Adverse Selection in Health Insurance

46 Pages Posted: 7 May 2000 Last revised: 6 Oct 2010

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)

Richard J. Zeckhauser

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

Date Written: July 1997

Abstract

Individual choice over health insurance policies may result in risk-based sorting across plans. Such adverse selection induces three types of losses: efficiency losses from individuals being allocated to the wrong plans; risk sharing losses since premium variability is increased; and losses from insurers distorting their policies to improve their mix of insureds. We discuss the potential for these losses, and present empirical evidence on adverse selection in two groups of employees: Harvard University, and the Group Insurance Commission of Massachusetts (serving state and local employees). In both groups, adverse selection is a significant concern. At Harvard, the University's decision to contribute an equal amount to all insurance plans led to the disappearance of the most generous policy within 3 years. At the GIC, adverse selection has been contained by subsidizing premiums on a proportional basis and managing the most generous policy very tightly. A combination of prospective or retrospective risk adjustment, coupled with reinsurance for high cost cases, seems promising as a way to provide appropriate incentives for enrollees and to reduce losses from adverse selection.

Suggested Citation

Cutler, David M. and Zeckhauser, Richard J., Adverse Selection in Health Insurance (July 1997). NBER Working Paper No. w6107. Available at SSRN: https://ssrn.com/abstract=55148

David M. Cutler (Contact Author)

Harvard University - Department of Economics ( email )

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

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Richard J. Zeckhauser

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

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National Bureau of Economic Research (NBER) ( email )

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