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Estimating Welfare in Insurance Markets Using Variation in Prices

  • Liran Einav

    (Stanford University and National Bureau of Economic Research.)

  • Amy Finkelstein

    (Massachusetts Institute of Technology and National Bureau of Economic Research.)

  • Mark R. Cullen

    (Stanford University.)

We provide a graphical illustration of how standard consumer and producer theory can be used to quantify the welfare loss associated with inefficient pricing in insurance markets with selection. We then show how this welfare loss can be estimated empirically using identifying variation in the price of insurance. Such variation, together with quantity data, allows us to estimate the demand for insurance. The same variation, together with cost data, allows us to estimate how insurers' costs vary as market participants endogenously respond to price. The slope of this estimated cost curve provides a direct test for both the existence and the nature of selection, and the combination of demand and cost curves can be used to estimate welfare. We illustrate our approach by applying it to data on employer-provided health insurance from one specific company. We detect adverse selection but estimate that the quantitative welfare implications associated with inefficient pricing in our particular application are small, in both absolute and relative terms. (c) 2010 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology..

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Article provided by MIT Press in its journal Quarterly Journal of Economics.

Volume (Year): 125 (2010)
Issue (Month): 3 (August)
Pages: 877-921

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Handle: RePEc:tpr:qjecon:v:125:y:2010:i:3:p:877-921
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