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Competition leverage: how the demand side affects optimal risk adjustment
Author(s) -
Bijlsma Michiel,
Boone Jan,
Zwart Gijsbert
Publication year - 2014
Publication title -
the rand journal of economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 3.687
H-Index - 108
eISSN - 1756-2171
pISSN - 0741-6261
DOI - 10.1111/1756-2171.12071
Subject(s) - leverage (statistics) , pooling , welfare , economic surplus , incentive , economics , risk pool , competition (biology) , subsidy , market risk , microeconomics , business , actuarial science , insurance policy , finance , key person insurance , ecology , artificial intelligence , machine learning , computer science , market economy , biology
We study optimal risk adjustment in imperfectly competitive health insurance markets when high‐risk consumers are less likely to switch insurer than low‐risk consumers. Insurers then have an incentive to select even if risk adjustment perfectly corrects for cost differences. To achieve first best, risk adjustment should overcompensate insurers for serving high‐risk agents. Second, we identify a trade‐off between efficiency and consumer welfare. Reducing the difference in risk adjustment subsidies increases consumer welfare by leveraging competition from the elastic low‐risk market to the less elastic high‐risk market. Third, mandatory pooling can increase consumer surplus further, at the cost of efficiency.