Optimal Long-Term Health Insurance Contracts: Characterization, Computation, and Welfare Effects
Cowles Foundation Discussion Paper No. 2218R2
82 Pages Posted: 28 May 2021
Date Written: May 27, 2021
Reclassiﬁcation risk is a major concern in health insurance where contracts are typically one year in length but health shocks often persist for much longer. While most health systems with private insurers emphasize short-run contracts paired 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. In this paper, we theoretically characterize optimal long-term insurance contracts with one-sided commitment, extending prior models of this form in several key directions that are important 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 and pair these estimates with our model to study comparative statics related to contract design and welfare. We ﬁnd that the welfare value of a system that eﬀectively implements these long-term contracts depends crucially on (i) the degree of public insurance pre-system health risk (ii) the distribution of expected lifetime income gradients in the population (iii) the stochastic process governing life-cycle health shocks (iv) the extent of consumer switching costs and (v) the degree of consumer myopia.
JEL Classification: L5, I1, D0
Suggested Citation: Suggested Citation