Welfare costs of reclassification risk in the health insurance market

Pashchenko, Svetlana and Porapakkarm, Ponpoje (2011): Welfare costs of reclassification risk in the health insurance market. Unpublished.

Abstract

One of the major problems of the U.S. health insurance market is that it leaves individuals exposed to reclassification risk. Reclassification risk arises because the health conditions of individuals evolve over time, while a typical health insurance contract only lasts for one year. A change in the health status can lead to a significant change in the health insurance premium. We study how costly this reclassification risk is for the welfare of consumers. More specifically, we use a general equilibrium model to quantify the implications of introducing guaranteed renewable contracts into the economy calibrated to replicate the key features of the health insurance system in the U.S. Guaranteed renewable contracts are private insurance contracts that can provide protection against reclassification risk even in the absence of consumer commitment or government intervention. We find that though guaranteed renewable contracts provide a good insurance against reclassification risk, the welfare effects from introducing this type of contracts are small. In other words, the presence of reclassification risk does not impose large welfare losses on consumers. This happens because some institutional features in the current U.S. system substitute for the missing explicit contracts that insure reclassification risk. In particular, a good protection against reclassification risk is provided through employer-sponsored health insurance and government means-tested transfers.

• Item Type: MPRA Paper
• Language: English
• Keywords: health insurance, reclassification risk, dynamic insurance, guaranteed renewable contracts, general equilibrium
• Subjects: I - Health, Education, and Welfare > I1 - Health > I11 - Analysis of Health Care Markets; G - Financial Economics > G2 - Financial Institutions and Services > G22 - Insurance; Insurance Companies; D - Microeconomics > D9 - Intertemporal Choice and Growth > D91 - Intertemporal Consumer Choice; Life Cycle Models and Saving; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D52 - Incomplete Markets; D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D58 - Computable and Other Applied General Equilibrium Models; D - Microeconomics > D6 - Welfare Economics > D60 - General

References

Cochrane, J., 1995. Time-consistent Health Insurance. The Journal of Political Economy, 103(3), 445-473

Daily, G., Hendel, I., Lizzeri, A., 2008. Does the Secondary Life Insurance Market Threaten Dynamic Insurance? American Economic Review, 98(2), 151-156

De Nardi, M., French, E., Jones, J., 2010. Why Do the Elderly Save? Journal of Political Economy, 118(1), 39-75

De Santis, M., 2007. Individual Consumption Risk and the Welfare Cost of Business Cycles. American Economic Review, 97(4), 1488–1506

Diamond, P., 1992. Organizing the Health Insurance Market. Econometrica, 60(6), 1233-5124

Fang, H., Kung, E., 2010. How Does Life Settlement Market Affects the Primary Life Insurance Marekt?. Manuscript, University of Pennsylvania

Finkelstein, A., McGarry, K., Sufi, A., 2005. Dynamic Inefficiencies in Insurance Markets: Evidence from Long-term Care Insurance. American Economic Review Papers and Proceedings, 95(2), 224-228

Gouveia, M., Strauss, R, 1994. Effective Federal Individual Income Tax Functions: An Exploratory Empirical Analysis. National Tax Journal, 47, 317-339

Hendel, I., Lizzeri, A., 2003. The Role of Commitment in Dynamic Contracts: Evidence from Life Insurance. The Quarterly Journal of Economics, 118(1), 299-327

Herring, B., Pauly, M., 2006. Incentive-Compatible Guaranteed Renewable Health Insurance Premiums. Journal of Health Economics, 25, 395-417

Hsu, Minchung, 2010. Health Insurance, the Social Welfare System and Household Saving. Manuscript, National Graduate Institute for Policy Studies (GRIPS)

Jeske, K., Kitao, S., 2009. U.S. Tax Policy and Health Insurance Demand: Can a Regressive Policy Improve Welfare? Journal of Monetary Economics, 56(2), 210-221

Kaiser Family Foundation, 2008. Tax Subsidies for Health Insurance: An Issue Brief, available at http://www.kff.org/insurance/7779.cfm

Kennickell, A., 2003. A Rolling Tide: Changes In the Distribution of Wealth in the U.S., 1989-2001. Working paper, Federal Reserve Board

Kahn, J., Kronick, R., Kreger, M., Gans, D. 2005. The Cost of Health Insurance Administration in California: Estimates for Insurers, Physicians, and Hospitals, Health Affairs 24

Kiffman, M., 2002. Insuring Premium Risk in Competitive Health Insurance Market. Ed. Mohr Siebek

Pashchenko, S., Porapakkarm, P., 2010. Quantitative Analysis of Health Insurance Reform: Separating Community Rating from Income Redistribution. Manuscript, University of Virginia

Pauly, M., Kunreuther, H., Hirth, R., 1995. Guaranteed Renewability in Insurance. Journal of Risk and Uncertainty, 10, 143-156

Sommers, J., 2002. Estimation of Expenditures and Enrollments for Employer-Sponsored Health Insurance. Agency for Healthcare Research and Quality, MEPS Methodology Report 14

Young, E., 2010. Solving the Incomplete Markets Model with Aggregate Uncertainty Using the Krusell-Smith Algorithm and Non-Stochastic Simulations. Journal of Economic Dynamics and Control, 34(1), 36-41