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Analyzing the Effects of Insuring Health Risks: On the Trade-off between Short Run Insurance Benefits vs. Long Run Incentive Costs

Listed author(s):
  • Harold L. Cole

    ()

    (Department of Economics, University of Pennsylvania and NBER)

  • Soojin Kim

    ()

    (Krannert School of Management, Department of Economics, Purdue University)

  • Dirk Krueger

    ()

    (Department of Economics, University of Pennsylvania, CEPR, CFS, NBER and Netspar)

This paper constructs a dynamic model of health insurance to evaluate the short- and long-run effects of policies that prevent firms from conditioning wages on health conditions of their workers, and that prevent health insurance companies from charging individuals with adverse health conditions higher insurance premia. Our study is motivated by recent US legislation that has tightened regulations on wage discrimination against workers with poorer health status (such as Americans with Disability Act of 1990, ADA, and its amendment in 2008, the ADAAA) and that prohibits health insurance companies from charging different premiums for workers of different health status starting in 2014 (Patient Protection and Affordable Care Act, PPACA). In the model, a trade-off arises between the static gains from better insurance against poor health induced by these policies and their adverse dynamic incentive effects on household efforts to lead a healthy life. Using household panel data from the PSID we estimate and calibrate the model and then use it to evaluate the static and dynamic consequences of no-wage discrimination and no-prior conditions laws for the evolution of the cross-sectional health and consumption distribution of a cohort of households, as well as ex-ante lifetime utility of a typical member of this cohort. In our quantitative analysis we find that although the competitive equilibrium features too little consumption insurance and a combination of both policies is effective in providing such insurance period by period, it is suboptimal to introduce both policies jointly since such a policy innovation severely undermines the incentives to lead healthier lives and thus induces a more rapid deterioration of the cohort health distribution over time. This effect more than offsets the static gains from better consumption insurance so that expected discounted lifetime utility is lower under both policies, relative to implementing wage nondiscrimination legislation alone. This is true despite the fact that both policy options are strongly welfare improving relative to the competitive equilibrium.

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File URL: http://economics.sas.upenn.edu/system/files/14-023.pdf
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Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 14-023.

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Length: 66 pages
Date of creation: 24 Apr 2014
Handle: RePEc:pen:papers:14-023
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