Information Frictions and Adverse Selection: Policy Interventions in Health Insurance Markets

Abstract

This paper develops and implements a general framework to study insurance market equilibrium and evaluate policy interventions in the presence of choice frictions. Friction-reducing policies can increase welfare by facilitating better matches between consumers and plans, but can decrease welfare by increasing the correlation between willingness-to-pay and costs, exacerbating adverse selection. We identify relationships between the underlying distributions of consumer (i) costs (ii) surplus from risk protection and (iii) choice frictions that determine whether friction-reducing policies will be on net welfare increasing or reducing. We extend the analysis to study how policies to improve consumer choices interact with the supply-side policy of risk-adjustment transfers and show that the effectiveness of the latter policy can have important implications for the effectiveness of the former. We implement the model empirically using proprietary data on insurance choices, utilization, and consumer information from a large firm. We leverage structural estimates from prior work with these data and highlight how the model's micro-foundations can be estimated in practice. In our specific setting, we find that friction-reducing policies exacerbate adverse selection, essentially leading to the market fully unravelling, and reduce welfare. Risk-adjustment transfers are complementary, substantially mitigating the negative impact of friction-reducing policies, but having little effect in their absence.

The Effect of Health Insurance on the Substitution between Public and Private Hospital Care

“…Indeed, numerous studies on the demand for insurance in Australia find that couple status is a strong predictor of insurance demand even after controlling for income, children and various other confounds (see, for example, Hopkins & Kidd, ; Doiron et al ., , ; Srivastava & Zhao, ; Cheng & Vahid, ; Johar et al ., ). A related recent literature based in the USA has focused attention on the potentially large impacts of ‘frictions’ or transactions costs in health insurance markets (Handel & Kolstad, ; Handel et al ., ).…”

Imperfect risk adjustment, risk preferences, and sorting in competitive health insurance markets

“…It is important to note, however, that this welfare metric makes the critical assumption that my estimates of willingness-to-pay for the Platinum plan are equal to consumer valuation of the plan. In practice, this may not always hold due to behavioral biases (Handel 2013; Spinnewijn 2017; Handel, Kolstad, and Spinnewijn 2015). …”

“… 4 Other papers have considered imperfect risk adjustment when studying adverse selection (Handel, Kolstad, and Spinnewijn 2015; Mahoney and Weyl 2014), but they have assumed that the imperfections are equal across individuals and services, effectively eliminating the interaction between preference heterogeneity and risk adjustment imperfections that generates the result I highlight in this paper that risk adjustment can result in transfers from the adversely selected plan and to the advantageously selected plan. …”

Inferring Risk Perceptions and Preferences Using Choice from Insurance Menus: Theory and Evidence

“…It also provides an alternative approach to estimating perceived risks. Our estimates could be used, in combination with claims data, to assess the accuracy of risk perceptions, which is relevant for welfare and policy analysis in insurance markets (Spinnewijn 2012, Handel, Kolstad andSpinnewijn 2015).…”