ECON 440 Lecture 16: Lecture 16 - Health Insurance Markets and Adverse Selection
13 Jun 2018
School
Department
Course
Professor
This is a result of adverse selection in insurance policies, in which lower risk policy holders choose to
change policies or be uninsured
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The simulation's differential Health Insurance premiums show the adverse selection "death spiral"
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It can't be sustained, and will eventually be taken off the market
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This generous plan that now only attracts the sickest people in the population isn't attractive to the
insurer
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Death Spiral: As the price spread between plans continues to grow, only the sickest types will choose that
plan
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Simulation
I know that average spending in the population is $1750
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I assume that a representative sample of people will enroll in each insurance plan
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I set premiums to reflect the differences in benefits offered
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The Not-So-Crafty Insurance Company
Plan A
Plan B
Inpatient
All medically necessary care
10% co-insurance up to $5000 total spending
All medically necessary care
No co-insurance
Outpatient
3 visits per person $15 copay
20% co-insurance beyond limit
6 visits per person, $15 copay
20% co-insurance beyond limit
Mental Health
12 visits $30 copay
50% beyond limit
50 visits $15 copay
50% beyond limit
Prescription Drugs
6 30-day Rx, $15 copay
50% beyond limit
Unlimited 30-day Rx, $15 copay
Annual Premium
$1600
$1900
Insurance Choices
After adjusting for average spending, the price of Plan A will lower, and the price of Plan B increase
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"death spiral" →continues until Plan B is no longer viable for most people
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As more and more individuals switch from the highest cost (more generous) Plan B to the lower cost
(less generous) Plan A, the middle ground disappears
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Here, the price differential between the premiums begins to increase more and more quickly, as one plan
becomes cheaper
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More generous plans - attract sicker individuals
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Less generous plans (or uninsurance) - attracts healthier individuals
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Plans will differentially attract people who will use different amounts of healthcare
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If everyone is employed on a public plan, there's no adverse selection problem
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In the US (more choice in the health insurance market), adverse selection begins to become a
problem
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Choice of insurance plans
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Healthy history, risk preferences, etc.
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Individuals know more about their health state than the insurer does
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Seller knows more about the value of the good than the buyer does (used car market)
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Asymmetric information
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Individuals are not charged their marginal cost of being in the plan
Actual marginal cost facing the seller (insurer) depends on the characteristics of the buyer (enrollee)
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Necessary Conditions for Selection to Occur
Lecture 16 - Health Insurance Markets and Adverse
Selection
Monday, March 12, 2018
10:05 AM
ECON 440 Page 1
