Selection in the Individual Health Insurance Market

The Affordable Care Act (ACA) significantly reformed the commercial individual health insurance market in the United States. The reforms embedded in the ACA combined with ex post alterations of intended regulations resulted in a restructuring of the individual health insurance market into three segments: Marketplace plans, off-Marketplace plans, and grandfathered plans. Individual coverage can be purchased with income-based premium subsidies on state-based Marketplaces, launched in 2014. Beginning the same year, the ACA also required all new plans sold in the individual market to provide “minimum essential coverage." Existing individual plans were considered “grandfathered” and were not subject to this standard. Variation in plan requirements and availability of premium subsidies across these segments could result in risk selection. While the ACA introduced risk adjustment to correct spending differences due to risk selection, grandfathered plans were excluded from the risk adjustment program.

Using data on the individual health insurance market in Colorado in 2014 and 2015, this paper studies the presence, direction, and extent of risk selection across these three market segments. We find that average monthly spending was significantly higher in Marketplace plans compared to non-grandfathered off-Marketplace plans. However, after controlling for differences in the components of risk that are compensated either by premium variation or by the risk adjustment program (i.e. risk scores, geography, and age), there is no spending difference between on- and off-Marketplace plans. We also find that average monthly spending was significantly higher in (on- and off-Marketplace) non-grandfathered plans compared to grandfathered plans. Again, we find that this spending difference disappears when adjusting for differences in risk scores.

We conclude that while there is significant risk selection between on- and off-Marketplace plans, premium rating factors combined with risk adjustment compensate adequately for these differences in risk, suggesting no remaining problems stemming from risk selection between these two segments of the market. Significant risk selection also exists between grandfathered and (on- and off-Marketplace) non-grandfathered plans. Because there is no risk adjustment between these segments of the market, this risk selection is likely to drive up the price of insurance in the non-grandfathered segments of the market. However, our results indicate that adding the grandfathered plans to the risk adjustment program would alleviate this problem by adequately compensating for differences in risk across these segments of the market.