Contracting with Limited Commitment: Evidence from Employment-Based Health Insurance Contracts

Abstract:     
When an individual’s health status is observable, but evolving over time, the key to maintaining a successful health insurance arrangement is to have the healthier members of the group cross-subsidize those who experience adverse health outcomes. We argue that impediments to worker mobility may serve to mitigate the attrition of healthy individuals from employer-sponsored insurance pools, thereby creating a de facto commitment mechanism that allows for more complete insurance of health risks than would be possible in the absence of such frictions. Using data on health insurance contracts obtained from the 1987 National Medical Expenditure Survey, we find that the quantity of insurance provided, as measured by lifetime limits on benefits and annual stop-loss amounts, is positively related to the degree of worker commitment. These results illustrate the importance of commitment in the design of long-term contracts, and provide an additional rationale for the practice of bundling health insurance with employment.

Number of Pages in PDF File: 60

JEL Classification: H11, J6

working papers series