Optimal Long-Term Health Insurance Contracts: Characterization, Computation, and Welfare Effects

Author:

Ghili Soheil1,Handel Ben2,Hendel Igal3,Whinston Michael D4

Affiliation:

1. Yale School of Management

2. Department of Economics, UC Berkeley

3. Department of Economics, Northwestern University

4. Department of Economics and Sloan School of Management, M.I.T.

Abstract

Abstract Reclassification risk is a major concern in health insurance where contracts are typically 1 year in length but health shocks often persist for much longer. While most health systems with private insurers pair short-run contracts with substantial pricing regulations to reduce reclassification risk, long-term contracts with one-sided insurer commitment have significant potential to reduce reclassification risk without the negative side effects of price regulation, such as adverse selection. We theoretically characterize optimal long-term insurance contracts with one-sided commitment, extending the literature in directions necessary for studying health insurance markets. We leverage this characterization to provide a simple algorithm for computing optimal contracts from primitives. We estimate key market fundamentals using data on all under-65 privately insured consumers in Utah. We find that dynamic contracts are very effective at reducing reclassification risk for consumers who arrive at the market in good health, but they are ineffective for consumers who come to the market in bad health, demonstrating that there is a role for the government insurance of pre-market health risks. Individuals with steeply rising income profiles find front-loading costly, and thus relatively prefer ACA-type exchanges. Switching costs enhance, while myopia moderately compromises, the performance of dynamic contracts.

Publisher

Oxford University Press (OUP)

Subject

Economics and Econometrics

Reference35 articles.

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2. Rare Disasters, Asset Prices, and Welfare Costs;Barro;Quarterly Journal of Economics,2006

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