Addressing adverse selection issues and the role of pregnancy in micro health insurance
Insurance is an important mechanism for economic development, and in recent years, many efforts have gotten off the ground to extend insurance products to traditionally underserved markets. Most of those efforts have focused on generating insurance markets in emerging economies, where the security of compensation for accidental losses can generate tremendous benefits. The costs of such efforts, however, are large relative to premiums, with many of the initiatives failing to become financially sustainable.
The primary impediment to expanding insurance markets in emerging economies is adverse selection, where only those with higher than average expected losses choose to purchase coverage. Because insurance prices are based on the average expected losses, adverse selection leads to situations where costs far exceed premiums, a condition obviously not viable in the long run without governmental and/or non-profit intervention.
In an effort to understand the issues of adverse selection better and ultimately identify new opportunities to expand health insurance protection to underserved markets, my colleagues Yi Yao at Peking University, Justin Sydnor, and I analyzed a rich data set from the first-ever market-based micro health insurance program in Pakistan. Observing that pregnancy-related care accounts for 40 percent of all claims and 36 percent of the total claims amount, we focused on understanding the role of pregnancy in micro health insurance.
We believe the poor financial experience is due to adverse selection and especially to coverage for pregnancy-related care. The health insurance policy we studied involves no underwriting or exclusions for pre-existing conditions, so all policyholders pay the same price per covered individual, and policies may be purchased following discovery of health care needs, such as pregnancy. Policies are designed with these characteristics in order to minimize underwriting and claims adjusting costs, yet result in significant adverse selection.
The creation of sustainable microinsurance products is known to be particularly challenging for numerous reasons, including poorly informed consumers, a workforce with limited expertise in insurance, a lack of available services that would be covered by the insurance, and inconsistent legal systems. All of these can lead to significant adverse selection.
Microinsurance is designed for people living at the lower end of the economic pyramid and is driven by a hybrid of social protection and market-based motivations. To meet the needs of the lower-income population, these contracts are characterized by small premiums in absolute value. Yet insurance coverage requires a variety of fixed costs, regardless of the policy size, so a small-premium policy has fewer resources available to cover losses once the fixed costs are paid. This leads insurers to seek ways to lower expenses, many of which yield less precise underwriting standards and claims adjusting practices, which in turn can yield issues like adverse selection.
In addition, microinsurance products are designed (sometimes by regulatory requirements) to be simple contracts, frequently without characteristics like deductibles, coinsurance, and exclusions used in more robust economies to address adverse selection issues, so it’s no surprise that microinsurance markets are abnormally vulnerable to adverse selection problems. It is possible that advances in technology (for example, using cell phones to pay premiums, receive claim payments, and provide exposure data) and greater knowledge about the microinsurance market will help insurers respond to the challenges of offering simple products.
Our most important finding is the significant influence of pregnancy-related claims on poor financial results. When we remove health care costs associated with normal deliveries, we find that the product is far more financially successful. We believe this demonstrates the potential for a successful market-based micro health insurance market.
Because pregnancy-related health care needs are incredibly important to the development of these communities, we encourage the government to provide pregnancy-related healthcare, either as a subsidy to insurers or directly to the households. This sort of government benefit would be similar to what is available in developed nations; for example, in the U.S., the majority of pregnancy-related health care for people without employer-provided health insurance has been financed through Medicaid. We encourage researchers, public policymakers, and insurers to consider these options and to study the question further.
We hope our research will add to the knowledge base about the causes and cures of adverse selection in microinsurance, ultimately with the goal of finding creative ways to tailor products and public policy to encourage an appropriate expansion of insurance to underserved markets.
Joan Schmit is American Family Insurance Distinguished Chair of Risk Management and Insurance, and professor of risk and insurance at the Wisconsin School of Business.
Justin Sydnor is Leslie P. Schultz Professorship Fund in Risk Management and Insurance, and assistant professor in risk and insurance at the Wisconsin School of Business.