Front-loaded contracts in health insurance market: How valuable is guaranteed renewability?

Ponpoje Porapakkarm and Svetlana Pashchenko
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Svetlana Pashchenko: University of Virginia

No 1268, 2011 Meeting Papers from Society for Economic Dynamics

Abstract: This paper studies how important reclassification risks in the health insurance market are for the welfare of consumers. Reclassification risks arise because health conditions of individuals evolve over time. Any change in health status will lead to a change in the price of health insurance when only short-term risk-adjusted insurance contracts are available. We study guaranteed renewable contracts that provide protection against reclassification risks because they allow individuals to renew health insurance in the future at a pre-specified premium. We use a general equilibrium overlapping generation model to quantify the implications of introducing this type of contracts into the economy calibrated to replicate key features of the health insurance sector in the U.S. We find that once guaranteed renewable contracts become available most of the people buying individual insurance switch to these new contracts. In addition, the number of uninsured drops substantially. However, the welfare effects from introducing guaranteed renewable contracts are small. We explore several factors potentially accounting for the small welfare effects, namely i) front-loaded premium, ii) labor income risk, iii) actuarially unfair premium, and iv) minimum consumption floor. Our quantitative results show that the minimum consumption floor can significantly affect the value of guaranteed renewable insurance since it provides a safety net in states when one's health deteriorates and health insurance becomes unaffordable.

Date: 2011
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