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The Welfare Effects of Adverse Selection in Privatized Medicare

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  • Lustig, Joshua

Abstract

This paper estimates the welfare losses from market failures caused by adverse selection in privatized Medicare. I model insurers' premium and coverage choices in an environment where consumers have heterogeneous preferences and may impose different costs on their insurers. The model generates predictions about insurers' costs and behavior under varying degrees of adverse selection. I use the model and exogenous variation in market structure to identify a causal link between consumers' types and insurers costs. From the estimated parameters, I can infer whether consumers' preferences, which determine how much insurance they purchase, contain information about their expected health. The empirical results imply that adverse selection is indeed present in privatized Medicare. It is more costly to insure consumers with strong preferences for health insurance. With the estimated model, I simulate new equilibria after removing the distortionary effects of adverse selection from insurers' costs and incentives. The new equilibria exhibit more generous insurance coverage and lower premiums. These effects are particularly strong in markets with many insurers. The total surplus associated with privatized Medicare increases by 15.1%, suggesting that the welfare losses from adverse selection are substantial.

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Bibliographic Info

Paper provided by Department of Economics, Institute for Business and Economic Research, UC Berkeley in its series Department of Economics, Working Paper Series with number qt7n09099j.

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Date of creation: 15 Aug 2008
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Handle: RePEc:cdl:econwp:qt7n09099j

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  1. Cutler, David M. & Zeckhauser, Richard J., 2000. "The anatomy of health insurance," Handbook of Health Economics, in: A. J. Culyer & J. P. Newhouse (ed.), Handbook of Health Economics, edition 1, volume 1, chapter 11, pages 563-643 Elsevier.
  2. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  3. Cutler David M. & Zeckhauser Richard J., 1998. "Adverse Selection in Health Insurance," Forum for Health Economics & Policy, De Gruyter, vol. 1(1), pages 1-33, January.
  4. Amy Finkelstein & James Poterba, 2000. "Adverse Selection in Insurance Markets: Policyholder Evidence from the U.K. Annuity Market," NBER Working Papers 8045, National Bureau of Economic Research, Inc.
  5. Fang, Hanming & Keane, Michael & Silverman, Dan, 2006. "Sources of Advantageous Selection: Evidence from the Medigap Insurance Market," Working Papers 17, Yale University, Department of Economics.
  6. Shiko Maruyama, 2006. "Welfare Analysis Incorporating a Structural Entry-Exit Model: A Case Study of Medicare HMOs," Hi-Stat Discussion Paper Series d06-166, Institute of Economic Research, Hitotsubashi University.
  7. Jeffrey M Wooldridge, 2010. "Econometric Analysis of Cross Section and Panel Data," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262232588, December.
  8. Cardon, James H & Hendel, Igal, 2001. "Asymmetric Information in Health Insurance: Evidence from the National Medical Expenditure Survey," RAND Journal of Economics, The RAND Corporation, vol. 32(3), pages 408-27, Autumn.
  9. 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.
  10. Amy Finkelstein & James Poterba, 2006. "Testing for Asymmetric Information Using 'Unused Observables' in Insurance Markets: Evidence from the U.K. Annuity Market," NBER Working Papers 12112, National Bureau of Economic Research, Inc.
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Cited by:
  1. Liran Einav & Amy Finkelstein & Mark R. Cullen, 2008. "Estimating Welfare in Insurance Markets Using Variation in Prices," NBER Working Papers 14414, National Bureau of Economic Research, Inc.
  2. Steven T. Berry & Philip Haile, 2010. "Identification in Differentiated Products Markets Using Market Level Data," Cowles Foundation Discussion Papers 1744R, Cowles Foundation for Research in Economics, Yale University, revised May 2012.
  3. 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.
  4. Abe Dunn, 2010. "The Value of Coverage in the Medicare Advantage Insurance Market," BEA Working Papers 0061, Bureau of Economic Analysis.
  5. Mark Cullen & Liran Einav & Amy Finkelstein, 2009. "Estimating Welfare in Insurance Markets Using Variation in Prices," Discussion Papers 08-046, Stanford Institute for Economic Policy Research.
  6. Mark Cullen & Liran Einav & Amy Finkelstein, 2008. "Estimating Welfare in Insurance Markets Using Variation in Prices," Discussion Papers 08-006, Stanford Institute for Economic Policy Research.
  7. 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.
  8. Raj Chetty & Amy Finkelstein, 2012. "Social Insurance: Connecting Theory to Data," NBER Working Papers 18433, National Bureau of Economic Research, Inc.

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