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Adverse Selection and its impact on Health Insurance

Adverse Selection in Health Insurance, Details collected by Insurance Companies during purchase of Insurance, Moral Hazard in Health Insurance

Have you heard about Chhatta Chowk or Meena Bazaar? It’s a marketplace exactly below Red Fort in New Delhi. This market boasts of traditional ornaments, jewellery, utensils, souvenirs, eatables, and drinks. As Red Fort is a major tourist destination, many tourists buy from this market. I have seen the shop owners selling one glass of mango juice for Rs 300 to European and American tourists. Here, we all know that given anytime a simple glass of mango juice cannot be this expensive. The tourists don’t have knowledge about the price range followed in India. This is the classic example of Adverse Selection which talks about asymmetric information in which one party has greater knowledge than the other party.

To put it down, Adverse Selection, may it be in economics, insurance, or risk management, means that buyers and sellers have different information. Sellers have information that buyers don’t have and vice versa. Generally, in many instances more informed party is that of sellers.


What are Adverse Selection in insurance?

In health insurance, adverse selection happens when insuRrance is given/extended to a policyholder whose actual risk is substantially higher than the risk known by the insurance company. Due to this, the insurance company suffers adverse effects by covering at a cost that does not exactly show the actual risk exposure.

For example, if any person does drug or nicotine abuse which causes serious health complications and does not state during the policy, then after purchasing of the policy if there are any health problems the insurance company will have to pay for the amount. This leads to misinformation and causes adverse effects on the insurance company.   

In other cases, during the purchase of health insurance, people with high-risk jobs and chronic diseases who have greater purchase requirements will purchase health insurance and healthy people or people with low-risk jobs will not purchase health insurance. This leads to irregular purchases of insurance and the company will have to deal with financial loss by paying out more benefits.

This would lead to the following scenario:

  • Negatively impact health insurance companies financially.
  • Insurance companies would have fewer insurers, mostly those who are at high risks.
  • To compensate for the loss, insurance companies will have to increase their premium price which in turn would drop healthy people from buying this policy.

In order to tackle any kind of fabrications, insurance companies collect data from the individual before giving them any policy.

What details are collected by Insurance Companies to avoid insurance adverse selection?

When you apply for health insurance the company collects your data and undergoes the following procedure to ensure that you have given genuine information for the policy. The following steps are:

1. Application Form

They collect all of your initial data through an application form where you will be filling it accordingly, as to what policy premium are you buying, your health conditions, lifestyle, age, etc.

2. Prescriptions

All your prescriptions and medical records have to be submitted to the insurance company to cross-check your health conditions. Nowadays this can be easily stored on mobile through a Digital Health ID Card account.

3. Doctor’s Statement

The insurer would want a written statement from a professional medical officer about your health conditions.

4. Paramedical Exam

The insurance company will send medical officers to examine your health and body conditions and whether everything on the application, prescriptions, and doctor’s statement match with their reports.

5. Cross-checking previous policies (if any)

If you have taken any previous health insurance policies previously, that will also be cross-checked with the current application.

If, in any case, an untruth slips through this method, it is called misrepresentation. If misrepresentation is discovered and your Life Insurance company can prove you intentionally lied, you'll be charged with life insurance fraud.

Also read: Health Insurance Claim Process: How does it work?

What are the different divisions for policyholders in Insurance Companies?

While charging rates to their customers they check their health condition, age, weight, occupation, lifestyle, medical history, and habits like drinking, smoking, etc. After this, the company follows risk order, in which premium category should the customer fall. The following are the risk classes:

  • Preferred Class

In this class, the policyholders are in good health with few minor conditions. Due to this reason the company opts for the low premium rates.

  • Standard Class

These policyholders have average health, with a history of health issues, and might become serious in the next few years.

  • Substandard Class

These policyholders are having high risk. These high risks may be due to the high-risk jobs they do, the lifestyle they live or chronic health issues. Different insurance companies have different steps to handle this class, but generally, this class people pay a high amount on premiums.

If an individual personates a greater risk to the insurance company than they reported on their application and are more likely to die before the date that the insurance company determined, there will be a gap between the amount the policyholder paid in premiums and their death benefit.

What is Moral Hazard in Health Insurance?

When one party in a transaction takes unnecessary risks which causes problems to the other party is known as a moral hazard. In health insurance, this can mean that when the policyholders take frequent needless risks which in turn causes the output of more money for the insurers. Insurance companies fear that policyholders might go for these risks as they might think they have insurance claims available and need not worry.

For example, if a person purchases insurance for diseases like liver cirrhosis, and in reverse, the person might get encouraged to consume more alcohol. This “Don’t worry, you are insured” attitude can cause a moral hazard in health insurance companies.

Also read: How to choose the best Health Insurance Plan in India

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