Equilibria in Health Exchanges: Adverse Selection vs. Reclassification Risk

84 Pages Posted: 6 Sep 2013 Last revised: 4 Jul 2022

See all articles by Benjamin Handel

Benjamin Handel

University of California, Berkeley

Igal Hendel

Northwestern University - Department of Economics; National Bureau of Economic Research (NBER)

Michael D. Whinston

Sloan School of Management and Department of Economics

Date Written: September 2013

Abstract

This paper studies regulated health insurance markets known as exchanges, motivated by their inclusion in the Affordable Care Act (ACA). We use detailed health plan choice and utilization data to model individual-level projected health risk and risk preferences. We combine the estimated joint distribution of risk and risk preferences with a model of competitive insurance markets to predict outcomes under different regulations that govern insurers' ability to use health status information in pricing. We investigate the welfare implications of these regulations with an emphasis on two potential sources of inefficiency: (i) adverse selection and (ii) premium reclassification risk. We find that market unravelling from adverse selection is substantial under the proposed pricing rules in the Affordable Care Act (ACA), implying limited coverage for individuals beyond the lowest coverage (Bronze) health plan permitted. Although adverse selection can be attenuated by allowing (partial) pricing of health status, our estimated risk preferences imply that this would create a welfare loss from reclassification risk that is substantially larger than the gains from increasing within-year coverage, provided that consumers can borrow when young to smooth consumption or that age-based pricing is allowed. We extend the analysis to investigate some related issues, including (i) age-based pricing regulation (ii) exchange participation if the individual mandate is unenforceable and (iii) insurer risk-adjustment transfers.

Suggested Citation

Handel, Benjamin and Hendel, Igal E. and Whinston, Michael D., Equilibria in Health Exchanges: Adverse Selection vs. Reclassification Risk (September 2013). NBER Working Paper No. w19399, Available at SSRN: https://ssrn.com/abstract=2321451

Benjamin Handel (Contact Author)

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
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Igal E. Hendel

Northwestern University - Department of Economics ( email )

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Evanston, IL 60208
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Michael D. Whinston

Sloan School of Management and Department of Economics ( email )

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E62-416
Cambridge, MA 02142
United States

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