New York -- Anyone stuck with buying individual health insurance knows about "The Letter." It comes from your health insurer, often once a year, and says the following: "Gee, because of increased medical costs, your premium will rise by 15 (or 20 or 40) percent."
That disingenuous explanation masks a destructive practice in the industry that consumers know almost nothing about. Your premium may be soaring not just because of medical-cost inflation but because of the way your insurer constructs its policies. It's known as the "death spiral," and here's how it works:
When you buy individual health insurance, you believe that you're sharing your personal risk with thousands of others who buy the same policy. In any year, policyholders with few claims help hold down the rates for those who get sick. The healthiest -- hence those most important to the pool -- are the new people who sign up each year.
Here's what you don't know: Your insurance company may sell your particular policy form for only 12 to 24 months. After that, it's closed. No new people are allowed to come into your pool. The newly insured are sold a new policy form in a newly established insurance pool. Blue Cross/Blue Shield doesn't play this game, but many other individual health insurers do.
As those in the older pool slowly age, the number and size of their insurance claims inevitably increase. To get extra money to pay the claims, the insurer starts jacking the premiums up.
Pretty soon, the healthiest people leave the pool and buy new insurance at lower rates. Those who remain are in poorer health (or their dependents are), or they have special problems such as high blood pressure that make it harder to get insurance. Their medical risk drives up the premiums even more. Eventually, the premium rises so high that even the people who can't get other coverage may be forced to quit and join the legion of the uninsured.
Some death-spiral policies are guaranteed renewable, which means the insurer can't cancel them as long as you're willing to pay the premiums. Others are conditionally renewable. They can be canceled as a group if your insurer doesn't want to bother with them any more.
If you're in good health, you may be attracted by death-spiral insurance. At the start, it offers lower rates. But once the pool closes, rot sets in.
If you stay in good health, you can hop from one policy to another -- always catching the spiral at its most attractive point. But one day, either you or someone in your family may suddenly acquire a health problem, which blocks you from getting insurance elsewhere. At that point, you're trapped. The policy eats you up.
How can you avoid this risk? There's no easy way, because almost all health-insurance policies close at some point in time. But here are some questions to ask your agent, suggested by Ken Tillman, who has administered health insurance for the Arkansas Farm Bureau (a user of Blue Cross):
* If you're offered low-cost health insurance, ask how long the company expects to keep that particular policy form on sale (your agent can get an answer to that question if he or she will ask). You want it to last at least five years, Mr. Tillman says.
* Ask about the company's previous health-insurance policy form and how long it was offered. If it was sold only for 12 to 36 months, you may be risking death-spiral pricing.
* Ask how many people are insured by this policy. You want to spread your risk among at least 80,000 people within the first two years, with the policy continuing to be sold.
The National Association of Insurance Commissioners is discussing ways to address the death spiral. The proposals include:
* Forcing insurers to combine small insurance pools into single larger ones.
* In certain cases, requiring the claims experience of older pools to be averaged with those of newer ones.
* Putting limits on how much more the people in older pools can be charged, compared with those in newer pools.
What is needed most is to keep pools open longer, so that insurance can do what we expect of it: Bunch us all together and spread the risk.