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The role of government in health insurance markets with adverse selection

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  • Roger Feldman
  • Carlos Escribano
  • Laura Pellisé

Abstract

This paper analyzes the welfare economics of three arrangements for purchasing health insurance: competitive markets in which consumers are free to choose among options with different levels of coverage and prices; systems with compulsory partial pooling which permit private firms to sell supplementary coverage; and government‐run pools that purchase comprehensive coverage at a single price for all consumers. Competitive insurance markets are assumed to face the problem of ‘adverse selection’. This refers to a situation in which the insurer cannot observe characteristics of individuals that affect the cost of insurance and that are known to the individuals. Competitive markets with adverse selection are not efficient because low risks cannot purchase comprehensive insurance coverage. However, government‐run pools with comprehensive coverage are an inefficient solution to the problem of adverse selection. Compulsory partial coverage may represent an attractive alternative to both competitive markets and comprehensive pools. We discover two situations when government intervention of this type will succeed: when there are not many high risks in the population, and when the risk types are similar. We discuss the implications of these results for health insurance programs in several countries. Our results also have implications for the allocation of public funds for disease‐prevention projects. A project targeted at high risks will produce external benefits for low risks, even though they are not directly affected by the program. However, a successful project might eliminate the market for private insurance; in this case the government should consider mandating partial insurance coverage.Copyright © 1998 John Wiley & Sons, Ltd.

Suggested Citation

  • Roger Feldman & Carlos Escribano & Laura Pellisé, 1998. "The role of government in health insurance markets with adverse selection," Health Economics, John Wiley & Sons, Ltd., vol. 7(8), pages 659-670, December.
    • Handle: RePEc:wly:hlthec:v:7:y:1998:i:8:p:659-670
    DOI: 10.1002/(SICI)1099-1050(199812)7:8<659::AID-HEC384>3.0.CO;2-1
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    References listed on IDEAS

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    1. B. Dahlby, 1981. "Adverse selection and Pareto improvements through compulsory insurance," Public Choice, Springer, vol. 37(3), pages 547-558, January.
    2. van de Ven, Wynand P.M.M. & Schut, Frederik T., 1994. "Should catastrophic risks be included in a regulated competitive health insurance market?," Social Science & Medicine, Elsevier, vol. 39(10), pages 1459-1472, November.
    3. Mark V. Pauly, 1974. "Overinsurance and Public Provision of Insurance: The Roles of Moral Hazard and Adverse Selection," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 88(1), pages 44-62.
    4. Michael Rothschild & Joseph Stiglitz, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 90(4), pages 629-649.
    5. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
    6. Joseph P. Newhouse, 1996. "Reimbursing Health Plans and Health Providers: Efficiency in Production versus Selection," Journal of Economic Literature, American Economic Association, vol. 34(3), pages 1236-1263, September.
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    Cited by:

    1. Daniel McFadden & Carlos Noton & Pau Olivella, "undated". "Remedies for Sick Insurance," Working Papers 620, Barcelona School of Economics.
    2. Pau Olivella & Marcos Vera-Hernandez, 2006. "Testing for adverse selection into private medical insurance," IFS Working Papers W06/02, Institute for Fiscal Studies.
    3. Amy Finkelstein, 2002. "When Can Partial Public Insurance Produce Pareto Improvements?," NBER Working Papers 9035, National Bureau of Economic Research, Inc.
    4. Chernew, Michael E. & Frick, Kevin D., 1999. "The impact of managed care on the existence of equilibrium in health insurance markets," Journal of Health Economics, Elsevier, vol. 18(5), pages 571-590, October.

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