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

Soheil Ghili (), Ben Handel, Igal Hendel and Michael D. Whinston
Additional contact information
Soheil Ghili: Cowles Foundation, Yale University, https://som.yale.edu/faculty/soheil-ghili
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

No 2218R, Cowles Foundation Discussion Papers from Cowles Foundation for Research in Economics, Yale University

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.

JEL-codes: D0 I1 L5 (search for similar items in EconPapers)
Pages: 66 pages
Date: 2019-12, Revised 2020-07
New Economics Papers: this item is included in nep-ias and nep-rmg
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