Assessing Incentives for Adverse Selection in Health Plan Payment Systems

Health insurance markets face two forms of adverse selection problems. On the demand side, adverse selection leads to plan price distortions and inefficient sorting of consumers across health plans. On the supply side, adverse selection creates incentives for insurers to inefficiently distort benefits to attract profitable enrollees. These problems can be addressed by features of health plan payment systems such as reinsurance, risk adjustment, and premium categories. In this paper, we develop Harberger-type measures of the efficiency consequences of price and benefit distortions under a given payment system. Our measures are valid, that is, based on explicit economic models of adverse selection. Our measures are complete, in that they are able to incorporate multiple features of plan payment systems. Finally, they are practical, in that they are based on the ex-ante data available to regulators and researchers during the design phase of payment system development, prior to observing actual insurer and consumer behavior. After developing the measures, we compare the performance of the payment system planned for implementation in the ACA Marketplaces in 2017 to several policy alternatives. We show that, in protecting against both types of selection problems, a payment system that incorporates reinsurance and prospective risk adjustment out-performs the planned payment system which includes only concurrent risk adjustment.