Paying for Health Insurance: The Tradeoff between Competition and Adverse Selection

40 Pages Posted: 8 May 2000 Last revised: 15 May 2000

See all articles by David M. Cutler

David M. Cutler

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)

Sarah Reber

University of California, Los Angeles (UCLA) - Department of Policy Studies

Date Written: October 1996

Abstract

This paper uses data on health insurance choices by employees of Harvard University to examine the effect of alternative pricing rules on market equilibrium. In the mid-1990s, Harvard moved from a system of subsidizing more expensive insurance to a system of contributing an equal amount to each plan. We estimate a substantial demand response to the policy change, with a short-run elasticity of about -2. The reform also induced substantial" adverse selection. Because of this selection, the long-run demand response is three times the short-run response. Price variation induced by adverse selection is inefficient; we estimate the magnitude of the welfare loss from adverse selection at 2 percent of baseline health spending. Finally, as insurance choice was made more competitive, premiums to Harvard fell relative to premiums in the Boston area by nearly 10 percent. This savings was large enough to compensate for the inefficiency induced by adverse selection, so that reform overall was welfare enhancing.

Suggested Citation

Cutler, David M. and Reber, Sarah Johanna, Paying for Health Insurance: The Tradeoff between Competition and Adverse Selection (October 1996). NBER Working Paper No. w5796. Available at SSRN: https://ssrn.com/abstract=5126

David M. Cutler (Contact Author)

Harvard University - Department of Economics ( email )

Littauer Center, Room 315A
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National Bureau of Economic Research (NBER) ( email )

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Harvard University - Harvard Kennedy School (HKS) ( email )

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Sarah Johanna Reber

University of California, Los Angeles (UCLA) - Department of Policy Studies ( email )

Los Angeles, CA
United States

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