Sophistication and Insurance: Asymmetric Information, the Ability to Game the System, and Prescription Drug Insurance

63 Pages Posted: 15 Oct 2009 Last revised: 26 Oct 2010

See all articles by Keith M. Marzilli Ericson

Keith M. Marzilli Ericson

Boston University - Markets, Public Policy, and Law; National Bureau of Economic Research (NBER)

Date Written: August 27, 2010

Abstract

In complex insurance contracts, individuals can use sophisticated strategies to avoid out-of-pocket expenses. Sophistication and expected claims are affected by similar factors, creating a systematic positive or negative correlation between them. Depending on this correlation, sophistication can lead to advantageous or adverse selection, and selection may differ between the intensive and extensive margin. Responding to sophistication, insurers may distort contracts by making them excessively simple or complex, to reduce or magnify enrollees' ability to game the system. I show two sophisticated prescription drug-related behaviors each reduce out-of-pocket prescription drug costs by half and are strongly associated with expected claims.

Keywords: insurance, sophistication, asymmetric information, health care, prescription drugs, contract design, adverse selection, advantageous selection, household decision making

JEL Classification: D1, D21, D82 , D83, D86, H3, I11

Suggested Citation

Ericson, Keith M. Marzilli, Sophistication and Insurance: Asymmetric Information, the Ability to Game the System, and Prescription Drug Insurance (August 27, 2010). Available at SSRN: https://ssrn.com/abstract=1488195 or http://dx.doi.org/10.2139/ssrn.1488195

Keith M. Marzilli Ericson (Contact Author)

Boston University - Markets, Public Policy, and Law ( email )

Boston, MA
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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