Moral Hazard and Adverse Selection in Private Health Insurance

Moral hazard and adverse selection create inefficiencies in private health insurance markets. We use claims data from a large firm to study the independent roles of both moral hazard and adverse selection. Previous studies have attempted to estimate moral hazard in private health insurance by assuming that individuals respond only to the spot price, end-of-year price, average price, or a related metric. There is little economic justification for such assumptions and, in fact, economic intuition suggests that the nonlinear budget constraints generated by health insurance plans make these assumptions especially poor. We study the differential impact of the health insurance plans offered by the firm on the entire distribution of medical expenditures without parameterizing the plans by a specific metric. We use a new instrumental variable quantile estimation technique introduced in Powell [2013b] that provides the quantile treatment effects for each plan, while conditioning on a set of covariates for identification purposes. This technique allows us to map the resulting estimated medical expenditure distributions to the nonlinear budget sets generated by each plan. Our method also allows us to separate moral hazard from adverse selection and estimate their relative importance. We estimate that 77% of the additional medical spending observed in the most generous plan in our data relative to the least generous is due to adverse selection. The remainder can be attributed to moral hazard. A policy which resulted in each person enrolling in the least generous plan would cause the annual premium of that plan to rise by over $1,500.