Deborah J. Chollet and Maureen Lewis
Private health insurance is a growing phenomenon in much of the world. Fueled by rising incomes and growing dissatisfaction with publicly financed (and often publicly delivered) health care services, private insurance coverage typically begins among large company managers in white−collar industries, and in multinational
companies with large numbers of employees. However, informal insurance arrangements exist even in the poorest countries, reflecting a universal desire for financial protection and, in some countries, access to better−quality health care than is offered in the public system.
A private insurance market can offer a number of advantages over a purely public system of health care financing.
It can allow governments to develop and maintain smaller and targeted systems of health care financing to serve people who do not have access to private insurance. Private insurance can help health care providers (private and public) rebuild infrastructure and amortize needed investment when government payments for health care are inadequate. In the best cases private insurance encourages health care systems—both the financing and the delivery of care—to innovate and to become more efficient, and offers a point of reference for improving the quality and efficiency of care in the public system. Typically encumbered by politics and bureaucracy, governments may find it difficult to innovate without a private market to lead the way.
Despite these advantages, private insurance presents a number of problems. First, health insurance can be
unaffordable for low−income people. In principle, governments can develop subsidies to help low−income people buy insurance, but such systems can be difficult to design and to administer. Second, insurers may want to deny coverage to people who are sick, and to limit coverage for high−cost conditions or services. By refusing people who are sick or by deterring them from seeking coverage, private insurance can contribute to higher average costs in public financing programs that enroll larger populations and serve as the insurer of last resort. The selection of low−cost patients into private insurance can cause serious problems for the public financing system (or the health care delivery system that it finances) if it cannot readily adjust to higher average costs—even when total costs decline. Governments can require private insurers to accept sick people, restrict how insurers price coverage, and require insurance plans to cover various types of high−cost health care. However, insurers may be unwilling to enter or remain in markets with such requirements.
Other problems with private insurance derive from the complexity of insurance contracts. Consumers typically do not understand many aspects of insurance contracts. Because consumers usually are unable to detect which insurers are unscrupulous or financially unsound, the market can attract these insurers. Consequently, insurance regulators play an essential role in stabilizing a competitive private insurance system. However, insurance regulation is more art than science. It should encourage innovations that improve efficiency and service, but it must require financial integrity and discourage practices that threaten the stability and effectiveness of the health insurance system—and, in turn, the health care system that it supports.
Deborah J. Chollet is associate director at the Alpha Center in Washington, D.C. Maureen Lewis is principal economist in the Human and Social Development Group of the Latin America and the Caribbean Regional Office
Private Insurance: Principles and Practice 102
at the World Bank. The authors are grateful to Jeffrey Hammer, Gerard La Forgia, Jack Langenbruner, and Len Nichols for helpful comments.
This paper has three sections. The first section reviews private health insurance principles—what private insurance is, how it works, and why insurance practices tend to evolve in particular ways. It then discusses the role of government regulation—specifically, how regulation can stabilize and guide the performance of private insurance markets—drawing on examples from OECD countries (especially the United States, which relies the most heavily on voluntary competitive private health insurance) and developing countries.
The second section addresses the extent of private insurance coverage in developing countries, summarizes selected countries' experience with private insurance, and describes emerging regulation in these countries.
The final section offers conclusions and a number of lessons for developing effective health insurance regulation.
By melding theory, practice, and experience, we hope to provide a context for evaluating the role of private health insurance and for designing effective systems of health insurance regulation in all countries.
Principles of Private Health Insurance Markets and Regulation
Like all forms of insurance, health insurance is a system of protection against financial loss. In a health insurance system a group of individuals agree to pay certain sums for a guarantee that they will be compensated for costs related to the use of specific kinds of health care. Formal health insurance contracts typically stipulate that covered health care services must be medically necessary and provided by appropriately trained health care professionals. Because health providers generally prefer to see patients who are insured rather than risk
nonpayment for care, in many countries having health insurance (private or public) is equated with having access to health care.
The premise of health insurance is simple: individual health care needs can be unpredictable and costly, but relatively few people need health care at any particular time. Thus, by pooling the risk of large health care expenditures over many people, health insurance can make necessary health care affordable to all.
Private health insurance systems differ from public financing systems in several ways. Most important, a private insurance plan typically competes for customers, either with a public system or with other private health insurance plans. Thus consumers may choose among plans that have different features (more or less financial protection, different access to physicians and hospitals, a greater emphasis on customer service and satisfaction, and so on).
Typically, these plans also have different prices, and consumers have to decide if a more desirable insurance plan is worth its higher price. In principle, competition among health plans will tend to drive up the quality and drive down the price of available insurance. But different prices are often associated with a range of plans that provide different benefits and may be difficult to compare. People with low incomes are unlikely to be able to afford any insurance at all, much less insurance that offers them access to comprehensive health care.
By comparison, in a public financing system consumers typically do not choose among health plans. Moreover, public financing may or may not allow patients to choose among hospitals, physicians, and other service
providers. A public system typically is financed in large part through taxes that are unrelated to the use of health care but that may be related to ability to pay. Thus differences in the quality of coverage may not be a problem.
Instead, problems with public financing usually derive from the absence of competition and, therefore, the absence of incentives for public systems to respond to consumers. Public systems typically have little incentive to continuously improve quality and customer service and also contain costs.
During the past two decades managed care plans have emerged in a number of countries. Managed care plans combine the financing and delivery of health care in the same contract, offering enrollees both insurance
Principles of Private Health Insurance Markets and Regulation 103
protection and a prescribed network of health care providers. In industrial countries managed care plans have been offered as a lower−cost alternative to financial insurance plans that do not constrain participants' choice of
provider. But as enrollment in managed care plans has grown, some plans are also striv−
ing to be known as a better−quality alternative to the fragmented, fee−for−service system of health care delivery.
Unless otherwise indicated, in this paper health insurance includes both financial insurance plans (which pay for covered services from any qualified provider) and managed care plans (which pay only for covered services that are delivered by providers who are under contract to the plan).
Roles of Private Insurance
Most countries have a private health insurance sector. In general, private insurance tends to emerge when the public financing system is perceived as financing lower−quality care (usually also restricting patients' choice of provider) or covers only some types of health care. Reflecting the diverse reasons that a private insurance sector would emerge, the role of private insurance varies widely among countries that allow or encourage it. In general, these roles are of three types:
Coverage for people who are ineligible for public insurance . For example, in the United States private insurance is considered the main source of coverage, while public insurance is intended to cover groups whom the private insurance market is likely to fail—the elderly (in Medicare) and people who are unable to work (children, the elderly, and the disabled) and poor (in Medicaid). People who are ineligible for public insurance do not always buy private insurance. Some rely on public hospitals (funded by local government) for care. In communities that do not have a public hospital, people without insurance may be unable to obtain routine care.
Coverage for people who withdraw from a universal public insurance program . For example, in Germany individuals may withdraw from the national payroll tax−financed system of sickness funds, which offer coverage to all resident workers, their families, and retirees. People who withdraw are not required to buy private insurance, but they usually do so. Few people withdraw from the national public insurance system, however, since they can never reenter it. In Chile insurance is compulsory but individuals can choose between buying regulated private insurance or relying on publicly financed and delivered health care. This approach has created a two−tier system in which healthy and high−income people buy private insurance and others rely on the public system.
Supplemental coverage for services not covered by a universal public insurance program . For example, in the United Kingdom, where the public insurance program is popular and provides comprehensive coverage, people may buy private insurance to finance care from specialists in private practice, "jumping the queue" for specialty care in the public program. Similarly, in Brazil no one may withdraw from the public system, but some people buy private insurance to get more timely or higher−quality care in the public system. In Australia private
insurance pays only for hospital care, either in private facilities (which offer patients a choice among physicians) or in public facilities. In the United States enrollees in Medicare, the social insurance program for the elderly and the disabled, can buy private supplemental coverage to pay for the public plan's extensive deductibles and coinsurance amounts, and to pay for major items (such as prescription drugs) that are not covered by the public plan. About one−third of retirees have a private Medicare supplement insurance plan.
Annex tables 1 and 2 provide additional detail about the alternative roles of private insurance in selected countries.
In many countries a large portion of health care spending is financed privately, either through insurance or out of pocket. But rarely does private insurance finance most health care use. In the United States, where private health insurance is unusually well developed (but purchase is voluntary), private insurance financed only about 37 percent of all personal health care spending in 1994; 59 percent was publicly financed. The Republic of Korea is
Roles of Private Insurance 104
unique in that private insurance is mandatory, and it finances most health care.
Even in industrial countries where public health care financing is universal, private insurance may still finance a significant share of health care. For example, in the United Kingdom private insurance financed 14 percent of health care in 1990. Similarly, in Canada (where public health care financing is universal and private insurance is prohibited from covering publicly insured health care services) a sizable minority of people buy private insurance to finance services that are not covered by provincial programs. Information about the shares of health
expenditures financed
Table 1
Private and public expenditures for personal health care services, selected countries (percentage of total expenditures)
Private health care expenditures Public health care expenditures
Country
Issued or prepaid
Out−of
pocket Total
Social insurance
programs Other Total
Argentina — 23 — 36 22 58
Brazil, 1995 — — — — — 75
Canada 20 — — 75 — —
Ecuador — 63 — 17 14 31
Egypt — — — 9 30 39
France 21 — — 75 — —
Germany, 1985a 7 7 14 69 12 81
India, 1990−91b 3 75 78 — — 21
Jamaica 9 — — 35 — —
Jordan, 1994 — — 53 39 8 47
Kenya, 1994 — — — — — 43
Niger 14 — — 67 — —
Nigeria 44 — — 45 — —
Peru, 1995 — 28 — 36 30 69
South Africa, 1993−94c
37 14 55 — — 45
Tanzania 14 — — 68 — —
Thailand, 1992 — 74 74 2 24 26
Tunisia 25 — — 67 — —
Uganda 15 — — 47 — —
United Kingdomd 13 — 14 85 2 87
32 3 37 30 29 59
Roles of Private Insurance 105
United States, 1994e
Uruguay 14 — — 76 — —
Note. Unless otherwise indicated, source did not provide a reference year. In all cases data are the most recent available.
a. Excludes 4.3 percent of expenditures financed from other sources.
b. Excludes 0.8 percent of expenditures financed by external donors.
c. Excludes 4 percent of private spending categorized as industrial health expenditures.
d. Excludes I percent of private spending not allocatable to categories.
e. Excludes 3.4 percent of private spending from other sources Social insurance figures include Medicare Part A and Part B.
Source: Lewis and Medici 1995; Musgrove 1996, Reinhardt 1995, World Bank 1995 and 1996; Collins and others 1996, Abel−Smith 1995, Levit and others 1996; Fernandez 1997;
TAI 1997; Nittayaramphong and Tangcharoensathien 1994, Rafeh in this volume.
by private insurance, out−of−pocket expenditures, and public insurance programs in selected countries is summarized in table 1.
Concept of Insurable Risk
Risk is defined in terms of both the probability and the magnitude of potential health care expenditures. A
high−risk situation may entail a high probability of expenditure (regardless of how great the expenditure may be), a high magnitude of expenditure (regardless of the probability), or both.
In general, health care for any illness or condition that occurs randomly among a population is insurable. But in a number of high−risk circumstances health care may be uninsurable. In these circumstances insurers will be unwilling to offer coverage, or will design insurance contracts in particular ways—usually trying to package coverage for uninsurable risks together with coverage for insurable risks. The kinds of situations in which some or all health care may be uninsurable are described below.
Nonrandom Health Care Risk
Possibly the main reason that health care would be uninsurable is if it were nonrandom. For example, during a war or civil conflict health care risks are systemic: the likelihood that any person will need health care is highly correlated with the likelihood that many others will need care as well. Similarly, in communities where serious, communicable health problems have reached epidemic proportions (for example, in communities with a high incidence of AIDS), much health care may be uninsurable. In these communi−
ties insurers may be unwilling to insure much of the population, or they may refuse health care for the specific injuries or illnesses that are most likely (for example, those due to war or civil conflict).
High−Probability Health Care Services
Even when the incidence of illness or injury is random, some health care services may be uninsurable if the probability that people will use those services is very high. The reason such services may be uninsurable relates to how insurance prices are determined. Specifically, the price of an insurance plan that would cover
high−probability losses may equal or exceed the cost to consumers of remaining uninsured, even if they could
Concept of Insurable Risk 106
afford to buy coverage.1 When this is the case, private insurance for those services may not emerge. Instead, insurers may offer insurance products that specifically exclude coverage for highưuse services Or for services that, when covered, would attract enrollment by highưuse patients. In the United States mental health care is one example of such a service; most private insurance plans strictly limit coverage for mental health care or care related to substance abuse.
Very LowưCost Health Care Services
Similarly, very small health care expenditures may be uninsurable, whether they are likely or not. For very small losses, the administrative costs of insurance may exceed consumers' demand to be protected from the associated risk. This does not mean that private insurance would not cover such expenditures, but it probably would not cover only such expenditures. Instead, insurers would package coverage for very small expenditures with coverage for more costly, less likely, and therefore insurable services (such as hospitalizations).
Uninsurable Individuals or Groups
Finally, health care that is insurable for some people may be uninsurable for others. Specifically, insurers are likely to view people as uninsurable if they are likely to need extensive and costly health care. This is the main reason that private insurance (when it is voluntary) does not finance most health care spending, even in countries with a wellưdeveloped insurance sector. If regulation permits, insurers will shun people with chronic health problems, people who are terminally ill, or people living or working in circumstances that suggest a high risk of illness or injury. Even if private health insurance is available to such people, it may be unaffordable.2 Although affordable private health insurance may emerge for relatively highưrisk populations (such as the elderly), it is likely to be available only to supplement extensive coverage from a public insurance program.
Dynamics of Private Insurance Systems
In private, voluntary health insurance systems, people can choose whether to buy health insurance. In a competitive system they can also choose which health insurance plan to buy. In many countries some workers ''buy" health insurance through their employers, taking insurance in lieu of higher wages. In this case the employer is the direct buyer of the health insurance plan for a group. Alternatively, consumers may buy health insurance directly, either as individuals or as a family—much as they would buy any product. As with most products, buyers will tend to choose an insurance plan that has a lower price if its essential features are acceptable.
Insurers can lower the price of a health insurance contract in four ways:
By trying to insure only lowưrisk people, denying coverage to people who are sick, or excluding coverage for some conditions.
By offering less coverage, limiting the scope or extent of covered services.
By discouraging excessive use of covered health care services.
By reducing the administrative costs of the plan.
Each of these methods can create immense problems for some consumers. Consumers may be unable to buy adequate insurance (or any insurance), especially if they are sick, and they may find that customer service under their plan (for example, timely and accurate payment of claims) is poor. But each method offers an economic advantage to consumers who are healthy. Because healthy consumers are unlikely to need much health care, they are unlikely to use their health plan extensively if at all. Thus private insurance can offer them relatively lowưcost
Very LowưCost Health Care Services 107
financial protection.
Insuring LowưRisk People: Insurance Underwriting and Pricing
Consumers seeking insurance are always more knowledgeable than insurers about their health status and about the likelihood that they will need health care.3 Moreover, consumers who have or anticipate health problems are more likely to seek insurance than are healthy consumers.4 These facts dictate a great deal of how insurance contracts are sold. Enrollment by people with greater health care needs than the insurer anticipated when setting the price of insurance is called adverse selection . Adverse selection can destabilize an insurance pool5 and even cause it to fail.6 Thus insurers have developed techniques to avoid or reduce adverse selection. Possibly the most important of these is underwriting .
Insurance underwriting is the practice of evaluating individual health status and either rejecting potential buyers who are deemed to pose excessively high risk or placing them in plans with other people who represent
approximately the same risk. Insurers are inclined to underwrite in order to avoid adverse selection, but
competitive insurance markets also tend to reward insurance plans that exclude or isolate people with extensive health care needs. That is, in a competitive market consumers search for the lowestưpriced plan that provides them with the coverage they want. Insurance plans that are able to exclude highưrisk participants are likely to be less costly and more comprehensive than plans that insure everyone and try to control cost in other ways. Thus consumers who are searching for the lowestưpriced insurance plan are likely to prefer an insurance plan that excludes people who are more costly than they are.7
Insurers that underwrite coverage typically require applicants to disclose their medical history (allowing the insurer to review their medical records) and may require that applicants undergo a physical examination by an approved physician. They may require applicants to present such "evidence of insurability" at the time the contract is first issued, and again each time the contract is renewed. Thus, while insurance underwriting enables insurers to price insurance plans more accurately, many consumers find it to be personally intrusive and offensive.
Insurers that are able to identify highưrisk consumers may nevertheless be willing to sell coverage to many of them if they are able to price insurance differently to consumers in different classes (or tiers) of risk. The practice of pricing insurance based on enrollee health status (or various indicators of medical risk) is called tiered rating . Tiered rating is a natural, stable result of competitive insurance markets: tiered rates simply reflect differences between the risks contained in different insurance pools.8 However, critics of tiered rating view it as splitting up risk unnecessarily. They argue that tiered rating makes health insurance unaffordable to people who have health problems or even to people who are in a demographic group that might suggest higher medical expenses. They argue that a single rate class, several rate classes reflecting broad geographic differences in the cost of care (pure community rating ), or broad rate classes based on demographic factors but not reflecting individual differences in health status (modified community rating ) would make health insurance more affordable to highưrisk people by forcing other members of the pool to subsidize them. But since lowưrisk consumers tend to prefer lowưcost insurance products over subsidizing people with predictably higher health care costs, community rating does not naturally occur in insurance markets. (Underwriting and community rating are discussed further in a later section on insurance regulation.)
Although some insurers reưunderwrite enrollees at the time of renewal, they are more likely to rely on a pricing strategy which assumes that customers who are renewing coverage are likely to have more (and more costly) health care needs than new customers in the same plan. The practice of charging more for renewal than for firstưissue coverage in the same plan is called durational rating .
Durational rating assumes that the claims experience of any risk pool will worsen over time—a phenomenon that in fact is usual in insurance pools. Some participants who were healthy at the start of the contract become sick or Insuring LowưRisk People: Insurance Underwriting and Pricing 108