Plan Has Disincentives For Young,

Healthy Individuals to Participate

The EGI pool is older because younger and healthier individuals can obtain coverage less expensively elsewhere.

The EGI pool is older and has fewer dependents than our comparator plans.  According to insurance industry theory, having an older pool has a compounding effect:  it raises costs to the plan and increases average premiums, so eligible persons who are younger, healthier, and can obtain cheaper coverage on the private market, leave the plan.  This makes the pool less healthy so that claims costs increase, and the cycle continues.

We believe aspects of the design of the plan create disincentives for younger and healthier individuals to participate in the EGI plan.  For example, the state makes a lower contribution for dependents of employees than our comparators, premiums are not risk-rated, and the plan’s tiers lacked analysis.

EGI Has Older Participants and Fewer

Dependents Than Comparators

There is a correlation between age and health care costs, with older individuals tending to incur higher costs.

Adverse selection occurs when a plan attracts individuals with health problems, creating disincentives for healthy individuals to participate.

Demographic data indicates that many employees may be

electing not to insure

dependents in the plan.

A majority of respondents to a

recent benefit survey said they do not insure their dependents

under the EGI plan.  

The number of employees who purchase dependent coverage has decreased 20 percent since 1996.

Compared to other public plans we examined within and outside of Wyoming, the EGI pool is older and has the lowest percentage of employees who purchase dependent contracts.  This is a concern because there is a proven relationship between people’s ages and the amount of health care costs they incur.  On the whole, those who are older tend to be less healthy and have higher health care costs, while  younger individuals tend to be healthier and thus less costly to cover. 

Group premiums are basically determined by dividing the pool’s total claims by the number of primary insureds.  Premiums will be lower if there are individuals in the plan who contribute premium income and spread risk, but incur minimal claims.  Thus, it is important for group plans to have a greater percentage of younger and healthier participants; the right balance can lower the overall costs to the plan. 

Adverse Selection Is Occurring

According to insurance industry literature, when a plan tends to attract older persons or those with health problems who are more expensive to insure, it has adverse selection.  In other words, younger, healthier and less costly individuals elect not to be part of a plan.  Insurance experts state that healthy individuals can typically obtain less expensive coverage in the private market.7  The assumption is that people will act in their best financial interest.  Older and less healthy people are not likely to get cheaper coverage on the private market, so they have an incentive to stay in the plan, which in turn makes the plan more costly. 

We cannot state with certainty that EGI is experiencing adverse selection, because the plan does not track demographic information about the universe of potential participants.  We considered whether, rather than experiencing adverse selection, the eligible participants are simply older with few dependents.  In this case, there would not be opportunities to insure a significantly higher number of dependents through EGI. 

However, the demographic data we reviewed leads us to conclude that there are many employees who are electing not to insure dependents through EGI.  Anecdotal evidence from a number of sources, including EGI officials and insurance experts in Wyoming, indicates that it is not unusual for EGI participants to insure their dependents on the private market.  Further, if public sector workers in Wyoming are older, one would expect the four other in-state public plans we examined to have demographics similar to EGI’s, but this is not the case.

Many Employees Elect Not to Enroll

Their Families in the EGI Plan

A primary indicator that the plan is experiencing adverse selection is the number of employees who are not insuring their dependents through EGI.  As part of the total compensation study efforts, A&I contracted for a survey of state employees to gain their perspectives about the state’s benefit package.8  This survey found that 71 percent of respondents are married, and 50 percent have children.  However, only 40 percent of all respondents enroll their family members in the EGI plan.

EGI Premiums Increasing,

Dependent Contracts Decreasing

Another indicator of adverse selection is the reduction in the number of employees who purchase dependent contracts.  Over the past five years, as EGI premiums have gone up, the number of dependent contracts has gone down.  From 1996 to 2000, in the low deductible plan, family premiums of actives increased by 36 percent, while coverage of their dependents decreased by 20 percent (see Figure 6). 

In the high deductible plan, family premiums also increased by 36 percent.  However, dependent participation of actives rose as well by 31 percent, which may have been due to the lower premium available under this option.

Figure 6:  Dependent Contracts
of Active Employees9

      Source: LSO analysis of EGI-reported data.

EGI Pool Is Older

EGI has an older pool of participants than the six comparators10 reporting demographic information, shown in Figure 7, including in-state, public comparators.  In 1999, EGI had the highest percentage of participants over the age of 54.  EGI also had more participants over the age of 44 than all four of the Wyoming plans we reviewed.

Figure 7:  Breakdown Of Ages In

Comparator Plans In 199911

EGI has the lowest percentage of young participants in its plan.

  Source: EGI and comparator-reported data.

EGI has a much

lower percentage of employees who insure their family members through the plan than the comparators.

EGI Has Lowest Percentage
of Dependent Contracts

The ratio of dependent contracts in comparator plans also indicates adverse selection in EGI.  Compared to seven12 other public plans we reviewed that provided demographic information, EGI has the lowest percentage of employees purchasing dependent coverage (as shown in Figure 8).  The ratio of individual to dependent contracts in the EGI plan is about 67 percent to 33 percent.  Insurance experts state that the reverse of this ratio is ideal:  30 percent individuals and 70 percent dependents.  This is because dependents such as children are generally young and healthy, and because they also add premium income to a plan.

Figure 8: Comparator Ratios
of Individual to Dependent Contracts

The percentage of family contracts is much higher in the comparators, indicating adverse selection

in the EGI plan.

   Source: EGI and comparator-reported data.

We believe EGI is experiencing significant adverse selection when measured against comparators.  EGI has roughly half as many dependent contracts as two comparable state plans, North Dakota and Montana.  Within Wyoming, all four comparators had proportionately more dependent contracts thanEGI; three of the four had more than twice EGI’s percentage, and the fourth had 23 percent more dependent contracts than EGI.

Adverse Selection Has

A Compounding Effect

Employees can

obtain less expensive  coverage for their families elsewhere.

In theory, adverse selection has a compounding effect (see diagram on the following page):  having an older pool results in higher costs to the plan, and higher plan costs result in increased premiums.  When young and healthy individuals can obtain coverage for less on the private market, they tend to do so.  Remaining individuals who cannot get less expensive coverage elsewhere, stay in the plan. This again contributes to higher plan costs, and the cycle continues.

Figure 9: Cycle of Compounding
Adverse Selection

Higher costs lead to increased premiums, creating financial  disincentives to purchase dependent coverage through EGI.

                         Source: LSO analysis of industry literature.

The question of adverse selection revolves around participants who, because of the cost they incur, choose to buy coverage elsewhere for their young, healthy dependents.  When participants’ premiums are fully covered, as are singles in the EGI plan, they have no financial reason to opt out of the plan. 

EGI Plan Design Creates Disincentives

To Cover Young, Healthy Dependents

It is important to

design a plan that

attracts as many

young and healthy participants as possible.

Aspects of the EGI plan structure are creating incentives for some employees to insure their dependents on the private market or through their spouse’s plan.  For example, EGI employees receive a lower employer contribution for dependent health insurance than the comparators because they do not receive a direct contribution from the state for dependent premiums. 

According to expert literature, “Inherent in the principle of group insurance is the understanding that all employees can be covered.”  Since the intention of group plans is to spread risk among many participants, including high-cost individuals, it is important to design a plan to attract as many young, healthy participants as possible.  This helps keep the average costs down.  However, certainaspects of EGI’s plan design provide disincentives for younger and healthier people to participate in the plan.  In addition to the lack of contribution for dependents, other disincentives are:  tiers that do not attract the young and healthy, premiums not rated according to risk, lack of choice, and open enrollment. 

Employers who pay a greater percentage of the premium can keep healthy participants

in the plan.

EGI participants pay

a higher percentage and higher dollar amount for their share of the family premium than comparators.

The degree to which the contribution affects adverse selection depends on what employees could

pay elsewhere.

No Targeted Dependent Contribution

Employees who elect individual coverage in the EGI plan are fully covered by the state’s contribution.  Employees who elect dependent coverage can apply this contribution towards the family premium, but the state does not make a direct contribution targeted to covering the cost of dependent coverage.  This is one of the factors contributing to adverse selection, since employees who can obtain coverage for healthy dependents elsewhere at lower cost, have incentives not to participate in the EGI plan.

A Wyoming consulting firm recently conducted an analysis of 12 Wyoming school districts that participate in the Educators’ Benefit Trust.  Their results show those plans that paid the majority of the family premium had lower premium costs for each primary insured.  This suggests that when employers pay a high enough portion of the family premium, healthy employees or dependents will not leave the plan, and consequently, the plan will have lower costs. 

As noted in the previous chapter, EGI participants pay a higher percentage and higher dollar amount for their share of the family premium than do the employees in all our comparators.  We believe this factor contributes to EGI’s low percentage of dependent contracts in the following way:  when employers do not pay a substantial amount of the family premium, and healthy employees can purchase dependent coverage less expensively on the private market, they tend to do so.  Losing those dependents leads to higher average claims costs and higher premiums for the remaining pool of employees who remain. 

The degree to which the amount of employer contribution affects adverse selection depends on how much of the premium the contribution covers, compared to what the employee could pay elsewhere.  According to experts, to avoid adverse selection, employers should ideally contribute 100 percent for employees and at least 50 percent for dependents.  Even though the EGI employer contribution rates meet industry standards, if employees or dependents can get coverage cheaper elsewhere, adverse selection will continue.  As will be discussed in Chapter 4, continual monitoring of a plan’s design, benefits, and costs, in relation to what people can obtain elsewhere, is of critical importance.

Plans can attract healthy individuals

by offering them a premium rate that reflects their lower risk.

More data is needed

to ensure the tier is

set at the optimal

level to attract

young dependents.

In the EGI plan,

the premiums of healthier participants are inflated compared to what they could pay on the private market.

Tiers Not Set to Attract
the Young and Healthy

Another way to attract healthy people is by offering them a premium rate that reflects their lower degree of risk.  Tiers are means of structuring different premium rates within a plan according to participant risk, thus providing for more equity in a plan.  Without tiers, everyone in the plan pays the same premium regardless of their degree of risk or the amount of claims they incur.

EGI has traditionally offered two tiers:  a single tier for an employee only; and a “family”tier that included an employee and dependent(s).  Consequently, smaller families are subsidizing larger families since they pay the same amount for coverage regardless of family size.  Effective January 1, 2001, EGI will add a third tier with a new premium rate for employees who insure themselves and a dependent spouse only, or themselves and a dependent child or children only.

Although this change shows initiative on EGI’s part, we believe that the board needs more data on the eligible participant population to ensure the tier is set at the optimal level to attract young dependents.  For example, plan managers need to know the number of dependents not currently insured under the plan.  Additionally, they need information about the level the premium should be set to create financial incentives for employees to insure their dependents through EGI. 

It is critical that the board strategically set the new tier for it to have the desired effect.  Unless the new tier attracts more premium revenue to offset its costs (which are being paid out of reserves in 2001), the board will need to increase family premiums.  This premium increase may cause other dependents to leave the plan.  Ironically, then, it is possible the net effect could be that more dependents leave the plan than come in with the new tier.  We believe more ongoing data analysis is necessary to strategically manage the plan, as will be discussed in the next chapter. 

EGI Premiums Are
Not Based on Risk

There are a number of ways to risk-rate premiums, such as by age and personal habits like smoking.  Setting premiums based on risk would serve as an incentive for the young and healthy to participate in a plan. 

A proven correlation exists between age and the amount of health insurance used in general:  the older the participant, the greater the claims.  Because higher age is probably the single biggest determinant of cost, older persons pay higher premiums than the average young person, on the private market.  However, since the EGI plan is not rated according to risk, older active employees pay the same premium as younger ones.  Thus, the premiums of healthier participants are inflated, and those of sicker participants are lower than they would be in the private market. 

The EGI board has taken some steps to rate retiree premiums to more closely reflect their risk.  However, as discussed in Chapter 1, active employees are still subsidizing early retirees.

The out-of-state

plans we reviewed offered more choice

to participants than

the EGI plan.

Paying lower out-of-pocket costs appears to be a higher priority to EGI participants

than having more benefit choice.

EGI Participants
Lack True Choice

“Choice” in the health insurance context refers to a variety of arrangements, such as the ability to select among plans with different deductibles and premiums, among types of provider arrangements such as HMOs and fee-for-service, or among specific benefits within a plan such as vision and orthodontic.  Other states we reviewed offer many more plan options in these three areas.  Offering greater choice can better meet individual needs both in terms of benefits and costs.  Theoretically, this could entice employees to insure their younger, healthier dependents in the EGI plan since they might perceive more personal benefit. 

Currently, the EGI plan contains some choice regarding providers.  Participants can elect to use PPO network providers and pay a lower co-insurance rate.  Participants are also free to choose their own out-of-network provider and pay a higher percentage of the cost. 

The current plan provides a fixed package of benefits to all participants and does not allow participants to choose among different types of benefits to meet individual needs.  Eighty percent of the respondents to

the A&I benefit survey stated they would like the option of selecting which benefits are included in their benefit package.

Nevertheless, based on interviews we conducted with employee representatives, paying lower out-of-pocket costs is a higher priority for EGI participants than having more benefit choice.  However, the EGI plan lacks true choice when it comes to allowing participants to select between plans with different monthly costs.  Although the plan has two deductible options, the premium for the high deductible plan is more than it should be, if it were based solely on claims experience.  More accurately rating the premiums of the high and low deductible plans might make the high option more attractive to those participants interested in paying a lower premium and assuming greater risk. 

Open Enrollment Contributes
to Adverse Selection

With true open enrollment, a plan accepts eligible individuals not currently covered without restriction.  Open enrollment has the potential to cause significant adverse selection, since it can draw in people who could not get coverage for less through the private market.  EGI has open enrollment every two years, with some pre-existing condition limitations, which can help to mitigate adverse selection.

Even though open enrollment contributes to adverse selection, discontinuing it would conflict with the inherent principle of group plans, that everyone can be covered.  Allowing open enrollment simply reinforces the importance of having a competitive plan in order to attract a healthy mix of participants and to mitigate adverse selection.

Actions Needed to
Modify Plan Design

Plan design features create disincentives for employees to purchase dependent coverage through EGI.

The factors of plan design mentioned above appear to be disincentives for employees to purchase dependent coverage through the EGI plan.  However, we do not make specific recommendations about what the plan should do to address adverse selection, because we believe the current administrative structure is ill-equipped to address these issues.  Changing the administrative structure, as outlined in the recommendation in the next chapter, is a necessary first step before plan administrators tackle plan design issues. 

An employer’s contribution for dependent coverage

is an important

factor in minimizing

adverse selection.

Analysis is needed

to determine the

contribution required

to entice employees

to purchase dependent coverage from EGI.

For example, we found the primary disincentive to employees purchasing dependent coverage through EGI is the low employer contribution.  Research shows that an employer’s contribution for dependent coverage is an important factor in minimizing adverse selection.  If the state were to make a targeted contribution for dependents of employees, our research strongly suggests that more dependents might be attracted into the plan.  In this way, the state may experience less of an increase in long-term premium costs. 

However, before requesting a direct contribution for dependent coverage, analysis is needed to determine the level of increased contribution needed to entice employees to purchase dependent coverage from EGI.  Examination of these and other factors that are theoretically contributing to adverse selection in the EGI pool should be conducted before taking action on these issues.  At the operational level, this information would benefit the plan by its potential to improve EGI’s demographic composition and costs relative to other plans.