Ben Handel, Igal Hendel, and Michael Whinston, Equilibria in Health Exchanges: Adverse Selection vs. Reclassification Risk, July 2012.


This paper studies equilibrium and welfare in a class of regulated health insurance markets known as exchanges. We use detailed health plan choice and utilization data to model individual-level (i) projected health risk and (ii) risk preferences. We combine these micro-foundations with a model of competitive insurance markets that generates predictions for plan prices, costs, and market shares under different counterfactual pricing /contract regulations and several equilbrium solution concepts. We investigate the welfare implications of different pricing regulations, with a focus on (i) adverse selection and (ii) premium re-classification risk. We find that market unravelling from adverse selection is substatial under the proposed pricing rules in the Affordable Care Act (ACA), implying limited coverage for individuals beyond the lowest tier (Bronze) health plan. Though advese selection can be attenuated by allowing (partial) pricing of health status, the welfare loss from re-classification risk is substatially higher than the gains of increasing coverage. Finally, we compute the subsidies / tax penalties that are required to induce different levels of participation in the exchanges.

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