Signature
T_i = c_i - P
| Inputs | Definition | Unit |
|---|---|---|
c_i | Expected annual cost per member of risk group i used by the fund | £ per member per year |
P | Community-rated premium of the pool, from HE-FM-CRAT-001 | £ per member per year |
T_i | Transfer from the fund to the insurer for each member of risk group i; negative values are payments into the fund | £ per member per year |
|---|
Function
Community-rated premium, cross-subsidy and risk equalisation function
Maps the number of members and the expected annual cost of each risk group in a community-rated pool to the single premium every member pays, the implicit cross-subsidy each group gives or receives, the risk equalisation transfers that offset those cross-subsidies for insurers, and the late-entry loadings that Ireland and Australia add to the premium of people who first buy cover when older. The same difference between payment and expected cost, read from the insurer's side, is the expected profit per member on the Cream Skimming page (HE-FM-CSKM-001).
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Implementations
Excel
Risk equalisation transfer per member in one Excel cell
With a group's expected cost in a cell named ExpectedCost and the premium in a cell named Premium, Excel returns the transfer per member; a negative result is a payment into the fund.
=ExpectedCost-Premium
Assumptions
Fund risk groups match the insurer's information on expected cost
The transfers remove the incentive to select only if the fund's risk groups capture the differences in expected cost that the insurer can observe. Differences the fund does not capture remain profitable to select, as in the risk-mix example on the Cream Skimming page (HE-FM-CSKM-002).
Risk equalisation based on predicted, not incurred, costs
The transfer is set from the expected cost of the member's risk group, not from the costs the insurer actually incurs. Compensation according to costs actually incurred is risk sharing, a different mechanism; Henriquez and colleagues describe Australia as relying on risk sharing alone.
Worked examples
Risk equalisation payment for a low-risk member of the article's pool
For each low-risk member, expected to cost £1,000 against a premium of £2,000, the insurer pays £1,000 into the fund.
c_i = 1000; P = 2000; T_i = -1000
Risk equalisation receipt for a high-risk member of the article's pool
For each high-risk member, expected to cost £6,000, the insurer receives £4,000. The fund collects 800 × 1,000 = 800,000 and pays out 200 × 4,000 = 800,000, as in the article.
c_i = 6000; P = 2000; T_i = 4000
Common errors
Paying risk equalisation on the costs an insurer incurs
Setting transfers from each insurer's actual costs rather than the expected cost of its members' risk groups turns risk equalisation into risk sharing. That reduces the gain from avoiding expensive members but also weakens the incentive to control costs, a trade-off set out on the Cream Skimming page.
Assuming risk equalisation removes every selection incentive
In the article's example the transfers remove the incentive only because the fund's two risk groups are the same as the insurer's. Van de Ven and colleagues found that even with the best risk adjustment formulas, insurers in European markets retain substantial incentives to select.
Sources
Removal of predictable over- and undercompensation as a goal of risk equalisation
van de Ven WPMM, Hamstra G, van Kleef RC, Reuser M, Stam PJA. The goal of risk equalization in regulated competitive health insurance markets. European Journal of Health Economics. 2023;24(1):111-123. Abstract, which reports a consensus that an element of the goal of risk equalisation is to remove the predictable over- and undercompensations of subgroups of insured people.
Irish Risk Equalisation Scheme credits supporting community rating
Department of Health, Health Insurance Authority. Public consultation: community-rated health insurance market in Ireland and proposed changes to the Risk Equalisation Scheme. Dublin; 2025. Pages 2 to 4, which describe the fund financed by a stamp duty on premiums and credits that subsidise the higher claims costs of older and sicker people, whom insurers would otherwise have an incentive to avoid.
Risk adjustment and risk sharing as compensation for predictable profits under community rating
Henriquez J, van Kleef RC, Matthews A, McGuire TG, Paolucci F. Combining risk adjustment with risk sharing in health plan payment systems: private health insurance in Australia. NBER Working Paper 31052. Cambridge, MA: National Bureau of Economic Research; 2023. Abstract, which states that payment systems with community-rated premiums typically include risk adjustment, risk sharing or both to compensate insurers for predictable profits and losses, and that Australia's is based only on risk sharing.
Canonical Identity
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