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Selection in Insurance Markets: Theory and Empirics in Pictures

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  • Liran Einav
  • Amy Finkelstein
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    Abstract

    Government intervention in insurance markets is ubiquitous and the theoretical basis for such intervention, based on classic work from the 1970s, has been the problem of adverse selection. Over the last decade, empirical work on selection in insurance markets has gained considerable momentum. This research finds that adverse selection exists in some insurance markets but not in others. And it has uncovered examples of markets that exhibit "advantageous selection"—a phenomenon not considered by the original theory, and one that has different consequences for equilibrium insurance allocation and optimal public policy than the classical case of adverse selection. Advantageous selection arises when the individuals who are willing to pay the most for insurance are those who are the most risk averse (and so have the lowest expected cost). Indeed, it is natural to think that in many instances individuals who value insurance more may also take action to lower their expected costs: drive more carefully, invest in preventive health care, and so on. Researchers have taken steps toward estimating the welfare consequences of detected selection and of potential public policy interventions. In this essay, we present a graphical framework for analyzing both theoretical and empirical work on selection in insurance markets. This graphical approach provides both a useful and intuitive depiction of the basic theory of selection and its implications for welfare and public policy, as well as a lens through which one can understand the ideas and limitations of existing empirical work on this topic.

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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.25.1.115
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    Bibliographic Info

    Article provided by American Economic Association in its journal Journal of Economic Perspectives.

    Volume (Year): 25 (2011)
    Issue (Month): 1 (Winter)
    Pages: 115-38

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    Handle: RePEc:aea:jecper:v:25:y:2011:i:1:p:115-38

    Note: DOI: 10.1257/jep.25.1.115
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    References

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    1. repec:rje:randje:v:37:y:2006:i:4:p:783-798 is not listed on IDEAS
    2. Liran Einav & Amy Finkelstein & Jonathan Levin, 2010. "Beyond Testing: Empirical Models of Insurance Markets," Annual Review of Economics, Annual Reviews, vol. 2(1), pages 311-336, 09.
    3. Liran Einav & Amy Finkelstein & Mark R. Cullen, 2010. "Estimating Welfare in Insurance Markets Using Variation in Prices," The Quarterly Journal of Economics, MIT Press, vol. 125(3), pages 877-921, August.
    4. Alma Cohen & Liran Einav, 2005. "Estimating Risk Preferences from Deductible Choice," Discussion Papers 04-031, Stanford Institute for Economic Policy Research.
    5. Akerlof, George A, 1970. "The Market for 'Lemons': Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, MIT Press, vol. 84(3), pages 488-500, August.
    6. Hanming Fang & Michael P. Keane & Dan Silverman, 2006. "Sources of Advantageous Selection: Evidence from the Medigap Insurance Market," NBER Working Papers 12289, National Bureau of Economic Research, Inc.
    7. Amy Finkelstein & Kathleen McGarry, 2006. "Multiple Dimensions of Private Information: Evidence from the Long-Term Care Insurance Market," American Economic Review, American Economic Association, vol. 96(4), pages 938-958, September.
    8. Alma Cohen & Peter Siegelman, 2009. "Testing for Adverse Selection in Insurance Markets," NBER Working Papers 15586, National Bureau of Economic Research, Inc.
    9. Pierre‐André Chiappori & Bruno Jullien & Bernard Salanié & François Salanié, 2006. "Asymmetric information in insurance: general testable implications," RAND Journal of Economics, RAND Corporation, vol. 37(4), pages 783-798, December.
    10. Benjamin M. Friedman & Mark Warshawsky, 1990. "The Cost of Annuities: Implications for Saving Behavior and Bequests," NBER Working Papers 1682, National Bureau of Economic Research, Inc.
    11. David M. Cutler & Sarah Reber, 1996. "Paying for Health Insurance: The Tradeoff between Competition and Adverse Selection," NBER Working Papers 5796, National Bureau of Economic Research, Inc.
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    Cited by:
    1. Yiyan Liu & Ginger Zhe Jin, 2013. "Employer Contribution and Premium Growth in Health Insurance," NBER Working Papers 19760, National Bureau of Economic Research, Inc.
    2. Denise Doiron & Denzil G Fiebig & Agne Suziedelyte, 2013. "Hips and hearts: the variation in incentive effects of insurance across hospital procedures," Discussion Papers 2013-14, School of Economics, The University of New South Wales.
    3. Raj Chetty & Amy Finkelstein, 2012. "Social Insurance: Connecting Theory to Data," NBER Working Papers 18433, National Bureau of Economic Research, Inc.
    4. Johar, Meliyanni & Savage, Elizabeth, 2012. "Sources of advantageous selection: Evidence using actual health expenditure risk," Economics Letters, Elsevier, vol. 116(3), pages 579-582.
    5. Dardanoni, Valentino & Li Donni, Paolo, 2012. "Incentive and selection effects of Medigap insurance on inpatient care," Journal of Health Economics, Elsevier, vol. 31(3), pages 457-470.
    6. Andre Veiga & E. Glen Weyl, 2011. "Multidimensional Heterogeneity and Platform Design," Working Papers 11-33, NET Institute, revised Nov 2011.
    7. Florian Scheuer & Kent Smetters, 2014. "Could a Website Really Have Doomed the Health Exchanges? Multiple Equilibria, Initial Conditions and the Construction of the Fine," NBER Working Papers 19835, National Bureau of Economic Research, Inc.
    8. Lee, Yong-Woo, 2012. "Asymmetric information and the demand for private health insurance in Korea," Economics Letters, Elsevier, vol. 116(3), pages 284-287.
    9. Jacob Glazer & Thomas G. McGuire & Julie Shi, 2013. "Risk Adjustment of Health Plan Payments to Correct Inefficient Plan Choice from Adverse Selection," NBER Chapters, in: Measuring and Modeling Health Care Costs National Bureau of Economic Research, Inc.
    10. Jacob Glazer & Thomas McGuire & Julie Shi, 2014. "Risk Adjustment of Health Plan Payments to Correct Inefficient Plan Choice from Adverse Selection," NBER Working Papers 19998, National Bureau of Economic Research, Inc.
    11. Ian Jewitt & Clare Leaver & Heski Bar-Isaac, 2014. "Asymmetric Information and Adverse Selection," Economics Series Working Papers 695, University of Oxford, Department of Economics.

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