DP10943 Community rating in health insurance: trade-off between coverage and selection

Author(s): Michiel Bijlsma, Jan Boone, Gijsbert Zwart
Publication Date: November 2015
Keyword(s): cherry picking, health insurance, mechanism design, risk adjustment
JEL(s): D02, D47, I13
Programme Areas: Public Economics, Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=10943

We analyze the role of community rating in the optimal design of a risk adjustment scheme in competitive health insurance markets when insurers have better information on their customers' risk profiles than the sponsor of health insurance. The sponsor offers insurers a menu of risk adjustment schemes to elicit this information. The optimal scheme includes a voluntary reinsurance option. Additionally, the scheme should sometimes be complemented by a community rating requirement. The resulting inefficient coverage of low-cost types lowers the sponsor's cost of separating different insurer types. This allows the sponsor to redistribute more rents from low-cost to high-cost consumers.