Collaborative Research: Equilibria in Health Exchanges: Adverse Selection, Reclassification Risk, and Dynamic Contracting

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Health insurance markets are subject to a variety of regulations driven by efficiency and equity provision. The Patient Protection and Affordable Care Act (PPACA) proposes the use of exchanges; markets where insurers offer yearly policies subject to several pricing rules. Despite the substantial public discussion of health exchanges, there has been little formal analysis of the likely outcomes and welfare impact of alternative designs. The goal of this project is model of insurer competition in a regulated marketplace in order to investigate both theoretically and empirically the functioning of exchanges.The PIs develop a model of an insurance exchange building on the models of Rothschild and Stiglitz (1976), Wilson (1977), Miyazaki (1977) and Riley (1985). They propose to investigate the properties of equilibria in exchanges and present an algorithm to find equilibria using a population and their estimated distributions of health risk and preferences. The PIs use detailed information on individual-level health plan choices and health claims from a large firm to simulate an exchange. Preferences are recovered from a structural choice model, while the distribution of health risk is quantified with a professional risk assessment software program.Preliminary results reveal lot of unraveling due to asymmetric information/adverse selection. One way to potentially reduce this unraveling is by allowing pricing based on pre-existing conditions, which the PPACA bans. However, in the longer run, pricing pre-existing conditions can subject consumers to re-classification risk. The PIs will examine the effects of this rule. Preliminary results suggest the losses from reclassification risk may far outweigh the adverse selection losses. In addition, absent subsidies, around 20% of the population would opt out of the exchange in the absence of a mandate compelling participation. The PIs also propose to examine the impact of a number of possible alternative designs of an exchange. One of these is the current suggestions for risk adjustment, which has recently been proposed by HHS.