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Controlling the effects of adverse selection in flexible benefit plans: A pricing-based approach

Author

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  • Ng, Cherie
  • Sanders, Barbara
  • Bégin, Jean-François

Abstract

Most flexible group benefit plans are currently designed and priced based on deterministic assumptions about the plan members' option selection. This can cause an adverse selection spiral—healthier insureds drop out of richer options, increasing the concentration of high-risk insureds covered in these options and thereby causing skyrocketing insurance rates. In this study, we propose and analyze a solution for the spiral based on pricing. Pricing-based strategies are infamously difficult to implement in practice as the deposit rates, the option selection, and the experience are interconnected: the pricing decisions impact selection patterns, which in turn influence the claims. We show that our pricing solution successfully controls the effects of adverse selection and keeps the flexible benefit plans sustainable and stable over time, unlike the current practice.

Suggested Citation

  • Ng, Cherie & Sanders, Barbara & Bégin, Jean-François, 2022. "Controlling the effects of adverse selection in flexible benefit plans: A pricing-based approach," Insurance: Mathematics and Economics, Elsevier, vol. 105(C), pages 293-312.
    • Handle: RePEc:eee:insuma:v:105:y:2022:i:c:p:293-312
    DOI: 10.1016/j.insmatheco.2022.04.008
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    More about this item

    Keywords

    Group insurance; Flexible benefits; Cafeteria plans; Multiple-choice environment; Adverse selection;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • J32 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Nonwage Labor Costs and Benefits; Retirement Plans; Private Pensions

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