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Paying for Health Insurance: The Tradeoff between Competition and Adverse Selection

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  • David M. Cutler
  • Sarah Reber

Abstract

This paper uses data on health insurance choices by employees of Harvard University to examine the effect of alternative pricing rules on market equilibrium. In the mid-1990s, Harvard moved from a system of subsidizing more expensive insurance to a system of contributing an equal amount to each plan. We estimate a substantial demand response to the policy change, with a short-run elasticity of about -2. The reform also induced substantial" adverse selection. Because of this selection, the long-run demand response is three times the short-run response. Price variation induced by adverse selection is inefficient; we estimate the magnitude of the welfare loss from adverse selection at 2 percent of baseline health spending. Finally, as insurance choice was made more competitive, premiums to Harvard fell relative to premiums in the Boston area by nearly 10 percent. This savings was large enough to compensate for the inefficiency induced by adverse selection, so that reform overall was welfare enhancing.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5796.

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Date of creation: Oct 1996
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Publication status: published as Quarterly Journal of Economics, Vol. 108, no. 2 (May 1998): 433-466.
Handle: RePEc:nbr:nberwo:5796

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  1. 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.
  2. Roger Feldman & Michael Finch & Bryan Dowd & Steven Cassou, 1989. "The Demand for Employment-Based Health Insurance Plans," Journal of Human Resources, University of Wisconsin Press, vol. 24(1), pages 115-142.
  3. Anne Beeson Royalty & Neil Solomon, 1999. "Health Plan Choice: Price Elasticities in a Managed Competition Setting," Journal of Human Resources, University of Wisconsin Press, vol. 34(1), pages 1-41.
  4. W. P. Welch, 1986. "The Elasticity of Demand for Health Maintenance Organizations," Journal of Human Resources, University of Wisconsin Press, vol. 21(2), pages 252-266.
  5. Holmer, Martin, 1984. "Tax policy and the demand for health insurance," Journal of Health Economics, Elsevier, vol. 3(3), pages 203-221, December.
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