Asymmetric Information Health Insurance

Why do insurance companies reject applicants rather than just raise their premiums?

As of 2011, in 45 out of 51 States (including DC) insurers can choose not to provide applicants with insurance coverage.  Requiring insurers to offer coverage to all individuals is known in insurance lingo as “guaranteed issue.”

One question is why don’t insurance companies just charge high-risk individuals higher premiums?  Why would they want to lose this business?

A paper by Nathaniel Hendren aims to answer this question.

This paper finds evidence consistent with the hypothesis that private information leads insurance companies to choose to not sell insurance to a subset of the population. We provide a new “no trade” theorem which shows why insurance companies may choose to not offer insurance at any price acceptable to anyone in the market…Across all of our settings, we find evidence of more private information for the rejectees, and we find its magnitude large enough to plausibly explain an absence of trade. In short, our results suggest that if insurance companies were to offer any contract or set of contracts to those currently rejected, they would be too adversely selected to yield a positive profit…Our results suggest a new interpretation of the role of private information in insurance markets: its most salient impact may not be the adverse selection of existing contracts, but rather the existence of the market itself.”

The paper is interesting throughout.


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