The more enrolled, the less the risk

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opinions

March 12, 2014 - 12:00 AM

This week we are going to look at one of the most popular aspects of the Marketplace — accepting all enrollees no matter of a pre-existing condition at no extra cost — and the most controversial provision, the “individual mandate” and see how they interrelate almost as two sides of the same coin. We will also look at how limited time windows for entering the Marketplace, known as “open enrollment periods” and “special enrollment periods,” also operate to make the Marketplace workable.

Both uncertainty and predictability are required in order to make insurance markets work. No one would buy insurance for a period, say for last month, when you already know that you would make no claims against the policy. Likewise, no insurer would be willing to sell coverage for a period of time in which they already knew a large claim would be made. Insurance is all about managing risk. Risks by definition deal with uncertainties. 

On the other hand, while individual losses and claims must be uncertain for insurance to work, aggregate losses and claims must be predictable. Insurance companies have to be able to predict what the overall number and cost of claims for all of the people they insure. This is known as the risk pool. Insurers don’t know which insured people will have heart attacks or get cancer. They do know that for any given age, locality, or tobacco use status, so many people out of every thousand will have these illnesses. This kind of actuarial analysis is at the heart of the insurance business. But these models work better for large risk pools than small ones. In fact, they would work best if everybody was in the pool. The smaller the risk pool, the greater the margin of error. To make up for the risk that the insurers’ predictions are wrong, they need to charge more. 

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