Reclassification Risk in the Small Group Health Insurance Market

Health insurance with annual contracts does not provide complete risk protection since enrollees with persistent adverse health shocks will be faced with higher future premiums. We consider the small group insurance market in a context where insurers could largely pass through expected risk in the form of higher premiums. Using a panel of claims, plan characteristics, and premium data from a large national insurer, we find that the insurer passes on 3 to 35% of expected mean health risk in the form of higher premiums, compared to 100% pass through with perfect competition. Assuming CARA preferences with published risk aversion estimates, this risk protection adds an equivalent mean of $755 annually in consumer welfare. Community rating would increase annual welfare $241 more.