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Imperfect risk adjustment, risk preferences, and sorting in competitive health insurance markets

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  • Layton, Timothy J.

Abstract

I develop a model of insurer price-setting and consumer welfare under risk-adjustment, a policy commonly used to combat inefficient sorting due to adverse selection in health insurance markets. I use the model to illustrate graphically that risk-adjustment causes health plan prices to be based on costs not predicted by the risk-adjustment model (“residual costs”) rather than total costs, either weakening or exacerbating selection problems depending on the correlation between demand and costs predicted by the risk-adjustment model. I then use a structural model to estimate the welfare consequences of risk-adjustment, finding a welfare gain of over $600 per person-year.

Suggested Citation

  • Layton, Timothy J., 2017. "Imperfect risk adjustment, risk preferences, and sorting in competitive health insurance markets," Journal of Health Economics, Elsevier, vol. 56(C), pages 259-280.
    • Handle: RePEc:eee:jhecon:v:56:y:2017:i:c:p:259-280
    DOI: 10.1016/j.jhealeco.2017.04.004
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    Citations

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    Cited by:

    1. Evan Saltzman, 2021. "Managing adverse selection: underinsurance versus underenrollment," RAND Journal of Economics, RAND Corporation, vol. 52(2), pages 359-381, June.
    2. Mladenovic, Svetlana Sokolov & Milovancevic, Milos & Mladenovic, Igor & Petrovic, Jelena & Milovanovic, Dragan & Petković, Biljana & Resic, Sead & Barjaktarović, Miljana, 2020. "Identification of the important variables for prediction of individual medical costs billed by health insurance," Technology in Society, Elsevier, vol. 62(C).
    3. Carey, Colleen, 2021. "Sharing the burden of subsidization: Evidence on pass-through from a subsidy revision in Medicare Part D," Journal of Public Economics, Elsevier, vol. 198(C).
    4. repec:hal:spmain:info:hdl:2441/2ioennpq5m90holakkatq7cmms is not listed on IDEAS
    5. Michele Fioretti & Hongming Wang, 2020. "Performance Pay in Insurance Markets: Evidence from Medicare," Working Papers 2020.03, International Network for Economic Research - INFER.
    6. repec:hal:wpspec:info:hdl:2441/2ioennpq5m90holakkatq7cmms is not listed on IDEAS
    7. de Meza, David & Reito, Francesco & Reyniers, Diane, 2021. "Too much trade: The hidden problem of adverse selection," Journal of Public Economics, Elsevier, vol. 204(C).
    8. Colleen Carey, 2017. "Technological Change and Risk Adjustment: Benefit Design Incentives in Medicare Part D," American Economic Journal: Economic Policy, American Economic Association, vol. 9(1), pages 38-73, February.
    9. Timothy J. Layton & Randall P. Ellis & Thomas G. McGuire, 2015. "Assessing Incentives for Adverse Selection in Health Plan Payment Systems," Boston University - Department of Economics - Working Papers Series wp2015-024, Boston University - Department of Economics.
    10. Michael Geruso & Timothy J. Layton, 2017. "Selection in Health Insurance Markets and Its Policy Remedies," Journal of Economic Perspectives, American Economic Association, vol. 31(4), pages 23-50, Fall.
    11. Michael Geruso, 2017. "Demand heterogeneity in insurance markets: Implications for equity and efficiency," Quantitative Economics, Econometric Society, vol. 8(3), pages 929-975, November.
    12. Anell, Anders & Dackehag, Margareta & Dietrichson, Jens & Ellegård, Lina Maria & Kjellsson, Gustav, 2022. "Better Off by Risk Adjustment? Socioeconomic Disparities in Care Utilization in Sweden Following a Payment Reform," Working Papers 2022:15, Lund University, Department of Economics, revised 12 Mar 2024.
    13. Timothy J. Layton & Thomas G. McGuire & Anna D. Sinaiko, 2016. "Risk Corridors and Reinsurance in Health Insurance Marketplaces: Insurance for Insurers," American Journal of Health Economics, University of Chicago Press, vol. 2(1), pages 66-95, Winter.
    14. Liran Einav & Amy Finkelstein, 2023. "Empirical analyses of selection and welfare in insurance markets: a self-indulgent survey," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 48(2), pages 167-191, September.
    15. Tomas Pedro Sanguinetti, 2019. "How Do Couples Choose Individual Insurance Plans? Evidence from Medicare Part D," 2019 Papers psa1760, Job Market Papers.

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