control or regulate) effect of health insurance on the demand for and supply of medical services.

Nor does this report apply the term moral hazard, as is sometimes done, to the tendency of individuals to make choices among different health insurance plans based on which plan best meets their needs. In this usage, the hazard for insurers is that individuals make health insurance choices using knowledge of their risk status that is more complete than that available to (or even sought by) insurers. Those who expect to need dental care or complicated surgery may choose health plans with coverage to fit these needs and may typically do so without behaving dishonestly or deceptively. Those who do not expect to need care may take a chance on a high-deductible health plan without being irresponsible or imprudent. In this analysis, individuals making these kinds of decisions are regarded as rational consumers, although the combined effect of these decisions may have consequences such as risk segmentation that many would regard as undesirable.

Whether characterized as moral hazard or rational decisionmaking, the behavior just described is one aspect of an especially difficult problem in health insurance, biased risk selection. Biased risk selection is a nonrandom process that occurs (1) when the individuals or groups that purchase insurance differ in their risk of incurring health care expenses from those who do not or (2) when those who enroll in competing health plans differ in the level of risk they present to each plan. When a health plan, an insurer, or—in some cases—an employer attracts a less risky or costly group than the average (or the competition), it has experienced favorable selection. A group with a more risky or costly membership has experienced unfavorable or adverse selection.

The committee does not view the term biased risk selection as pejorative, and it views the factors or behaviors contributing to biased risk selection (described further in Chapter 5) as sometimes desirable or at least acceptable and sometimes undesirable. Again, reasonable individual and organizational behavior can sometimes have undesirable social consequences. In any case, for the sake of simplicity, the remainder of this report refers just to risk selection.

For purposes of this report, risk selection is viewed as a process related to individual or group choices that is influenced by a variety of individual, employer, and insurer characteristics. Its most serious potential consequence— the clustering of higher-and lower-risk individuals in different health plans or the exclusion of higher-risk individuals from coverage altogether—is described here as risk segmentation.9 In other discussions, the terms are


Risk segmentation also can occur in systems in which insurance is largely compulsory and the opportunity to choose among health plans is quite limited, as it is in Germany. Risk segmentation among the German sickness funds occurs because plans draw or are assigned their membership from occupational and other groups that differ in age, income, and other risk factors (Wysong and Abel, 1990).

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