Optimal Long-Term Health Insurance Contracts: Characterization, Computation, and Welfare Effects

Cowles Foundation Discussion Paper No. 2218R2

82 Pages Posted: 28 May 2021

See all articles by Soheil Ghili

Soheil Ghili

Yale University

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: May 27, 2021

Abstract

Reclassification risk is a major concern in health insurance where contracts are typically one year in length but health shocks often persist for much longer. While most health systems with private insurers emphasize short-run contracts paired with substantial pricing regulations to reduce reclassification risk, long-term contracts with one-sided insurer commitment have significant potential to reduce reclassification risk without the negative side effects of price regulation, such as adverse selection. In this paper, we theoretically characterize optimal long-term insurance contracts with one-sided commitment, extending prior models of this form in several key directions that are important for studying health insurance markets. We leverage this characterization to provide a simple algorithm for computing optimal contracts from primitives. We estimate key market fundamentals using data on all under-65 privately insured consumers in Utah and pair these estimates with our model to study comparative statics related to contract design and welfare. We find that the welfare value of a system that effectively implements these long-term contracts depends crucially on (i) the degree of public insurance pre-system health risk (ii) the distribution of expected lifetime income gradients in the population (iii) the stochastic process governing life-cycle health shocks (iv) the extent of consumer switching costs and (v) the degree of consumer myopia.

JEL Classification: L5, I1, D0

Suggested Citation

Ghili, Soheil and Handel, Benjamin and Hendel, Igal E. and Whinston, Michael D., Optimal Long-Term Health Insurance Contracts: Characterization, Computation, and Welfare Effects (May 27, 2021). Cowles Foundation Discussion Paper No. 2218R2, Available at SSRN: https://ssrn.com/abstract=3855055 or http://dx.doi.org/10.2139/ssrn.3855055

Soheil Ghili (Contact Author)

Yale University ( email )

165 Whitney Avenue
New Haven, CT 06511
United States

Benjamin Handel

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

Igal E. Hendel

Northwestern University - Department of Economics ( email )

2003 Sheridan Road
Evanston, IL 60208
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Michael D. Whinston

Sloan School of Management and Department of Economics ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

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