The True Cost of Health Insurance: Who pays the price?

  

 

(Photo from the Sadar Psychological and Sports center)

 

Ever wondered why your Health insurance costs more than someone else’s? The answer lies in risk, uncertainty and asymmetric information. At first glance, Health insurance may look like a drop in the vast ocean of insurance. However, instead, it plays a vital part of the economy, shaping the way individuals, in the face of rising prices, access health care. The premiums you and your family pay depend heavily on the economic principles of risk, the likelihood of an activity or action harming you, as well as uncertainty, something inherent in healthcare with the unpredictability of events. (Royal College of Obstetricians and Gynaecologists, 2015)

This makes us question: is it right to use risk to make some individuals pay high premiums while others get a good deal? And finally, what is the true cost of insurance and who ultimately pays the price?

This blog will explore how Health insurance companies assess risk through economic factors such as asymmetric information, moral hazard and adverse selection. Through deepening our understanding of these factors holistically, we can evaluate the true cost of insurance and who bears the highest cost.

 

As insurance companies assess individuals based on factors such as age and lifestyle, clearly risk plays a paramount role in pricing. Risk, unlike uncertainty, has a known probability. In comparison, where neither the outcome nor probability of that outcome is known with uncertainty .(Eachempati, Prashanti, et al, 2022)  Expected utility is a decision-making theory where rational consumers make choices based on maximising their expected utility of an outcome. (Biglieri, 2022) This lets us decide which insurance policy to purchase based on our expected reward. We are more likely to pay a higher premium if our expected value is higher because of this purchase. The price mechanism depends heavily on our own interpretation of value. Our human nature and risk preferences play a crucial role in pricing. Risk-averse individuals can’t handle risk and are more likely to purchase Health insurance. (Blunck, 2025) However, those who are risk neutral are less likely to purchase. (Otudeko, 2021) This decreases the target market for insurance, decreasing policy holders. This results in companies having to set a higher unit price, meaning policyholders are unlikely to have access to fair prices. Instead, risk-averse individuals bear a large proportion of costs. (Zweifel, 2021) Ultimately, resulting in unaffordability, leaving many uninsured.

Insurance companies utilise economic principles to assess risk and set premiums effectively. A core concept is risk pooling, where individuals contribute to a collective fund to protect against financial loss, enabling them to trade uncertainty for stability. Insurers strive to balance risk management with profitability, ensuring total premiums can cover potential claims. Competitive exchange and comparative advantage shape insurance offerings. Some insurers focus on high-risk individuals with specialised policies at higher rates, while others cater to lower-risk clients with more affordable options. Premiums are calculated based on age, health, profession, location, and lifestyle. For instance, those with chronic conditions face higher rates due to their increased likelihood of filing claims. While insurers aim to create effective pricing models, this approach raises ethical questions regarding accessibility and affordability. (Pauly, 1986)

(Photo from The Balance Money)

Asymmetric information arises when one party in a transaction has more information than the other. For example, individuals typically know more about their health risks than health insurance companies do. This imbalance leads to adverse selection, where those at higher risk are likelier to buy insurance. In comparison, those at lower risk often do not, leading to increased costs for insurers. (Akerlof, 1970) If health insurance premiums were identical regardless of health status, individuals with health issues would be more likely to buy policies, compelling insurers to raise prices. This ongoing problem makes it challenging for insurers to maintain balanced risk pools and offer affordable coverage. To address adverse selection, insurers implement medical exams and pre-existing condition clauses to better evaluate risk. While these measures help insurers achieve financial stability, they may also prevent individuals from accessing coverage.

Moral hazard occurs when individuals change their behavior after acquiring insurance, becoming more willing to take risks. For example, someone with comprehensive car insurance may drive recklessly, increasing the likelihood of accidents, or a person with health insurance may visit the doctor more often, raising medical costs. While this benefits the policyholder in the short term, it increases insurer costs, resulting in higher premiums that affect other policyholders. To mitigate moral hazard, insurers can set coverage limits or require the policyholder to pay part of the costs, with insurance covering the rest.

Market failure refers to a situation where, after low-risk individuals exit the insurance market, the remaining participants are all high-risk groups. As a result, insurance companies are forced to raise premiums, making insurance even more expensive for high-risk individuals. This, in turn, causes more high-risk participants to drop out of the market, creating a vicious cycle. In this situation, resources are not being allocated effectively, leading to market inefficiency, which constitutes market failure. In the US, market failure is evident in the private health insurance system. (Keisler-Starkey and Bunch, 2024) After low-risk individuals exit the market, most of the remaining participants are high-risk groups. To cover high costs, Insurance companies are forced to raise premiums, which in turn leads to even more low-risk individuals dropping out, creating a vicious cycle. Before the implementation of the Affordable Care Act (ACA), many low-risk individuals opted not to purchase insurance due to high premiums or the belief that they didn’t need it, leading to an imbalanced insurance market (U.S. Congress, 2010).

(Figure  2 from United States Census Bureau)

Health insurance pricing is shaped by risk, uncertainty, moral hazard, and asymmetric information, reflecting the balance insurers must strike between fairness and sustainability. When the market fails, it's the most vulnerable who pay the price. As low-risk individuals opt out, premiums rise for those who remain. (Arrow,1963) Risk-based pricing only makes things worse, forcing those most likely to make claims to pay even more. It benefits low-risk individuals while leaving high-risk ones with more expensive options. Furthermore, it raises questions about access and social responsibility. Moral hazard and adverse selection can mitigate insurer losses but also exclude vulnerable individuals. Ultimately, the question remains: Should premiums be equal or should they reflect individual risk, possibly compromising affordability? 

References:

Arrow, K. J. (1963). Uncertainty and the Welfare Economics of Medical Care. American       Economic Review, 53(5),

Akerlof, GA. (1970). The Market for ‘Lemons’: Quality Uncertainty and the Market Mechanism. The Quarterly Journal of Economics, 84(3), pp.488–500. https://scispace.com/pdf/the-market-for-lemons-quality-uncertainty-and-the-market-4tqqxk4zdn.pdfdoi:https://doi.org/10.2307/1879431. Accessed 17 March 2025.

Biglieri, Ezio. “Beyond probability.” Dimensions of Uncertainty in Communication Engineering, Academic Press, 2022, pp. 203-251. Dimensions of Uncertainty in Communication Engineering, https://www.sciencedirect.com/science/article/pii/B9780323992756000150. Accessed 13 March 2025.

Blunck, Antonia. “Risk Aversion – Everything You Need To Know.” InsideBE, 2025, https://insidebe.com/articles/risk-aversion/. Accessed 13 March 2025.

Caldwell, Miriam. How to Stop Worrying About Finances in 3 Easy Steps. 21 April 2021. The balance, https://www.thebalancemoney.com/are-you-dealing-with-your-finances-in-panic-mode-2385532. Accessed 2025 March 13.

Cutler, D. M., & Zeckhauser, R. J. (1998). Adverse Selection in Health Insurance. Frontiers in Health Policy Research, 1

Eachempati, Prashanti, et al. “Developing an integrated multilevel model of uncertainty in health care: a qualitative systematic review and thematic synthesis.” BMJ Global Health, 2 May 2022, https://gh.bmj.com/content/7/5/e008113. Accessed 12 March 2025.

Keisler-Starkey, Katherine, and Lisa Bunch. “Health Insurance Coverage in the United States: 2023.” Census Gov, September 2024, https://www2.census.gov/library/publications/2024/demo/p60-284.pdf. Accessed 13 March 2025.

Otudeko, David. “6 ways to manage risk and uncertainty in insurance.” Informa Connect, 2 August 2021, https://informaconnect.com/6-ways-to-manage-risk-and-uncertainty-in-insurance/#:~:text=According%20to%20Knight%2C%20in%20the,unknown%20probability%20(subjective%20probability). Accessed 12 March 2025.

Pauly, M V. “Taxation, health insurance, and market failure in the medical economy.” Journal of economic literature vol. 24,2 (1986): 629-75. https://www.jstor.org/stable/2725946            Accessed 17 March 2025.

Royal College of Obstetricians and Gynaecologists. “Understanding how risk is discussed in health care.” Royal College of Obstetricians and Gynaecologists, 1 August 2015, https://www.rcog.org.uk/for-the-public/browse-our-patient-information/understanding-how-risk-is-discussed-in-health-care/. Accessed 11 March 2025.

Sadar psychological and sports centre. “Illness Vs. Disease.” Sadar psychological and sports centre, 11 November 2019, https://sadarpsych.com/illness-vs-disease/. Accessed 2025 March 13.

U.S. Government (2010) Patient Protection and Affordable Care Act, Public Law 111-148. Available at: https://www.congress.gov/bill/111th-congress/house-bill/3590

Zweifel, Peter. “Bridging the gap between risk and uncertainty in insurance.” The Geneva Papers on Risk and Insurance - Issues and Practice, vol. 46, no. 1, 2021, pp. 200-213. Springer Nature Link, https://link.springer.com/article/10.1057/s41288-021-00220-y. Accessed 13 March 2025.