To pool or not to pool - Small group insurance economics

Pooling is essential for insurance, a large group of people pitch in a little bit of money each, and the result is a large reservoir of cash. Any claims are paid out of this pool, the water level drops a little but soon rises back to the high water mark with the many added contributions.

Group insurance typically pools Life, Accidental Death, Disability and Critical Illness Insurance. Because these claims are so unpredictable, and so large in value there is no way a small group can absorb their cost on their own. Sometimes for small groups, usually 10 or less, Health and Dental Insurance are pooled as well. A more common way of pricing health and dental insurance though, is called prospectively rated, or experience rated. Just like if you are constantly in car accidents or regularly set your house on fire, your insurance rates increase. The same can also be true for health insurance, if you are constantly in the hospital or have higher than normal claims your rates go up. The opposite can also be true, if you claim less you pay less.

Health and Dental expenses are different because they are more predictable than a death or disability claim. You can fairly accurately predict that the average person will go to the dentist twice a year approximately 6 months apart. You can predict that a prescription for the birth control pill will be filled once a month. Because we have a pretty good idea of what is going to happen we start budgeting rather than insuring. The wonderful thing about a budget is that you can come under budget and bank the difference.

I normally like experience rated health and dental benefits because it lets me and the client set out a budget for their claims, if they are over or under budget we have that information and can react accordingly. The client knows that they are paying for only as much as they are claiming. Under a fully pooled plan the client might be paying far more than they are actually claiming, they have no idea if they are getting a good deal or not, the insurance company doesn’t tell them.

A pool is big, stable, and predictable, a small group is just the opposite, volatile, unpredictable. The pool is safe and calm, what little ripples there are you can see coming from across the water. Small groups can seem like river rapids; rates and claims wildly gyrating, swirling constantly changing and never knowing what is coming around the next bend.

I instinctively gravitate towards the river rapids, as I think it is the best value. However, the wild rate changes a group can experience can easily backfire against me. When I have to tell a group their rates are going up 30% next year it is never a good day for anyone. On the other hand, a large pooled plan might only go up 6% that same year, with the same claims from that same member group. It doesn’t mean that group doesn’t deserve a 30% increase it just means other member groups in the pool paid too much and offset my groups high claims.

Fully pooled plans are, by nature, unfair. Some groups pay more than their share, while others profit from it. But in the end everyone gets the same rates. I think as a first step a pooled plan can be good for a client, if they don’t want to worry about the plan, and just want it in place and they can think about it as a true insurance sunk cost. Then a pooled plan will probably be alright, but I will still feel like I’m not getting them the best value, and I lie awake at night worrying that they might be spending too much (seriously, I lose sleep over this stuff, it's a good thing I have those psychologist benefits). On the other hand they could go experience rated and see their rates fly through the roof, that doesn’t help them either as it means their benefits now cost more than the pooled plan would have. That client also can’t get the better pooled rate anymore since they have to disclose their experience to the pool before they join, so even if they did try and go into the pooled plan they will get a higher rate which reflects their past experience.

It is a tough choice, be ignorant of your actual cost but maintain stability in rates, or have transparency and volatility. I am an open information kinda guy, so I choose transparency and freedom of information over closed systems and being in the dark. I know of some clients who would have been better in a pool. But I have just as many that are far better off being experience rated. The choice ultimately comes down to what the client wants and their risk tolerance, If they are willing to accept some volatility in the name of potential savings. Or if they are willing to possibly pay too much to reduce their risk.