Flexible Spending Accounts and Adverse Selection

James Cardon

Journal of Risk & Insurance, 2010, vol. 77, issue 1, 145-153

Abstract: I model the interaction of flexible spending accounts (FSAs) and conventional insurance in a simple discrete loss setting with asymmetric information. I show that FSA availability can break a separating equilibrium, even when one would otherwise exist, because high‐risk types might prefer the lower‐coverage contract supplemented with FSA funds. In this case there may exist a Pareto‐inferior separating equilibrium. It is also shown that FSA availability alters the optimal pooling contract. Employers can reduce coverage levels, raising expected utility for low‐risk types, and can compensate high‐risk types by offering supplemental FSA coverage. Thus, it is possible that FSAs strengthen pooling contracts.

Date: 2010
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https://doi.org/10.1111/j.1539-6975.2009.01341.x

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