How Health Care Providers Prevent Adverse Selection

Receptionist giving insurance card to patient.
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Adverse Selection in health insurance happens when sicker people, or those who present a higher risk to the insurer, buy health insurance while healthier people don’t buy it. Adverse selection can also happen if sicker people buy more health insurance or more robust health plans while healthier people buy less coverage.

Adverse selection puts the insurer at a higher risk of losing money through claims than it had predicted.

If adverse selection were allowed to continue unchecked, health insurance companies would become unprofitable and eventually go out of business.

How Adverse Selection Works

Here’s a grossly simplified example. Let’s say a health insurance company was selling a health plan membership for $500 per month. Healthy 20-year-old men might look at that monthly premium and think, “Heck, if I remain uninsured, I’m probably not going to spend $500 all year long on health care. I’m not going to waste my money on $500 monthly premiums when the chance that I’ll need surgery or an expensive health care procedure is so small.”

Meanwhile, a 64-year-old obese diabetic with heart disease is likely to look at the $500 monthly premium and think, “Wow, for only $500 per month, this health insurance company will pay the bulk of my health care bills for the year! Even after paying the deductible, this insurance is still a great deal.

I’m buying it!”

This adverse selection results in the health plan’s membership consisting mainly of people with health problems who thought they’d probably spend more than $500 per month if they had to pay their own health care bills. Because the health plan is only taking in $500 per month per member, but is paying out more than $500 per month per member in claims, the health plan loses money.

If the health insurance company doesn’t do something to prevent this adverse selection, it will eventually lose so much money it won’t be able to continue to pay claims.

How Health Plans Prevent Adverse Selection

There are several ways health insurance companies can avoid or discourage adverse selection. However, government regulations prevent health insurers from using some of these methods and limit the use of other methods.

In an unregulated health insurance market, health insurance companies would use underwriting to try to avoid adverse selection. During the underwriting process, the underwriter examines the applicant’s medical history, demographics, prior claims, and lifestyle choices. It tries to determine the risk the insurer will face in insuring the person applying for a health insurance policy.

The insurer might then decide not to sell health insurance to someone who poses too great a risk, or to charge a riskier person higher premiums than it charges someone likely to have fewer claims.

Additionally, a health insurance company might limit its risk by placing an annual or lifetime limit on the amount of coverage it provides someone, by excluding pre-existing conditions from coverage, or by excluding certain types of expensive health care products or services from coverage.

In the United States, health insurance companies aren’t allowed to use most of these techniques. The Affordable Care Act

  • prohibits health insurers from refusing to sell health insurance to people with pre-existing conditions.
  • prohibits insurers from charging people with pre-existing conditions more than it charges healthy people.
  • prohibits health plans from imposing annual or lifetime caps on benefits.
  • requires health plans to cover a uniform set of essential health benefits; health plans can’t exclude certain expensive health care services or products from coverage.

Although the Affordable Care Act eliminated many of the tools health insurers used to use to prevent adverse selection, it established other means to help prevent unchecked adverse selection.

  • It requires all legal residents of the U.S. to have health insurance or pay a tax penalty. This encourages younger, healthier people who might otherwise be tempted to save money by going without health insurance to enroll in a health plan. If they don’t enroll, they pay a hefty tax penalty.
  • It places restrictions on when people are allowed to enroll in a health plan so that people can’t wait to buy health insurance until they’re sick and know they’ll be incurring health care expenses. People are only allowed to sign up for health insurance during the annual open enrollment period each autumn, or during a time-limited special enrollment period triggered by certain life events like losing job-based health insurance, getting married or divorced, or moving out of the area.
  • It allows a short waiting period between the time someone enrolls in health insurance and the time coverage begins.
  • It allows health insurers to charge smokers up to 50% higher premiums than non-smokers.
  • It allows health insurers to charge older people up to 3 times more than it charges young people since older people tend to have more medical expenses than younger people do, so present a higher risk to the insurer.


Adverse Selection Issues and Health Insurance Exchanges Under the Affordable Care Act. National Association of Insurance Commissioners. Accessed August 9, 2015.

How Marketplace Plans Set Your Health Insurance Premiums. Accessed August 9, 2015. 

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