Adverse Selection and Credit Constraints

Adverse selection predicts that lowering the price of health insurance should induce those with lower marginal costs (the “healthy”) to enroll. However, in settings where individuals lack access to credit and financial markets, credit constraints play an important role in the decision to purchase health insurance. As a result, reducing the price of insurance may, on net, attract those who want more healthcare but cannot afford it. As a result, insurance subsidies may increase adverse selection in the risk pool by attracting poorer individuals. On the other hand, encouraging enrollment of the healthy in other ways—such as improving convenience—may also be an important way to improve the average health in the risk pool, and improve the financial sustainability of insurance schemes.

In this paper, we analyze the trade-off between income, opportunity cost, and health characteristics in determining health insurance enrollment. We use detailed data from an experiment conducted in Nicaragua in 2008. Adults were randomly offered 6-month subsidies for government health insurance; they could enroll at the local insurance office. A cross-randomized subset of adults were revisited and allowed to enroll on the spot- a time subsidy. Overall, 19 percent of respondents enrolled. Enrollment is significantly increased by both the price subsidy and the time subsidy.

We show that a 1 standard deviation improvement in a health characteristics index decreases enrollment by 7.2 percentage points, consistent with adverse selection. However, we find that individuals randomly allocated to pay lower prices for insurance are also more likely to be of poor health. In other words, the subsidy increases adverse selection. In contrast, we see no correlation of income or opportunity costs with health insurance enrollment.

Next, we examine the role of credit constraints in determining enrollment. Individuals who are near the middle of the income distribution—potentially those who are most credit constrained—are disproportionately likely to enroll in health insurance. We contrast the health utilization behaviors of those in the middle with individuals near the top, who likely are already able to obtain the healthcare that they need, and individuals near the bottom, who are likely using low-quality, free care in the public sector. In contrast, we find that the entire distribution of the health index is shifted to the left for individuals who did not insure, suggesting substantial adverse selection. By making care more affordable, health insurance induced those who were previously going without care to enroll.

We conclude that in the presence of credit constraints, lowering prices may affect financial sustainability of health insurance programs. Because poor individuals are also more likely to be in worse health, lowering the price may exacerbate adverse selection. Our results also have implications for using other types of incentives to encourage enrollment. We find that making enrollment more convenient substantially increases enrollment without changing the risk pool characteristics. This study has important implications for health insurance programs, like the State Marketplace exchanges, that encourage enrollment of the poor through subsidies with websites that users may find difficult.