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Adverse selection and heterogeneity of demand responsiveness

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  • Normann Lorenz
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    Abstract

    This paper analyzes the distortions of (health) insurers' benefit levels due to adverse selection if individuals' responsiveness to differences in contracts is heterogeneous. Within a discrete choice model with two risk types and imperfect competition the following results are shown: In the pooling equilibrium, a positive correlation of low risk and high responsiveness (e.g., younger individuals being both healthier and faster to switch insurers than older individuals) increases the distortion of the uniform benefit level if the share of low risks is small; if the share of low risks is large, the reverse holds, but only if the average level of responsiveness is high. In the separating equilibrium, a positive correlation increases the distortion of the contract for the low risks, unless the number of insurers offering the contract for the high risks is very small or a large share of the high risks chooses the contract designated for the low risks. These results imply that the welfare effects of a policy intervention of making individuals more responsive crucially depend on which risk types' responsiveness is increased more. The results also have implications for the estimation of the level of risk aversion and of the welfare effects of adverse selection.

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    File URL: http://www.uni-trier.de/fileadmin/fb4/prof/VWL/EWF/Research_Papers/2014-02.pdf
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    Bibliographic Info

    Paper provided by University of Trier, Department of Economics in its series Research Papers in Economics with number 2014-02.

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    Length: 32 pages
    Date of creation: 2014
    Date of revision:
    Handle: RePEc:trr:wpaper:201402

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    Keywords: Adverse selection; discrete choice;

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    References

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    1. M. Bundorf & Jonathan Levin & Neale Mahoney, 2008. "Pricing and Welfare in Health Plan Choice," Discussion Papers, Stanford Institute for Economic Policy Research 07-047, Stanford Institute for Economic Policy Research.
    2. Kenneth Train, 2003. "Discrete Choice Methods with Simulation," Online economics textbooks, SUNY-Oswego, Department of Economics, SUNY-Oswego, Department of Economics, number emetr2, Spring.
    3. Bijlsma, Michiel & Boone, Jan & Zwart, Gijsbert, 2011. "Competition leverage: how the demand side affects optimal risk adjustment," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8461, C.E.P.R. Discussion Papers.
    4. Alma Cohen & Peter Siegelman, 2009. "Testing for Adverse Selection in Insurance Markets," NBER Working Papers 15586, National Bureau of Economic Research, Inc.
    5. Einav, Liran & Finkelstein, Amy & Levin, Jonathan, 2009. "Beyond Testing: Empirical Models of Insurance Markets," Department of Economics, Working Paper Series, Department of Economics, Institute for Business and Economic Research, UC Berkeley qt90g407hf, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    6. 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.
    7. Harris, Katherine & Schultz, Jennifer & Feldman, Roger, 2002. "Measuring consumer perceptions of quality differences among competing health benefit plans," Journal of Health Economics, Elsevier, Elsevier, vol. 21(1), pages 1-17, January.
    8. Fang, Hanming & Keane, Michael & Silverman, Dan, 2006. "Sources of Advantageous Selection: Evidence from the Medigap Insurance Market," Working Papers, Yale University, Department of Economics 17, Yale University, Department of Economics.
    9. Olivella, Pau & Vera-Hernandez, Marcos, 2007. "Competition among differentiated health plans under adverse selection," Journal of Health Economics, Elsevier, Elsevier, vol. 26(2), pages 233-250, March.
    10. Jack, William, 2006. "Optimal risk adjustment with adverse selection and spatial competition," Journal of Health Economics, Elsevier, Elsevier, vol. 25(5), pages 908-926, September.
    11. 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, MIT Press, vol. 90(4), pages 630-49, November.
    12. Keith Marzilli Ericson & Amanda Starc, 2012. "Heuristics and Heterogeneity in Health Insurance Exchanges: Evidence from the Massachusetts Connector," American Economic Review, American Economic Association, American Economic Association, vol. 102(3), pages 493-97, May.
    13. Liran Einav & Amy Finkelstein & Mark R. Cullen, 2010. "Estimating Welfare in Insurance Markets Using Variation in Prices," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 125(3), pages 877-921, August.
    14. Normann Lorenz, 2013. "Adverse selection and risk adjustment under imperfect competition," Research Papers in Economics, University of Trier, Department of Economics 2013-05, University of Trier, Department of Economics.
    15. Sinaiko, Anna D. & Hirth, Richard A., 2011. "Consumers, health insurance and dominated choices," Journal of Health Economics, Elsevier, Elsevier, vol. 30(2), pages 450-457, March.
    16. Johar, Meliyanni & Savage, Elizabeth, 2012. "Sources of advantageous selection: Evidence using actual health expenditure risk," Economics Letters, Elsevier, Elsevier, vol. 116(3), pages 579-582.
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