Incentive and Selection Effects of Medigap Insurance on Inpatient Care

The Medicare program, which provides insurance coverage to the elderly in the United States, does not protect them fully against high out-of-pocket costs. For this reason private supplementary insurance, named Medigap, has been available to cover Medicare gaps. This paper studies how Medigap affects the utilization of inpatient care, separating the incentive and selection effects of supplementary insurance. For this purpose, we use two alternative estimation methods: a standard recursive bivariate probit and a discrete multivariate finite mixture model. We find that estimated incentive effects are modest and quite similar across models. On the other hand, there seems to be very significant selection when one conditions only on variables used by Medigap insurers, with the presence of both adversely and advantageously selected individuals, stemming from the multidimensional nature of residual heterogeneity.