How Adverse Selection Affects the Health Insurance Market
Adverse selection can be defined as strategic behavior by the more informed partner in a contract against the interest of the less informed partner(s). In the health insurance field, this manifests itself through healthy people choosing managed care and less healthy people choosing more generous plans. Drawing on theoretical literature on the problem of adverse selection in the health insurance market, the author synthesizes concepts developed piecemeal over more than 20 years, using two examples and revisiting the classical contribution of Rothschild and Stiglitz. He highlights key insights, especially from the literature on "equilibrium refinements" and on the theory of "second best." The government can correct spontaneous market dynamics in the health insurance market by directly subsidizing insurance or through regulation; the two forms of intervention provide different results. Providing partial public insurance, even supplemented by the possibility of opting out, can lead to second-best equilibria. The same result holds as long as the government can subsidize contracts with higher-than-average premium-benefit ratios and can tax contracts with lower-than-average premium-benefit ratios. The author analyzes the following policy options relating to the public provision of insurance: a) Full public insurance. b) Partial public insurance with or without the possibility of acquiring supplementary insurance and with or without the possibility of opting out. In recent plans implemented in Germany and the Netherlands, where competition among several health funds and insurance companies was promoted, a public fund was created to discourage risk screening practices by providing the necessary compensation across riks groups. But only "objective" risk adjusters (such as age, gender, and region) were used to decide which contracts to subsidize. Those criteria alone cannot correct the effects of adverse selection. Regulation can exacerbate the problem of adverse selection and lead to chronic market instability, so certain steps must be taken to prevent risk screening and preserve competition for the market. The author considers the following three policy options for regulating the private insurance market: 1) A standard contract with full coverage. 2) Imposition of a minimum insurance requirement. 3) Imposition of premium rate restrictions.
| Summary: | Adverse selection can be defined as
strategic behavior by the more informed partner in a
contract against the interest of the less informed
partner(s). In the health insurance field, this manifests
itself through healthy people choosing managed care and less
healthy people choosing more generous plans. Drawing on
theoretical literature on the problem of adverse selection
in the health insurance market, the author synthesizes
concepts developed piecemeal over more than 20 years, using
two examples and revisiting the classical contribution of
Rothschild and Stiglitz. He highlights key insights,
especially from the literature on "equilibrium
refinements" and on the theory of "second
best." The government can correct spontaneous market
dynamics in the health insurance market by directly
subsidizing insurance or through regulation; the two forms
of intervention provide different results. Providing partial
public insurance, even supplemented by the possibility of
opting out, can lead to second-best equilibria. The same
result holds as long as the government can subsidize
contracts with higher-than-average premium-benefit ratios
and can tax contracts with lower-than-average
premium-benefit ratios. The author analyzes the following
policy options relating to the public provision of
insurance: a) Full public insurance. b) Partial public
insurance with or without the possibility of acquiring
supplementary insurance and with or without the possibility
of opting out. In recent plans implemented in Germany and
the Netherlands, where competition among several health
funds and insurance companies was promoted, a public fund
was created to discourage risk screening practices by
providing the necessary compensation across riks groups. But
only "objective" risk adjusters (such as age,
gender, and region) were used to decide which contracts to
subsidize. Those criteria alone cannot correct the effects
of adverse selection. Regulation can exacerbate the problem
of adverse selection and lead to chronic market instability,
so certain steps must be taken to prevent risk screening and
preserve competition for the market. The author considers
the following three policy options for regulating the
private insurance market: 1) A standard contract with full
coverage. 2) Imposition of a minimum insurance requirement.
3) Imposition of premium rate restrictions. |
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