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Adverse Selection in Health Insurance

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  • David M. Cutler
  • Richard J. Zeckhauser

Abstract

Individual choice over health insurance policies may result in risk-based sorting across plans. Such adverse selection induces three types of losses: efficiency losses from individuals being allocated to the wrong plans; risk sharing losses since premium variability is increased; and losses from insurers distorting their policies to improve their mix of insureds. We discuss the potential for these losses, and present empirical evidence on adverse selection in two groups of employees: Harvard University, and the Group Insurance Commission of Massachusetts (serving state and local employees). In both groups, adverse selection is a significant concern. At Harvard, the University's decision to contribute an equal amount to all insurance plans led to the disappearance of the most generous policy within 3 years. At the GIC, adverse selection has been contained by subsidizing premiums on a proportional basis and managing the most generous policy very tightly. A combination of prospective or retrospective risk adjustment, coupled with reinsurance for high cost cases, seems promising as a way to provide appropriate incentives for enrollees and to reduce losses from adverse selection.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6107.

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Date of creation: Jul 1997
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Publication status: published as Cutler, David M. and Richard J. Zeckhauser. "Adverse Selection In Health Insurance," Forum for Health Economics and Policy, 1998, v1, Article 2.
Handle: RePEc:nbr:nberwo:6107

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  1. David M. Cutler & Sarah J. Reber, 1998. "Paying For Health Insurance: The Trade-Off Between Competition And Adverse Selection," The Quarterly Journal of Economics, MIT Press, vol. 113(2), pages 433-466, May.
  2. David M. Cutler & Richard J. Zeckhauser, 1999. "Reinsurance for Catastrophes and Cataclysms," NBER Chapters, in: The Financing of Catastrophe Risk, pages 233-274 National Bureau of Economic Research, Inc.
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