# Risk Equalization and deductibles

In this blog, I have written about the Swiss (part one, part two) and Dutch healthcare system extensively. Both systems have a “regulated competition” where insurance is mandatory and insurance companies are mandated to provide a specific insurance benefit package. In the Swiss system, 85% of medical expenditures are financed by insurance premiums and 15% are financed by user fees. In the Netherlands, 50% of expenditures are paid by income-related contributions, 45% are paid by insurance premiums and 5% are paid by user fees. In both systems, the government pays a risk equalization premium to insurance companies who have a higher percentage of sick people to help eliminate cream skimming. However, does this risk equalization system still function when voluntary deductibles are introduced?

This is the question which a paper by van Kleef, et al. (2008) attempt to answer. Currently, the Swiss only count net claims (medical claims paid by the insurance company, ignoring out-of-pocket payments by insurers). Is this a problem? Let us give one example:

Let us assume that Healthy Hank spends \$1000 on health care per year and is insured by HealthNet and Sick Sally spends \$2000 on health care per year and is insured by SickFund. In the Swiss system, insurance companies receive (pay) a risk equalization payment based on whether they have above (below) average medical expenditures. This would mean that insurance premiums would be \$1500, the average of Hank and Sally’s expenditures. HealthNet would pay \$500 into the risk equalization pool and SickFund would receive \$500.

What happens in the presence of deductibles? Let us assume that HealthNet offers an insurance package with a \$500 deductible and HealthNet offers an insurance package with no deductible. Healthy Hanks will sort into the HealthNet deductible package and Sick Sallys sort into the no deductible SickFund package. Now, we have that HealthNet will have \$500 of net claims on average since Hank will pay \$500 and the insurance company will pay \$500. SickFund will still have \$2000 of cost.

Now the insurance premium will be \$1250 since the insurance premium is based on net claims [(2000+500)/2]. HealthNet will have risk equalization payment of \$750 and SickFund will receive \$750. The insurance premium for Healthy Harry will be \$1250 (\$500 + the \$750 equalization payment) . The premium for SickFund will be \$1250 as well (\$2000-the \$750 risk equalization payment). Thus, there will be no benefit to choosing the deductible since there is no premium benefit. Yet policy makers would like people to choose the deductible plan to reduce moral hazard. The paper gives a few other scenarios where the risk equalization scheme fails and cream skimming occurs.

In general, economist love choice. Yet in insurance markets, the more choice is given to consumers, the more incentive insurance companies have to cream skim. Despite policymakers best attempts to control cream skimming through risk equalization payments, no risk equalization scheme will be perfect. Like everything in life, there is a tradeoff. In this case, the tradeoff is between offering consumers more choice, and reducing cream-skimming.