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Optimal Long-Term Health Insurance Contracts: Characterization, Computation, and Welfare Effects

Author

Listed:
  • Soheil Ghili

    (Cowles Foundation, Yale University)

  • Ben Handel

    (Department of Economics, UC Berkeley)

  • Igal Hendel

    (Department of Economics, Northwestern University)

  • Michael D. Whinston

    (Department of Economics and Sloan School of Management, M.I.T)

Abstract
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. We theoretically characterize optimal long-term insurance contracts with one-sided commitment, and use our characterization to provide a simple computation algorithm for computing optimal contracts from primitives. We apply this method to derive empirically-based optimal long-term health insurance contracts using all-payers claims data from Utah, and then evaluate the potential welfare performance of these contracts. We find that optimal long-term health insurance contracts that start at age 25 can eliminate over 94% of the welfare loss from reclassification risk for individuals who arrive on the market in good health, but are of little benefit to the worst age-25 health risks. As a result, their ex ante value depends significantly on whether pre-age-25 health risk is otherwise insured. Their value also depends on individuals' expected income growth.

Suggested Citation

  • Soheil Ghili & Ben Handel & Igal Hendel & Michael D. Whinston, 2019. "Optimal Long-Term Health Insurance Contracts: Characterization, Computation, and Welfare Effects," Cowles Foundation Discussion Papers 2218R, Cowles Foundation for Research in Economics, Yale University, revised Jul 2020.
    • Handle: RePEc:cwl:cwldpp:2218r
    as

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    File URL: https://cowles.yale.edu/sites/default/files/files/pub/d22/d2218-r.pdf
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    References listed on IDEAS

    as
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    Cited by:

    1. Martin Gaynor & Kate Ho & Robert J. Town, 2015. "The Industrial Organization of Health-Care Markets," Journal of Economic Literature, American Economic Association, vol. 53(2), pages 235-284, June.
    2. Kate Ho & Robin S. Lee, 2023. "Health insurance menu design for large employers," RAND Journal of Economics, RAND Corporation, vol. 54(4), pages 598-637, December.
    3. Nathaniel Hendren & Camille Landais & Johannes Spinnewijn, 2021. "Choice in Insurance Markets: A Pigouvian Approach to Social Insurance Design," Annual Review of Economics, Annual Reviews, vol. 13(1), pages 457-486, August.
    4. Olivier Darmouni & Dan Zeltzer, 2022. "Horizon effects and adverse selection in health insurance markets," Canadian Journal of Economics/Revue canadienne d'économique, John Wiley & Sons, vol. 55(2), pages 800-827, May.

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    More about this item

    JEL classification:

    • L5 - Industrial Organization - - Regulation and Industrial Policy
    • I1 - Health, Education, and Welfare - - Health
    • D0 - Microeconomics - - General

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