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Adverse selection and heterogeneity of demand responsiveness

  • Normann Lorenz
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    This paper analyzes the distortions of (health) insurers' benefit levels due to adverse selection if individuals' responsiveness to differences in contracts is heterogeneous. Within a discrete choice model with two risk types and imperfect competition the following results are shown: In the pooling equilibrium, a positive correlation of low risk and high responsiveness (e.g., younger individuals being both healthier and faster to switch insurers than older individuals) increases the distortion of the uniform benefit level if the share of low risks is small; if the share of low risks is large, the reverse holds, but only if the average level of responsiveness is high. In the separating equilibrium, a positive correlation increases the distortion of the contract for the low risks, unless the number of insurers offering the contract for the high risks is very small or a large share of the high risks chooses the contract designated for the low risks. These results imply that the welfare effects of a policy intervention of making individuals more responsive crucially depend on which risk types' responsiveness is increased more. The results also have implications for the estimation of the level of risk aversion and of the welfare effects of adverse selection.

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    File URL: http://www.uni-trier.de/fileadmin/fb4/prof/VWL/EWF/Research_Papers/2014-02.pdf
    File Function: First version, 2014
    Download Restriction: no

    Paper provided by University of Trier, Department of Economics in its series Research Papers in Economics with number 2014-02.

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    Length: 32 pages
    Date of creation: 2014
    Date of revision:
    Handle: RePEc:trr:wpaper:201402
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    Web page: http://www.uni-trier.de/index.php?id=2118
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    1. Harris, Katherine & Schultz, Jennifer & Feldman, Roger, 2002. "Measuring consumer perceptions of quality differences among competing health benefit plans," Journal of Health Economics, Elsevier, vol. 21(1), pages 1-17, January.
    2. 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.
    3. Jack, William, 2006. "Optimal risk adjustment with adverse selection and spatial competition," Journal of Health Economics, Elsevier, vol. 25(5), pages 908-926, September.
    4. Keith Marzilli Ericson & Amanda Starc, 2012. "Heuristics and Heterogeneity in Health Insurance Exchanges: Evidence from the Massachusetts Connector," American Economic Review, American Economic Association, vol. 102(3), pages 493-97, May.
    5. Normann Lorenz, 2013. "Adverse selection and risk adjustment under imperfect competition," Research Papers in Economics 2013-05, University of Trier, Department of Economics.
    6. 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.
    7. Liran Einav & Amy Finkelstein & Jonathan Levin, 2010. "Beyond Testing: Empirical Models of Insurance Markets," Annual Review of Economics, Annual Reviews, vol. 2(1), pages 311-336, 09.
    8. Mark Cullen & Liran Einav & Amy Finkelstein, 2009. "Estimating Welfare in Insurance Markets Using Variation in Prices," Discussion Papers 08-046, Stanford Institute for Economic Policy Research.
    9. Hanming Fang & Michael P. Keane & Dan Silverman, 2006. "Sources of Advantageous Selection: Evidence from the Medigap Insurance Market," NBER Working Papers 12289, National Bureau of Economic Research, Inc.
    10. repec:cup:cbooks:9780521766555 is not listed on IDEAS
    11. M. Bundorf & Jonathan Levin & Neale Mahoney, 2008. "Pricing and Welfare in Health Plan Choice," Discussion Papers 07-047, Stanford Institute for Economic Policy Research.
    12. Johar, Meliyanni & Savage, Elizabeth, 2012. "Sources of advantageous selection: Evidence using actual health expenditure risk," Economics Letters, Elsevier, vol. 116(3), pages 579-582.
    13. Michiel Bijlsma & Gijsbert Zwart & Jan Boone, 2011. "Competition leverage: How the demand side affects optimal risk adjustment," CPB Discussion Paper 181, CPB Netherlands Bureau for Economic Policy Analysis.
    14. Alma Cohen & Peter Siegelman, 2010. "Testing for Adverse Selection in Insurance Markets," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 77(1), pages 39-84.
    15. repec:cup:cbooks:9780521747387 is not listed on IDEAS
    16. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
    17. Sinaiko, Anna D. & Hirth, Richard A., 2011. "Consumers, health insurance and dominated choices," Journal of Health Economics, Elsevier, vol. 30(2), pages 450-457, March.
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