The Effects of Community Rating

Let's play a game. You and I will represent two different health insurance companies. We are each competing for a population of 1,000 potential insureds. Make it simple; half are 20 and half are 50. The cost of the 50 year olds on average is three times the 20 year olds: $750 per month and $250 per month respectively.

Now, you are an egalitarian who believes that everyone should pay the same, so you charge $500 per month, which is the average cost of the 1,000 potential insureds. I am a greedy capitalist, so I have a tiered premium structure that follows the cost. That is, I charge the 20 year-olds $250 per month and the 50 year-olds $750 per month. What do you think happens at first? I will get all the 20 year-olds and you will get all the 50 year-olds. I'll make money and be happy because my premium covers the average cost of the group I got. You, on the other hand, will lose $250 per month per insured because you are charging $500, but the costs of group you got is $750.

This is what happens when you charge the average and your competitor is free to charge in relation to what it costs.

So, the government comes up with a mandate for the insurance companies. Now let's say that insurance companies are required to use community ratings. Something different happens: the 20 year-olds opt not to buy the insurance because it costs too much for them. And both companies lose money.

This is also why the insurance companies insist on an individual mandate in return for issuing policies with community rating and no underwriting. That is the only way to assure that the scenarios above won't happen. The averaging process is what happens in group plans. Strange that no one seems to mind that, but they have huge issues with it in an individual context. Could be that the employer is paying or greatly subsidizing the group insurance.