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Does Adverse Selection Matter? Evidence from a Natural Experiment

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  • Grönqvist, Erik

    ()
    (Centre for Health Economics)

Abstract

The empirical evidence of adverse selection in insurance markets is mixed. The problem in assessing the extent of adverse selection is that private information, on which agents act, is generally unobservable to the researcher, which makes it difficult to distinguish between adverse selection and moral hazard. Unique micro data, from a dental insurance natural experiment, is here used to provide a direct test of selection. All agents in a population were stratified into different risk classes, and were unexpectedly given the opportunity to insure their dental care costs. The setup of the insurance makes it possible to observe a proxy for private information. Interestingly, results differ across risk classes. Within high-risk classes, there is evidence of adverse selection and within low-risk classes, the results, surprisingly, indicate an advantageous selection. This dual selection can explain the limited empirical evidence for adverse selection in insurance markets in the literature: the two effects may balance out on the aggregate level. The paper also presents a model of insurance choice that can harbor both adverse and advantageous selection. The pattern in the data is explained by differences in the effectiveness of prevention across high and low risk classes.

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Bibliographic Info

Paper provided by Stockholm School of Economics in its series Working Paper Series in Economics and Finance with number 575.

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Length: 38 pages
Date of creation: 10 Nov 2004
Date of revision:
Handle: RePEc:hhs:hastef:0575

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Keywords: Asymmetric information; Adverse Selection; Advantageous Selection; Health Insurance;

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References

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  1. Mark V. Pauly & Kate H. Withers & Krupa Subramanian-Viswana & Jean Lemaire & John C. Hershey, 2003. "Price Elasticity of Demand for Term Life Insurance and Adverse Selection," NBER Working Papers 9925, National Bureau of Economic Research, Inc.
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  11. Thomas Buchmueller & John Dinardo, 2002. "Did Community Rating Induce an Adverse Selection Death Spiral? Evidence from New York, Pennsylvania, and Connecticut," American Economic Review, American Economic Association, vol. 92(1), pages 280-294, March.
  12. Barsky, Robert B, et al, 1997. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Study," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 537-79, May.
  13. Olsson, Christina, 1999. "Essays in the Economics of Dental Insurance and Dental Health," UmeÃ¥ Economic Studies 494, Umeå University, Department of Economics.
  14. Amy Finkelstein & James Poterba, 2002. "Selection Effects in the United Kingdom Individual Annuities Market," Economic Journal, Royal Economic Society, vol. 112(476), pages 28-50, January.
  15. 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.
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Cited by:
  1. Grönqvist, Erik, 2006. "(M)oral Hazard?," Working Paper Series in Economics and Finance 642, Stockholm School of Economics.

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