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Competition leverage: How the demand side affects optimal risk adjustment

  • Michiel Bijlsma

    ()

  • Gijsbert Zwart

    ()

  • Jan Boone

In this paper, the authors study optimal risk adjustment in imperfectly competitive health insurance markets when high-risk consumers are less likely to switch insurer than low-risk consumers. First,�they find that insurers still have an incentive to select even if risk adjustment perfectly corrects for cost differences among consumers. Consequently, the outcome is not efficient even if cost differences are fully compensated. To achieve first best, risk adjustment should overcompensate for serving high-risk agents to take into account the difference in markups among the two types. Second, the difference in switching behavior creates a trade�off between efficiency and consumer welfare. Reducing the difference in risk adjustment subsidies to high and low types increases consumer welfare by leveraging competition from the elastic low-risk market to the less elastic high-risk market. Finally, mandatory pooling can increase consumer surplus even further, at the cost of efficiency.

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File URL: http://www.cpb.nl/sites/default/files/publicaties/download/dp181-risk-adjustment.pdf
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Paper provided by CPB Netherlands Bureau for Economic Policy Analysis in its series CPB Discussion Paper with number 181.

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Date of creation: Jun 2011
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Handle: RePEc:cpb:discus:181
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  1. 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.
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  5. Joseph P. Newhouse, 1996. "Reimbursing Health Plans and Health Providers: Efficiency in Production versus Selection," Journal of Economic Literature, American Economic Association, vol. 34(3), pages 1236-1263, September.
  6. Armstrong, Mark, 2006. "Price discrimination," MPRA Paper 4693, University Library of Munich, Germany.
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  8. Olivella, Pau & Vera-Hernandez, Marcos, 2007. "Competition among differentiated health plans under adverse selection," Journal of Health Economics, Elsevier, vol. 26(2), pages 233-250, March.
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  14. J. Miguel Villas-Boas & Udo Schmidt-Mohr, 1999. "Oligopoly with Asymmetric Information: Differentiation in Credit Markets," RAND Journal of Economics, The RAND Corporation, vol. 30(3), pages 375-396, Autumn.
  15. Armstrong, John & Paolucci, Francesco & McLeod, Heather & van de Ven, Wynand P.M.M., 2010. "Risk equalisation in voluntary health insurance markets: A three country comparison," Health Policy, Elsevier, vol. 98(1), pages 39-49, November.
  16. Beaulieu, Nancy Dean, 2002. "Quality information and consumer health plan choices," Journal of Health Economics, Elsevier, vol. 21(1), pages 43-63, January.
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  18. Strombom, Bruce A. & Buchmueller, Thomas C. & Feldstein, Paul J., 2002. "Switching costs, price sensitivity and health plan choice," Journal of Health Economics, Elsevier, vol. 21(1), pages 89-116, January.
  19. Jack, William, 2001. "Controlling selection incentives when health insurance contracts are endogenous," Journal of Public Economics, Elsevier, vol. 80(1), pages 25-48, April.
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