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The Welfare Effects of Adverse Selection in Privatized Medicare

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  • Lustig, Joshua

Abstract

This paper estimates the welfare losses from market failures caused by adverse selection in privatized Medicare. I model insurers' premium and coverage choices in an environment where consumers have heterogeneous preferences and may impose different costs on their insurers. The model generates predictions about insurers' costs and behavior under varying degrees of adverse selection. I use the model and exogenous variation in market structure to identify a causal link between consumers' types and insurers costs. From the estimated parameters, I can infer whether consumers' preferences, which determine how much insurance they purchase, contain information about their expected health. The empirical results imply that adverse selection is indeed present in privatized Medicare. It is more costly to insure consumers with strong preferences for health insurance. With the estimated model, I simulate new equilibria after removing the distortionary effects of adverse selection from insurers' costs and incentives. The new equilibria exhibit more generous insurance coverage and lower premiums. These effects are particularly strong in markets with many insurers. The total surplus associated with privatized Medicare increases by 15.1%, suggesting that the welfare losses from adverse selection are substantial.

Suggested Citation

  • Lustig, Joshua, 2008. "The Welfare Effects of Adverse Selection in Privatized Medicare," Department of Economics, Working Paper Series qt7n09099j, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  • Handle: RePEc:cdl:econwp:qt7n09099j
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    References listed on IDEAS

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    Cited by:

    1. Dunn, Abe, 2010. "The value of coverage in the medicare advantage insurance market," Journal of Health Economics, Elsevier, vol. 29(6), pages 839-855, December.
    2. Kurt Lavetti & Kosali Simon, 2018. "Strategic Formulary Design in Medicare Part D Plans," American Economic Journal: Economic Policy, American Economic Association, vol. 10(3), pages 154-192, August.
    3. Steven T. Berry & Philip A. Haile, 2014. "Identification in Differentiated Products Markets Using Market Level Data," Econometrica, Econometric Society, vol. 82, pages 1749-1797, September.
    4. Liran Einav & Amy Finkelstein & Mark R. Cullen, 2010. "Estimating Welfare in Insurance Markets Using Variation in Prices," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 125(3), pages 877-921.
    5. Amanda Starc, 2014. "Insurer pricing and consumer welfare: evidence from Medigap," RAND Journal of Economics, RAND Corporation, vol. 45(1), pages 198-220, March.
    6. Raj Chetty & Amy Finkelstein, 2012. "Social Insurance: Connecting Theory to Data," NBER Working Papers 18433, National Bureau of Economic Research, Inc.
    7. Jacob Glazer & Thomas G. McGuire & Julie Shi, 2016. "Risk Adjustment of Health Plan Payments to Correct Inefficient Plan Choice from Adverse Selection," NBER Chapters, in: Measuring and Modeling Health Care Costs, pages 379-418, National Bureau of Economic Research, Inc.
    8. Decarolis, Francesco & Guglielmo, Andrea, 2017. "Insurers’ response to selection risk: Evidence from Medicare enrollment reforms," Journal of Health Economics, Elsevier, vol. 56(C), pages 383-396.

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