Demand Heterogeneity in Insurance Markets: Implications for Equity and Efficiency
54 Pages Posted: 15 Jul 2016 Last revised: 11 Jan 2017
Date Written: October 2016
In many markets insurers are barred from price discrimination based on consumer characteristics like age, gender, and medical history. In this paper, I build on a recent literature to show why such policies are inefficient if consumers differ in their willingness-to-pay for insurance conditional on the insured losses they generate. Using administrative claims data, I then show that this type of demand heterogeneity is empirically relevant in a consumer health plan setting. Younger and older consumers and men and women reveal strikingly different demand for health insurance, conditional on their objective medical spending risk. This implies that these groups must face different prices in order to sort themselves efficiently across insurance contracts. The theoretical and empirical analysis highlights a fundamental tradeoff between equity and efficiency that is unique to selection markets.
Keywords: insurance, asymmetric information, selection, heterogeneity, community rating
JEL Classification: I11, I13
Suggested Citation: Suggested Citation