Flexible Spending Accounts and Adverse Selection

9 Pages Posted: 8 Feb 2010

See all articles by James Cardon

James Cardon

Princeton University - Department of Economics

Abstract

I model the interaction of flexible spending accounts (FSAs) and conventional insurance in a simple discrete loss setting with asymmetric information. I show that FSA availability can break a separating equilibrium, even when one would otherwise exist, because high-risk types might prefer the lower-coverage contract supplemented with FSA funds. In this case there may exist a Pareto-inferior separating equilibrium. It is also shown that FSA availability alters the optimal pooling contract. Employers can reduce coverage levels, raising expected utility for low-risk types, and can compensate high-risk types by offering supplemental FSA coverage. Thus, it is possible that FSAs strengthen pooling contracts.

Suggested Citation

Cardon, James H., Flexible Spending Accounts and Adverse Selection. Journal of Risk and Insurance, Vol. 77, Issue 1, pp. 145-153, March 2010, Available at SSRN: https://ssrn.com/abstract=1548168 or http://dx.doi.org/10.1111/j.1539-6975.2009.01341.x

James H. Cardon (Contact Author)

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

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