Who is Changing Health Insurance Coverage? Empirical Evidence on Policyholder Dynamics

• Author: Lorenz Zirkelbach,Martin Eling,Marcus C. Christiansen,Jan‐Philipp Schmidt
• Date: 01 June 2016
• DOI: http://doi.org/10.1111/jori.12053
• Published date: 01 June 2016

WHO ISCHANGING HEALTH INSURANCE COVERAGE?

EMPIRICAL EVIDENCE ON POLICYHOLDER DYNAMICS

Marcus C. Christiansen

Martin Eling

Jan-Philipp Schmidt

Lorenz Zirkelbach

ABSTRACT

Long-term health insurance contracts provide policyholders with the option

of lapsing coverage or switching to another tariff within the same insurance

company. We empirically analyze policyholder behavior regarding con-

tract commitment in a large data set of German private health insurance

contracts. We show that short-term as well as long-term premium

development, along with premium adjustment frequency, affect lapse and

tariff switch rates. Moreover, the sales channel has a strong impact on

switching behavior, indicating that policyholder choice is not fully

independent of sales representatives. Our results are important for risk

assessment and risk management of portfolios of health insurance contracts

and provide better understanding of the dynamics of policyholder behavior

in health insurance.

INTRODUCTION

In this article, we study policyholder behavior in regard to long-term health

insurance. We focus on policyholder options to change insurance coverage.

Policyholders may leave their current insurer, thereby lapsing the contract, or

alternatively, they may remain with the insurer but choose different coverage at a

different tariff. Lapse is often financially irrational. First, most people experience

worsening health as they age; therefore, a new policy will likely include a higher risk

charge and therefore higher premiums. Second, the accumulated reserves generated

from overcharging policyholders in the early years of the contract in order to

Marcus C. Christiansen, Jan-Philipp Schmidt, and Lorenz Zirkelbach are at the Institute of

Insurance Science, University of Ulm, 89069 Ulm, Germany. Christiansen can be contacted via

e-mail: marcus.christiansen@uni-ulm.de. Martin Eling is at the Institute of Insurance

Economics, University of St. Gallen, 9010 St. Gallen, Switzerland. We thank Sandra Blome,

An Chen, Lukas Hahn, Christian Kraus, Andreas Reuß, Joan T. Schmit, Hans-Joachim Zwiesler,

and the participants of the 39th Annual Seminar of the European Group of Risk and Insurance

Economists for very helpful questions and comments.

© 2014 The Journal of Risk and Insurance. Vol. 83, No. 2, 269–299 (2016).

DOI: 10.1111/jori.12053

269

undercharge them in later years and maintain a level premium are forfeited

(Baumann, Meier, and Werding, 2008). Tariff switch, however, may allow policy-

holders to avoid being reclassified for underwriting purposes while also allowing

them to maintain the accumulated reserves.

In German long-term health insurance contracts, reimbursement of costs charged by

physicians and other medical services is contractually fixed until death, lapse, or tariff

switch by the policyholder. Pricing of these policies is based on an estimate of

healthcare reimbursements over the entire life of the individual, which is made at the

time the policy is purchased based on community risk classifications.

1

Individuals

pay a whole-life level premium so that in the early years of the contract, the part of the

level premium exceeding expected reimbursement is accumulated in a reserve and

used for higher reimbursement in later contract years.

2

This health insurance funding

approach may be denoted as individual whole‐life balancing and it is fundamentally

different from the guaranteed renewable short-term health insurance found in other

countries (Pauly, Kunreuther, and Hirth, 1995) or from time-consistent health

insurance proposed by Cochrane (1995).

Lapse may have a severe impact on the insurance company’s financial situation. In

other settings, high lapse rates have been shown to cause losses due to unpaid

acquisition costs (e.g., Kuo, Tsai, and Chen, 2003; Eling and Kiesenbauer, 2014) and to

diminish future profits due to a potentially shrinking portfolio. Adverse selection and

adverse retention (good risks leave the pool, while only bad risks remain) are likely

outcomes of lapse as well, distorting the insurer’s competitive position (Altman,

Cutler, and Zeckhauser, 1998). An interesting aspect of the German private health

insurance system is that high lapse rates (exceeding expected lapse rates) may

increase the short-term profit as reserves of lapsed policies in most cases enlarge the

annual gross surplus.

Why, then, would policyholders choose to lapse? Goldman, Leibowitz, and Robalino

(2004) study policyholder choice across different health insurance plans in U.S. group

health insurance. They show empirically that relative premium increases affect

policyholder decisions about switching coverage, confirming earlier empirical results

for individual health insurance with Californian health insurance data (Buchmueller

and Feldstein, 1997). Crocker and Moran (2003) provide theoretical and empirical

evidence that lapse rates fall (i.e., policyholders have higher policy commitment)

when health insurance is bundled with employment contracts. Analyzing European

long-term health insurance contracts as part of an insurance bundle, Pinquet, Guille

´n,

and Ayuso (2011) observe immobile policyholders who make financially irrational

lapse decisions. Specifically considering German long-term health insurance

1

To compensate for very high expected reimbursements, high-risk policyholders have to pay an

additional premium loading on top of the premium based on the community rating.

2

If the portfolio experience of health expenditure is deteriorating, then the health insurance

company is allowed to adjust level premiums, as will be discussed in detail later. Moreover,

there is a balancing between low risks (health expenditure below portfolio-average health

expenditure) and high risks (health expenditure above portfolio-average health expenditure).

270 THE JOURNAL OF RISK AND INSURANCE