. Long-term treatments, especially those that involve semi-permanent hospitalization, and also disability costs such as wheelchairs, are covered by a state-controlled mandatory insurance...
) Dutch insurers are not allowed to risk-rate their premiums. In practice, the sponsor often encounters difficulties to find adequate measures of the S-type risk factors (e.g. health status) to include in the risk equalization model.
External links
- Regulated competition in the new Dutch health care system
- The purpose of risk equalization, English version
- The purpose of risk equalization, Dutch version
- Testing the effectiveness of risk equalization models, English version
- Testing the effectiveness of risk equalization models, Dutch version
Videos
- A theoretical introduction to risk equalization
- The new Dutch health care system (Note: The video has a soundtrack in both English and Dutch. It is necessary to click the T symbol in video window early on during video playback to see subtitles in English.)