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

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.