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Demand Heterogeneity in Insurance Markets: Implications for Equity and Efficiency

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  • Michael Geruso

Abstract

In many markets insurers are barred from price discrimination based on consumer characteristics like age, gender, and medical history. In this paper, I build on a recent literature to show why such policies are inefficient if consumers differ in their willingness-to-pay for insurance conditional on the insured losses they generate. Using administrative claims data, I then show that this type of demand heterogeneity is empirically relevant in a consumer health plan setting. Younger and older consumers and men and women reveal strikingly different demand for health insurance, conditional on their objective medical spending risk. This implies that these groups must face different prices in order to sort themselves efficiently across insurance contracts. The theoretical and empirical analysis highlights a fundamental tradeoff between equity and efficiency that is unique to selection markets.

Suggested Citation

  • Michael Geruso, 2016. "Demand Heterogeneity in Insurance Markets: Implications for Equity and Efficiency," NBER Working Papers 22440, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22440
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    References listed on IDEAS

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    1. Amy Finkelstein & James Poterba, 2004. "Adverse Selection in Insurance Markets: Policyholder Evidence from the U.K. Annuity Market," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 183-208, February.
    2. Alma Cohen & Liran Einav, 2007. "Estimating Risk Preferences from Deductible Choice," American Economic Review, American Economic Association, vol. 97(3), pages 745-788, June.
    3. 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.
    4. Thomas G. McGuire & Jacob Glazer, 2000. "Optimal Risk Adjustment in Markets with Adverse Selection: An Application to Managed Care," American Economic Review, American Economic Association, vol. 90(4), pages 1055-1071, September.
    5. Keith M. Marzilli Ericson & Amanda Starc, 2015. "Pricing Regulation and Imperfect Competition on the Massachusetts Health Insurance Exchange," The Review of Economics and Statistics, MIT Press, vol. 97(3), pages 667-682, July.
    6. Martin B. Hackmann & Jonathan T. Kolstad & Amanda E. Kowalski, 2015. "Adverse Selection and an Individual Mandate: When Theory Meets Practice," American Economic Review, American Economic Association, vol. 105(3), pages 1030-1066, March.
    7. Train,Kenneth E., 2009. "Discrete Choice Methods with Simulation," Cambridge Books, Cambridge University Press, number 9780521747387, December.
    8. Finkelstein, Amy & Poterba, James & Rothschild, Casey, 2009. "Redistribution by insurance market regulation: Analyzing a ban on gender-based retirement annuities," Journal of Financial Economics, Elsevier, vol. 91(1), pages 38-58, January.
    9. Timothy J. Layton & Randall P. Ellis & Thomas G. McGuire, 2015. "Assessing Incentives for Adverse Selection in Health Plan Payment Systems," NBER Working Papers 21531, National Bureau of Economic Research, Inc.
    10. Benjamin R. Handel, 2013. "Adverse Selection and Inertia in Health Insurance Markets: When Nudging Hurts," American Economic Review, American Economic Association, vol. 103(7), pages 2643-2682, December.
    11. Amy Finkelstein & Kathleen McGarry, 2006. "Multiple Dimensions of Private Information: Evidence from the Long-Term Care Insurance Market," American Economic Review, American Economic Association, vol. 96(4), pages 938-958, September.
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    Cited by:

    1. Pietro Tebaldi & Alexander Torgovitsky & Hanbin Yang, 2019. "Nonparametric Estimates of Demand in the California Health Insurance Exchange," NBER Working Papers 25827, National Bureau of Economic Research, Inc.
    2. Layton, Timothy J. & McGuire, Thomas G. & van Kleef, Richard C., 2018. "Deriving risk adjustment payment weights to maximize efficiency of health insurance markets," Journal of Health Economics, Elsevier, vol. 61(C), pages 93-110.
    3. Drake, Coleman, 2019. "What are consumers willing to pay for a broad network health plan?: Evidence from covered California," Journal of Health Economics, Elsevier, vol. 65(C), pages 63-77.
    4. Wiseman, Thomas, 2018. "Competitive long-term health insurance," Journal of Health Economics, Elsevier, vol. 58(C), pages 144-150.
    5. Geruso, Michael & Layton, Timothy J. & McCormack, Grace & Shepard, Mark, 2019. "The Two Margin Problem in Insurance Markets," Working Paper Series rwp19-035, Harvard University, John F. Kennedy School of Government.
    6. 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.

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    More about this item

    JEL classification:

    • I11 - Health, Education, and Welfare - - Health - - - Analysis of Health Care Markets
    • I13 - Health, Education, and Welfare - - Health - - - Health Insurance, Public and Private

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