Working Paper: NBER ID: w9888
Authors: Bradley Herring; Mark Pauly
Abstract: Multi-period theoretical models of renewable insurance display front-loaded premium schedules that both cover lifetime total claims of low-risk and high-risk individuals and provide an incentive for those who remain low-risk to continue to purchase the policy. In practice, however, an age profile of premiums that decreases with age might result in relatively high premiums for younger individuals which they may consider unaffordable. In this paper, we use medical expenditure data to estimate an optimal competitive age-based premium schedule for a benchmark renewable health insurance policy. We find that the amount of prepayment by younger individuals that would be necessary to cover future claims is mitigated by three factors: high-risk individuals will either recover or die, low-risk expected expense increases with age, and the likelihood of developing a high-risk condition increases with age. Although medical cost growth over time increases the amount of prepayment necessary, the resulting optimal premium path generally increases with age. We also find that actual premium paths exhibited by purchasers of individual insurance with guaranteed renewability is close to the optimal schedule we estimate. Finally, we examine consumers' gain in expected utility associated with the guaranteed renewability feature.
Keywords: health insurance; guaranteed renewability; premium structure; risk management
JEL Codes: G22; I10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| premium structure (L11) | retention of low-risk individuals in the insurance pool (G52) |
| setting premiums equal to expected expense for low-risk individuals (G52) | loss of low-risk individuals who would switch to other insurers (G52) |
| expected expenses for low-risk individuals increase with age (G52) | premiums should increase over time (G52) |
| structure of premiums (G22) | market stability (D53) |
| guaranteed renewability feature (G52) | consumer utility from avoiding uncertainty associated with future risk-rated premiums (G52) |