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Optimal risk adjustment in a model with adverse selection and spatial competition

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Abstract

We develop a model that incorporates both spatial heterogeneity and adverse selection to examine the features of optimal prices paid by an agency purchasing a bundle of services on behalf of consumers with different underlying characteristics. Service bundles are two dimensional, and to be implementable a proposed allocation must respect incentive compatibility constraints. Equilibrium provision by a duopoly is characterized, and delivery of the constrained optimal bundles is possible, as long as providers are paid risk-adjusted fees for each individual they serve. When the payment can be made on the basis of an individual's type, it should be sufficient to cover the cost of delivering the socially optimal bundle for that person, plus a mark-up over cost. If payments can be made only on the basis of a partially informative signal, the optimal type-based payments should be adjusted according to a simple linear transformation, identified by Glazer and McGuire (2000). Finally, if payments differentiated by consumer type or signal are infeasible, subsidising the cost of one of the services relative to the other can improve welfare, but in general the constrained social optimum cannot be attained. Classification-JEL Codes: D820, I110, I180

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Bibliographic Info

Paper provided by Georgetown University, Department of Economics in its series Working Papers with number gueconwpa~04-04-15.

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Date of creation: 15 Apr 2004
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Handle: RePEc:geo:guwopa:gueconwpa~04-04-15

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Postal: Georgetown University Department of Economics Washington, DC 20057-1036
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Postal: Marcia Suss Administrative Officer Georgetown University Department of Economics Washington, DC 20057-1036
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Keywords: Risk adjustment; adverse selection;

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  1. Olivella, Pau & Vera-Hernandez, Marcos, 2007. "Competition among differentiated health plans under adverse selection," Journal of Health Economics, Elsevier, vol. 26(2), pages 233-250, March.
  2. Biglaiser, Gary & Ma, Ching-to Albert, 2003. " Price and Quality Competition under Adverse Selection: Market Organization and Efficiency," RAND Journal of Economics, The RAND Corporation, vol. 34(2), pages 266-86, Summer.
  3. Van de ven, Wynand P.M.M. & Ellis, Randall P., 2000. "Risk adjustment in competitive health plan markets," Handbook of Health Economics, in: A. J. Culyer & J. P. Newhouse (ed.), Handbook of Health Economics, edition 1, volume 1, chapter 14, pages 755-845 Elsevier.
  4. Jack, W., 1998. "Controlling Risk Selction Incentives when Health Insurance Contracts are Endogenous," Papers 341, Australian National University - Department of Economics.
  5. Joseph P. Newhouse, 2004. "Pricing the Priceless: A Health Care Conundrum," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262640589, December.
  6. Joseph P. Newhouse, 1996. "Reimbursing Health Plans and Health Providers: Efficiency in Production versus Selection," Journal of Economic Literature, American Economic Association, vol. 34(3), pages 1236-1263, September.
  7. Ching-to A. Ma, 2004. "Managed care and shadow price," Health Economics, John Wiley & Sons, Ltd., vol. 13(2), pages 199-202.
  8. Yujing Shen & Randall P. Ellis, 1999. "Cost-Minimizing Risk Adjustment," Papers 0097, Boston University - Industry Studies Programme.
  9. Frank, Richard G. & Glazer, Jacob & McGuire, Thomas G., 2000. "Measuring adverse selection in managed health care," Journal of Health Economics, Elsevier, vol. 19(6), pages 829-854, November.
  10. 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.
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Cited by:
  1. Bardey, David & Canta, Chiara & Lozachmeur, Jean-Marie, 2010. "Health Care Providers Payments Regulation when Horizontal and Vertical Differentiation Matter," IDEI Working Papers 532, Institut d'Économie Industrielle (IDEI), Toulouse.
  2. Ronald Eduardo Gómez Suárez, 2007. "Cream-Skimming And Risk Adjustment in Colombian Health Insurance System:: The Public Insurer Case," ARCHIVOS DE ECONOMÍA 004295, DEPARTAMENTO NACIONAL DE PLANEACIÓN.

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