Moral hazard and risk adjustment

Gijsbert Zwart

Journal of Health Economics, 2025, vol. 99, issue C

Abstract: We analyse a model of optimal risk adjustment in competitive health-insurance markets which suffer from both ex-ante adverse selection and ex-post moral hazard. We find, firstly, that, unlike in an adverse-selection-only market, in an environment where also moral hazard is important, removing insurers’ selection incentives requires risk-adjustment payments that do not fully equalize costs among consumer types. Current practice of attempting to correct for all predictable cost differences among consumers is then misguided. Secondly, if the sponsor of the risk-adjustment system is not only concerned with eliminating selection distortions, but also wants to redistribute towards high-risk consumers, the required higher risk-adjustment payments will introduce selection distortions in high-risk consumers’ contracts. This leads to excessive equilibrium provision of care for those suffering severe health shocks. Finally, insurer market power creates countervailing incentives, helping the risk adjuster to combat selection distortions but working against a risk-adjustment regulation that also cares about redistribution.

Keywords: Health insurance; Moral hazard; Selection; Risk adjustment; Mechanism design; Countervailing incentives; Competition in contracts (search for similar items in EconPapers)
JEL-codes: D02 D47 I13 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jhecon:v:99:y:2025:i:c:s0167629624001000

DOI: 10.1016/j.jhealeco.2024.102955

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