Seminar

The Welfare Impact of Long-Term Health Insurance Contracts

Igal Hendel (Northwestern University)

November 14, 2016, 14:00–15:30

Room MF 323

Industrial Organization seminar

Abstract

Reclassification risk is a major concern in health insurance. Regulation, like the ACA, prescribes community rating to contend with reclassification risk. However, community rating comes at the cost of adverse selection. We use a rich data set with individual-level information on health risk to empirically study an alternative solution: dynamic contracts. We compare equilibria under four contractual arrangements: (i) spot contracts, (ii) long-run contracts with two-sided commitment, (iii) long-term contracts with one-sided commitment, and (iv) ACA-like markets with spot contracts and community rating. Empirically, dynamic contracts with one-sided commitment deliver a substantial welfare gain over spot contracts by attenuating reclassification risk. Dynamic contracts achieve close to the first-best for consumers with flat income profiles who are willing to front-load payments to facilitate long-run insurance. Consumers with steeper income growth over their lifetimes prefer community rating over dynamic contracts.