Group health insurance, unlike any other insurance policy, follows the principles of insurance in which the risk is shared among a group of members.
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How Risk Pooling in Insurance Happens?
Under group health insurance, the insurance company acts as an intermediary between a group of people who would like to hedge their risk by taking the insurance and paying the premium.
In this way, the premium collected from a group of people will be utilized to settle the loss suffered by a small group of people due to an unforeseen event. For this process to occur, the group should consist of people who claim and people who do not claim.
In simple terms, a health insurance policy should be taken by healthy people as well as unhealthy people so that the loss ratio could be maintained by the insurance company. Assume a situation where there are only takers of claims, then the loss ratio would be high and the insurance company would go into losses.
Types of Risk Pooling in Group Health Insurance
The insurance company would act as the intermediary between different people who want to have common coverage and hedge their risks by paying a premium for the insurance.
For instance, let us assume the insurance company has 10 customers paying ₹100 each and there would be one customer claiming up to ₹1000 during the policy period.
If the amount of the claim is equal to the amount of premium received the insurance company would make neither profit nor loss, but if the amount of the claim is more than the premium received then the insurance company would go into losses.
This could also happen if there is more than one customer claiming during the policy period, the more customers go for a claim the more would be the loss ratio.
A higher loss ratio would imply that more premiums are to be contributed by the members.
The scenario where more unhealthy people are taking the health insurance policy is known as “adverse selection.”
Adverse selection impacts the insurance company as well as the existing and newly joined policyholders, as the premiums would increase drastically.
Group health insurance selection is not permitted by the insurance companies as this would impact the loss ratio as mentioned above. Insurance companies operate on the basis of the law of large numbers. The more the number of members in the policy participation, the more the risk would be distributed among the numbers.
Insurance companies would have better predictions regarding the claims when the number is high. Another example of adverse selection can be when a smoker and drinker manages to get a health insurance policy.
In such cases, the claims payout and frequency would be high resulting in increased premiums at the time of renewal for everyone in the group. Nonsmokers would also be penalized by the insurance company by increasing the premiums up to a certain extent to compensate for the increased loss ratios.
This may discourage healthy people from opting for health insurance plans which again increases the adverse selection with only non-healthy people opting for group health insurance.
The process can be observed in group health insurance when most old age people or people who have a certain illness or experienced certain hospitalization rush to take health insurance. The concept of young and healthy people paying for the old and disabled can be justified that the young people would turn old in the future and someone would be paying for them and this cycle repeats.
Group health insurance is a type of health insurance policy that is usually offered to a group of people, such as the employees of an organization. The group health insurance premiums are generally paid by the employers, and the health insurance benefits are enjoyed by the members.
Group health insurance covers the hospitalization and other expenses of the insured due to an accident and disease or illness. The limit of coverage under the group health insurance would be the sum insured mentioned under the plan.
Group health insurance can also be extended to cover the family members such as spouses, children, and dependent parents or parents-in-law.
Hope this article helps you understand risk pooling in Insurance. Feel free to connect with experts at Ethika for more clarification.