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Adverse Selection in Health Insurance

In: Frontiers in Health Policy Research, Volume 1

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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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Suggested Citation

  • David M. Cutler & Richard J. Zeckhauser, 1998. "Adverse Selection in Health Insurance," NBER Chapters,in: Frontiers in Health Policy Research, Volume 1, pages 1-32 National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberch:9822
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    1. 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.
    2. David M. Cutler & Sarah Reber, 1996. "Paying for Health Insurance: The Tradeoff between Competition and Adverse Selection," NBER Working Papers 5796, National Bureau of Economic Research, Inc.
    3. Hill, Steven C. & Wolfe, Barbara L., 1997. "Testing the HMO competitive strategy: An analysis of its impact on medical care resources," Journal of Health Economics, Elsevier, vol. 16(3), pages 261-286, June.
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