Horizon Effects and Adverse Selection in Health Insurance Markets

35 Pages Posted: 15 Feb 2017 Last revised: 16 Dec 2017

See all articles by Olivier Darmouni

Olivier Darmouni

Columbia University - Columbia Business School

Dan Zeltzer

Tel Aviv University - Eitan Berglas School of Economics

Date Written: December 16, 2017

Abstract

We study how increasing contract length affects adverse selection in health insurance markets. Although health risks are persistent, private health insurance contracts in the United States have short, one-year terms. Short-term, community-rated contracts allow patients to increase their coverage only after risks materialize, which leads to market unraveling. Longer contracts ameliorate adverse selection because both demand and supply exhibit horizon effects. Intuitively, longer horizon risk is less predictable, thus elevating demand for coverage and lowering equilibrium premiums. We estimate risk dynamics using data from 3.5 million U.S. health insurance claims and find that risk predictability falls significantly with horizon. Counterfactuals using these estimates suggest that a reform implementing two-year contracts would increase equilibrium coverage by 12-19 percentage points and yield average annual welfare gains of $600-$900 per person. A third of these effects are driven by insurers' response and the rest by changes in consumer expectations.

Keywords: health insurance, adverse selection, contract length

JEL Classification: I13

Suggested Citation

Darmouni, Olivier and Zeltzer, Dan, Horizon Effects and Adverse Selection in Health Insurance Markets (December 16, 2017). Columbia Business School Research Paper No. 17-27, Available at SSRN: https://ssrn.com/abstract=2916823 or http://dx.doi.org/10.2139/ssrn.2916823

Olivier Darmouni

Columbia University - Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

Dan Zeltzer (Contact Author)

Tel Aviv University - Eitan Berglas School of Economics ( email )

P.O. Box 39040
Ramat Aviv, Tel Aviv, 69978
Israel
+972(3)640-5824 (Phone)

HOME PAGE: http://www.tau.ac.il/~dzeltzer

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