Measuring Welfare Losses from Adverse Selection and Imperfect Competition in Privatized Medicare

This paper measures welfare losses caused by adverse selection and imperfect competition in privatized Medicare. I model insurers’ premium and coverage choices in an environment where consumers with heterogeneous preferences may impose di¤erent costs on their insurers. Using insurers’ behavior and exogenous variation in market structure, I identify a causal link between consumers’types and insurers’ costs and infer whether preferences, which determine insurance demand, contain information about expected health. The results suggest adverse selection is indeed present. Simulated equilibria without adverse selection suggest the resulting welfare losses are substantial, 8.1% of total spending, but are smaller than those caused by imperfect competition. Department of Economics, Boston University, 270 Bay State Road, Boston, MA 02215; [email protected]; http://people.bu.edu/jlustig/