Illustrating Adverse Selection in Health Insurance Markets with a Classroom Game

This paper describes a classroom game that illustrates the effects of asymmetric information and adverse selection in health insurance markets. The first part of this game simulates a market in which buyers can purchase insurance from sellers; in some periods, government regulation of the insurance market prevents sellers from using information about buyer type to determine premiums. The results demonstrate the classic prediction that asymmetric information will result in adverse selection. Here, low risk buyers will forego the purchase of insurance at a measurable loss of potential earnings. In the second part of the game, sellers and buyers can trade two different types of health insurance policies, one moderate and another generous. The results from this part show that adverse selection can lead to an inefficient sorting of buyers across plans under government-mandated community rating and limits on premium increases. Under these circumstances, no buyers will purchase the generous insurance plan. The paper provides a series of questions to stimulate class discussion on the causes and consequences of adverse selection for consumers and insurers, and solutions that can be implemented in employer and government-sponsored programs.