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Competition Leverage : How the Demand Side Affects Optimal Risk Adjustment

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  • Bijlsma, M.
  • Boone, J.

    (Tilburg University, Center For Economic Research)

  • Zwart, Gijsbert

    (Tilburg University, Center For Economic Research)

Abstract

We 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, we 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 mark- ups 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.

Suggested Citation

  • Bijlsma, M. & Boone, J. & Zwart, Gijsbert, 2011. "Competition Leverage : How the Demand Side Affects Optimal Risk Adjustment," Discussion Paper 2011-071, Tilburg University, Center for Economic Research.
  • Handle: RePEc:tiu:tiucen:c7739c3e-866e-4509-bfc2-e7a5d596b488
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Normann Lorenz, 2013. "Adverse selection and risk adjustment under imperfect competition," Research Papers in Economics 2013-05, University of Trier, Department of Economics.
    2. repec:eee:pubeco:v:155:y:2017:i:c:p:21-37 is not listed on IDEAS
    3. Normann Lorenz, 2014. "Using quantile regression for optimal risk adjustment," Research Papers in Economics 2014-11, University of Trier, Department of Economics.
    4. Bijlsma, M. & Boone, Jan & Zwart, G.T.J., 2015. "Community Rating in Health Insurance : Trade-Off Between Coverage and Selection," Discussion Paper 2015-022, Tilburg University, Tilburg Law and Economic Center.
    5. Boone, Jan, 2015. "Basic versus supplementary health insurance: Moral hazard and adverse selection," Journal of Public Economics, Elsevier, pages 50-58.
    6. R. C. Kleef & R. C. J. A. Vliet & W. P. M. M. Ven, 2016. "Overpaying morbidity adjusters in risk equalization models," The European Journal of Health Economics, Springer;Deutsche Gesellschaft für Gesundheitsökonomie (DGGÖ), vol. 17(7), pages 885-895, September.
    7. Normann Lorenz, 2014. "The interaction of direct and indirect risk selection," Research Papers in Economics 2014-12, University of Trier, Department of Economics.
    8. Colleen Carey, 2017. "Technological Change and Risk Adjustment: Benefit Design Incentives in Medicare Part D," American Economic Journal: Economic Policy, American Economic Association, vol. 9(1), pages 38-73, February.
    9. Lorenz, Normann, 2015. "The interaction of direct and indirect risk selection," Journal of Health Economics, Elsevier, vol. 42(C), pages 81-89.
    10. Normann Lorenz, 2014. "Adverse selection and heterogeneity of demand responsiveness," Research Papers in Economics 2014-02, University of Trier, Department of Economics.

    More about this item

    Keywords

    health insurance; risk adjustment; imperfect competition; leverage;

    JEL classification:

    • I11 - Health, Education, and Welfare - - Health - - - Analysis of Health Care Markets
    • I18 - Health, Education, and Welfare - - Health - - - Government Policy; Regulation; Public Health
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets

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