Community Rating and Equalisation

Several countries have made community rating mandatory for certain lines of insurance, particularly health insurance. This paper offers a theoretical solution to the problem of designing equalization schemes to support community rating in a market where different insurers are selling different benefit plans. The criterion chosen is that an equalization scheme should minimize the opportunities for arbitrage between insurers, which community rating otherwise would generate. Several possible measures of arbitrage are presented, and the optimal schemes are compared against data from Australian health insurers. Finally, the approach is extended to partial community rating, for example unisex rating. Keywords: Arbitrage; Community rating; Credibility theory; Equalization; Health insurance; Risk adjustment.