Low-Quality Health Plans and Adverse Selection: A Sufficient Statistics Approach

Adverse selection is a persistent problem in health insurance markets. In many markets, selection can occur on both the intensive margin (more vs. less generous coverage) or the extensive margin (insurance vs. uninsurance). However, modern sufficient statistics approaches to welfare analysis of adverse selection are typically only designed to capture one margin or the other. This has led to important tradeoffs between selection on the intensive and extensive margins being overlooked.

In this paper, we develop a new approach to welfare analysis when consumers make both intensive and extensive margin insurance choices. We show that the welfare consequences of adverse selection and of policies intended to combat selection problems can be evaluated using a simple set of sufficient statistics that can be easily recovered given exogenous variation in plan prices. We describe our general model using a series of figures that provide intuition for the tradeoff between intensive and extensive margin selection. We then present an application of our method to the Massachusetts health insurance exchange, the Connector.

Through this exercise we uncover two important interactions between the two margins of selection: (1) the presence of a low quality plan brings more consumers into the market but also causes consumers previously enrolled in high quality coverage to switch to lower quality coverage and (2) the implementation of risk adjustment transfers across plans within the market causes some consumers to enroll in higher quality overage but also causes some consumers to drop out of the market altogether. Finally, we use our sufficient statistics framework to evaluate the welfare consequences of a variety of common selection-related policies and derive optimal subsidies for the Massachusetts market.