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The Effects of HMOs on Conventional Insurance Premiums: Theory and Evidence

  • Laurence C. Baker
  • Kenneth S. Corts

We develop a model of imperfectly competitive insurers that compete with HMOs for consumers who have private information about their health status. We illustrate two conflicting effects of increasing HMO activity on conventional insurance premiums. We term these effects market discipline -- HMO competition may limit the ability of insurers to exercise market power, thus driving prices down -- and market segmentation -- HMOs may skim the healthiest patients, thus driving insurers' costs and prices up. We empirically examine the relative importance of these effects using data from a firm-level survey that provides data on premiums, together with market-level measures of HMO activity. Our results suggest that the market segmentation effect is important, and that increases in HMO activity may increase insurance premiums.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5356.

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Date of creation: Nov 1995
Date of revision:
Publication status: published as American Economic Review, Paper and Proceedings, Vol. 86, no. 2, 1996, pp. 389-94
Handle: RePEc:nbr:nberwo:5356
Note: HC
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  1. Charles E. Phelps, 1992. "Diffusion of Information in Medical Care," Journal of Economic Perspectives, American Economic Association, vol. 6(3), pages 23-42, Summer.
  2. Corts, Kenneth S., 1998. "Conduct parameters and the measurement of market power," Journal of Econometrics, Elsevier, vol. 88(2), pages 227-250, November.
  3. David Cutler, 1994. "Market Failure in Small Group Health Insurance," NBER Working Papers 4879, National Bureau of Economic Research, Inc.
  4. Newhouse, Joseph P., 1984. "Cream skimming, asymmetric information, and a competitive insurance market," Journal of Health Economics, Elsevier, vol. 3(1), pages 97-100, April.
  5. Pauly, Mark V., 1984. "Is cream-skimming a problem for the competitive medical market?," Journal of Health Economics, Elsevier, vol. 3(1), pages 87-95, April.
  6. van de Ven, Wynand P. M. M. & van Vliet, ReneC. J. A., 1995. "Consumer information surplus and adverse selection in competitive health insurance markets: An empirical study," Journal of Health Economics, Elsevier, vol. 14(2), pages 149-169, June.
  7. Laurence C. Baker, 1995. "HMOs and Fee-For-Service Health Care Expenditures: Evidence from Medicare," NBER Working Papers 5360, National Bureau of Economic Research, Inc.
  8. Lewis Tracy R. & Sappington David E. M., 1995. "Insurance, Adverse Selection, and Cream-Skimming," Journal of Economic Theory, Elsevier, vol. 65(2), pages 327-358, April.
  9. Feldman, Roger & Dowd, Bryan, 1986. "Is there a competitive market for hospital services?," Journal of Health Economics, Elsevier, vol. 5(3), pages 277-292, September.
  10. Marquis, M. Susan, 1992. "Adverse selection with a multiple choice among health insurance plans: A simulation analysis," Journal of Health Economics, Elsevier, vol. 11(2), pages 129-151, August.
  11. repec:cup:cbooks:9780521385824 is not listed on IDEAS
  12. Feldman, Roger & Dowd, Bryan, 1991. "Must adverse selection cause premium spirals?," Journal of Health Economics, Elsevier, vol. 10(3), pages 349-357, October.
  13. William E. Encinosa & David E. M. Sappington, 1997. "Competition among Health Maintenance Organizations," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 6(1), pages 129-150, 03.
  14. Jerrold Hill & Randall Brown & Dexter Chu & Jeanette Bergeron, 1992. "The Impact of the Medicare Risk Program on the Use of Services and Costs to Medicare," Mathematica Policy Research Reports c3a2029be3384733aa2c4901e, Mathematica Policy Research.
  15. Noether, Monica, 1988. "Competition among hospitals," Journal of Health Economics, Elsevier, vol. 7(3), pages 259-284, September.
  16. Randall S. Brown & Jeanette W. Bergeron & Dolores Gurnick Clement & Jerrold W. Hill & Sheldon M. Retchin, 1993. "The Medicare Risk Program for HMOs: Final Summary Report on Findings from the Evaluation," Mathematica Policy Research Reports bcd980d40db84cfa936366a0a, Mathematica Policy Research.
  17. John Bound & David A. Jaeger & Regina Baker, 1993. "The Cure Can Be Worse than the Disease: A Cautionary Tale Regarding Instrumental Variables," NBER Technical Working Papers 0137, National Bureau of Economic Research, Inc.
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