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Moral hazard and risk adjustment

Author

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  • Zwart, Gijsbert

Abstract

We analyse a model of optimal risk adjustment in competitive health-insurance markets which suffer from both ex-ante adverse selection and ex-post moral hazard. We find, firstly, that, unlike in an adverse-selection-only market, in an environment where also moral hazard is important, removing insurers’ selection incentives requires risk-adjustment payments that do not fully equalize costs among consumer types. Current practice of attempting to correct for all predictable cost differences among consumers is then misguided. Secondly, if the sponsor of the risk-adjustment system is not only concerned with eliminating selection distortions, but also wants to redistribute towards high-risk consumers, the required higher risk-adjustment payments will introduce selection distortions in high-risk consumers’ contracts. This leads to excessive equilibrium provision of care for those suffering severe health shocks. Finally, insurer market power creates countervailing incentives, helping the risk adjuster to combat selection distortions but working against a risk-adjustment regulation that also cares about redistribution.

Suggested Citation

  • Zwart, Gijsbert, 2025. "Moral hazard and risk adjustment," Journal of Health Economics, Elsevier, vol. 99(C).
  • Handle: RePEc:eee:jhecon:v:99:y:2025:i:c:s0167629624001000
    DOI: 10.1016/j.jhealeco.2024.102955
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    More about this item

    Keywords

    Health insurance; Moral hazard; Selection; Risk adjustment; Mechanism design; Countervailing incentives; Competition in contracts;
    All these keywords.

    JEL classification:

    • I13 - Health, Education, and Welfare - - Health - - - Health Insurance, Public and Private
    • D02 - Microeconomics - - General - - - Institutions: Design, Formation, Operations, and Impact
    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design

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