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Welfare costs of reclassification risk in the health insurance market

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  • Pashchenko, Svetlana
  • Porapakkarm, Ponpoje

Abstract

One of the major problems of the U.S. health insurance market is that it leaves individuals exposed to reclassification risk. Reclassification risk arises because the health conditions of individuals evolve over time, while a typical health insurance contract only lasts for one year. A change in the health status can lead to a significant change in the health insurance premium. We study how costly this reclassification risk is for the welfare of consumers. More specifically, we use a general equilibrium model to quantify the implications of introducing guaranteed renewable contracts into the economy calibrated to replicate the key features of the health insurance system in the U.S. Guaranteed renewable contracts are private insurance contracts that can provide protection against reclassification risk even in the absence of consumer commitment or government intervention. We find that though guaranteed renewable contracts provide a good insurance against reclassification risk, the welfare effects from introducing this type of contracts are small. In other words, the presence of reclassification risk does not impose large welfare losses on consumers. This happens because some institutional features in the current U.S. system substitute for the missing explicit contracts that insure reclassification risk. In particular, a good protection against reclassification risk is provided through employer-sponsored health insurance and government means-tested transfers.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 34189.

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Date of creation: 19 Oct 2011
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Handle: RePEc:pra:mprapa:34189

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Keywords: health insurance; reclassification risk; dynamic insurance; guaranteed renewable contracts; general equilibrium;

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References

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  1. Mariacristina De Nardi & Eric French & John Bailey Jones, 2009. "Why do the Elderly Save? The Role of Medical Expenses," NBER Working Papers 15149, National Bureau of Economic Research, Inc.
  2. Amy Finkelstein & Kathleen McGarry & Amir Sufi, 2005. "Dynamic Inefficiencies in Insurance Markets: Evidence from long-term care insurance," NBER Working Papers 11039, National Bureau of Economic Research, Inc.
  3. Hanming Fang & Edward Kung, 2010. "How Does Life Settlement Affect the Primary Life Insurance Market?," NBER Working Papers 15761, National Bureau of Economic Research, Inc.
  4. Hsu, Minchung, 2008. "Health Insurance, the Social Welfare System and Household Saving," MPRA Paper 21281, University Library of Munich, Germany, revised 2010.
  5. Jeske, Karsten & Kitao, Sagiri, 2009. "U.S. tax policy and health insurance demand: Can a regressive policy improve welfare?," Journal of Monetary Economics, Elsevier, vol. 56(2), pages 210-221, March.
  6. Ponpoje Porapakkarm & Svetlana Pashchenko, 2011. "Quantitative Analysis of Health Insurance Reform: Separating Community Rating from Income Redistribution," 2011 Meeting Papers 1254, Society for Economic Dynamics.
  7. Igal Hendel & Alessandro Lizzeri, 2000. "The Role of Commitment in Dynamic Contracts: Evidence from Life Insurance," NBER Working Papers 7470, National Bureau of Economic Research, Inc.
  8. Cochrane, John H, 1995. "Time-Consistent Health Insurance," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 445-73, June.
  9. Young, Eric R., 2010. "Solving the incomplete markets model with aggregate uncertainty using the Krusell-Smith algorithm and non-stochastic simulations," Journal of Economic Dynamics and Control, Elsevier, vol. 34(1), pages 36-41, January.
  10. Gouveia, Miguel & Strauss, Robert P., 1994. "Effective Federal Individual Tax Functions: An Exploratory Empirical Analysis," National Tax Journal, National Tax Association, vol. 47(2), pages 317-39, June.
  11. Pauly, Mark V & Kunreuther, Howard & Hirth, Richard, 1995. "Guaranteed Renewability in Insurance," Journal of Risk and Uncertainty, Springer, vol. 10(2), pages 143-56, March.
  12. Massimiliano De Santis, 2007. "Individual Consumption Risk and the Welfare Cost of Business Cycles," American Economic Review, American Economic Association, vol. 97(4), pages 1488-1506, September.
  13. Glenn Daily & Igal Hendel & Alessandro Lizzeri, 2008. "Does the Secondary Life Insurance Market Threaten Dynamic Insurance?," American Economic Review, American Economic Association, vol. 98(2), pages 151-56, May.
  14. Diamond, Peter, 1992. "Organizing the Health Insurance Market," Econometrica, Econometric Society, vol. 60(6), pages 1233-54, November.
  15. Herring, Bradley & Pauly, Mark V., 2006. "Incentive-compatible guaranteed renewable health insurance premiums," Journal of Health Economics, Elsevier, vol. 25(3), pages 395-417, May.
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  1. Reclassification risk in health insurance
    by Economic Logician in Economic Logic on 2012-01-18 15:28:00
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Cited by:
  1. Pashchenko, Svetlana & Porapakkarm, Ponpoje, 2013. "Cross-subsidization in employer-based health insurance and the effects of tax subsidy reform," MPRA Paper 48054, University Library of Munich, Germany.

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