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How adverse selection affects the health insurance market

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  • Belli, Paolo

Abstract

Adverse selection can be defined as strategic behavior by the more informed partner in a contract against the interest of the less informed partner(s). In the health insurance field, this manifests itself through healthy people choosing managed care and less healthy people choosing more generous plans. Drawing on theoretical literature on the problem of adverse selection in the health insurance market, the author synthesizes concepts developed piecemeal over more than 20 years, using two examples and revisiting the classical contribution of Rothschild and Stiglitz. He highlights key insights, especially from the literature on"equilibrium refinements"and on the theory of"second best."The government can correct spontaneous market dynamics in the health insurance market by directly subsidizing insurance or through regulation; the two forms of intervention provide different results. Providing partial public insurance, even supplemented by the possibility of opting out, can lead to second-best equilibria. The same result holds as long as the government can subsidize contracts with higher-than-average premium-benefit ratios and can tax contracts with lower-than-average premium-benefit ratios. The author analyzes the following policy options relating to the public provision of insurance: a) Full public insurance. b) Partial public insurance with or without the possibility of acquiring supplementary insurance and with or without the possibility of opting out. In recent plans implemented in Germany and the Netherlands, where competition among several health funds and insurance companies was promoted, a public fund was created to discourage risk screening practices by providing the necessary compensation across riks groups. But only"objective"risk adjusters (such as age, gender, and region) were used to decide which contracts to subsidize. Those criteria alone cannot correct the effects of adverse selection. Regulation can exacerbate the problem of adverse selection and lead to chronic market instability, so certain steps must be taken to prevent risk screening and preserve competition for the market. The author considers the following three policy options for regulating the private insurance market: 1) A standard contract with full coverage. 2) Imposition of a minimum insurance requirement. 3) Imposition of premium rate restrictions.

Suggested Citation

  • Belli, Paolo, 2001. "How adverse selection affects the health insurance market," Policy Research Working Paper Series 2574, The World Bank.
  • Handle: RePEc:wbk:wbrwps:2574
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    References listed on IDEAS

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    1. B. Dahlby, 1981. "Adverse selection and Pareto improvements through compulsory insurance," Public Choice, Springer, vol. 37(3), pages 547-558, January.
    2. Diamond, Peter, 1992. "Organizing the Health Insurance Market," Econometrica, Econometric Society, vol. 60(6), pages 1233-1254, November.
    3. David M. Cutler & Richard J. Zeckhauser, 1998. "Adverse Selection in Health Insurance," NBER Chapters,in: Frontiers in Health Policy Research, Volume 1, pages 1-32 National Bureau of Economic Research, Inc.
    4. Van de ven, Wynand P.M.M. & Ellis, Randall P., 2000. "Risk adjustment in competitive health plan markets," Handbook of Health Economics,in: A. J. Culyer & J. P. Newhouse (ed.), Handbook of Health Economics, edition 1, volume 1, chapter 14, pages 755-845 Elsevier.
    5. Frank, Richard G. & Glazer, Jacob & McGuire, Thomas G., 2000. "Measuring adverse selection in managed health care," Journal of Health Economics, Elsevier, vol. 19(6), pages 829-854, November.
    6. Harris Milton & Townsend, Robert M, 1981. "Resource Allocation under Asymmetric Information," Econometrica, Econometric Society, vol. 49(1), pages 33-64, January.
    7. 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.
    8. Joseph E. Stiglitz, 1977. "Monopoly, Non-linear Pricing and Imperfect Information: The Insurance Market," Review of Economic Studies, Oxford University Press, vol. 44(3), pages 407-430.
    9. Neudeck, Werner & Podczeck, Konrad, 1996. "Adverse selection and regulation in health insurance markets," Journal of Health Economics, Elsevier, vol. 15(4), pages 387-408, August.
    10. Spence, Michael, 1978. "Product differentiation and performance in insurance markets," Journal of Public Economics, Elsevier, vol. 10(3), pages 427-447, December.
    11. 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, March.
    12. Joseph P. Newhouse, 1996. "Reimbursing Health Plans and Health Providers: Efficiency in Production versus Selection," Journal of Economic Literature, American Economic Association, vol. 34(3), pages 1236-1263, September.
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    Cited by:

    1. El-Sayed, Abdulrahman M. & Palma, Anton & Freedman, Lynn P. & Kruk, Margaret E., 2015. "Does health insurance mitigate inequities in non-communicable disease treatment? Evidence from 48 low- and middle-income countries," Health Policy, Elsevier, vol. 119(9), pages 1164-1175.
    2. Ronald Eduardo Gómez Suárez, 2007. "Cream-Skimming And Risk Adjustment in Colombian Health Insurance System:: The Public Insurer Case," ARCHIVOS DE ECONOMÍA 004295, DEPARTAMENTO NACIONAL DE PLANEACIÓN.
    3. Daniel Simonet, 2009. "Managed Care expansion to Asia: a critical review," Asian-Pacific Economic Literature, Asia Pacific School of Economics and Government, The Australian National University, vol. 23(2), pages 29-51, November.
    4. Hussey, P. & Anderson, G. F., 2003. "A comparison of single- and multi-payer health insurance systems and options for reform," Health Policy, Elsevier, vol. 66(3), pages 215-228, December.

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    Keywords

    Health Economics&Finance; Environmental Economics&Policies; Insurance&Risk Mitigation; Insurance Law; Financial Intermediation;

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