Working Paper: NBER ID: w19835
Authors: Florian Scheuer; Kent Smetters
Abstract: Public attention has focused on how the launch of the national health exchanges could impact the types of risks who initially enroll and thereby affect future premiums and enrollment. We introduce simple dynamics into a standard model of insurance under adverse selection to show that such "initial conditions" can indeed matter. When firms are price-takers, the market can converge to a Pareto-inferior "bad" equilibrium if there are at least three equilibria, which we suggest has empirical support. Strategic pricing eliminates Pareto dominated equilibria but requires common knowledge of preference and risk distributions. Changing the fine on non-participants from a fixed amount to a fraction of equilibrium prices increases the range of initial conditions consistent with reaching the "good" equilibrium while reducing the "badness" of the bad equilibrium -- all without increasing the fine value in the good equilibrium. Allowing insurers to quickly change prices can encourage them to experiment with strategic pricing if market fundamentals are not perfectly known, increasing the chance of reaching the good equilibrium independently from initial conditions.
Keywords: health exchanges; adverse selection; insurance markets; Affordable Care Act; equilibrium
JEL Codes: D4; D8; H3; I1
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| initial conditions (C62) | performance of health exchanges (I18) |
| three equilibria (D59) | performance of health exchanges (I18) |
| good equilibrium (D50) | performance of health exchanges (I18) |
| bad equilibrium (D59) | performance of health exchanges (I18) |
| fine structure (D49) | likelihood of reaching good equilibrium (C62) |
| changing fine from absolute to relative (F33) | likelihood of reaching good equilibrium (C62) |
| allowing insurers to adjust prices quickly (G52) | chances of reaching good equilibrium (C62) |