Estimating Welfare in Insurance Markets Using Variation in Prices

Abstract

We show how standard consumer and producer theory can be used to estimate welfare in insurance markets with selection. The key observation is that the same price variation needed to identify the demand curve also identifies how costs vary as market participants endogenously respond to price. With estimates of both the demand and cost curves, welfare analysis is straightforward. We illustrate our approach by applying it to the employee health insurance choices at Alcoa, Inc. We detect adverse selection in this setting but estimate that its quantitative welfare implications are small, and not obviously remediable by standard public policy tools.

Beyond Testing: Empirical Models of Insurance Markets

“…At the competitive price p c , there is a set of consumers who do not purchase coverage but for whom their value ṽ ( φ , ζ ) exceeds their cost of coverage c ( φ , ζ ). Einav et al (2010a) provide a graphical analysis of this case that highlights the close connection to standard supply and demand analysis. They observe that competitive equilibrium occurs at the intersection of the demand and average cost curve, whereas the efficient allocation occurs at the intersection of the demand and marginal cost curves, so that the inefficiency is captured by a familiar deadweight loss triangle.…”

“…A variant of this approach models contract valuations in product space rather than characteristic space. For instance, Einav et al (2010a) use data from a single large employer to estimate demand over health insurance options. Rather than modeling contract valuation as a function of plan and individual characteristics, they simply trace out the distribution of willingness to pay for incremental health coverage, and the average cost of covering consumers with each level of willingness to pay, using the observed price variation in their data.…”

“…Cutler & Reber (1998), Carlin & Town (2007), Bundorf et al (2008), and Einav et al (2010a) all follow this approach to analyze the efficiency of alternative allocations in employer-sponsored health insurance 16 Einav et al (2010a). focus on the difference between competitive and efficient allocations.…”

Building Bridges between Structural and Program Evaluation Approaches to Evaluating Policy

“…One strand of the reduced form approach uses explicit economic models to motivate and interpret empirical analyses and approximates the economic models using simple econometric techniques. Harberger (1964), Shimer and Werning (2008), Chetty (2009), and Einav et al (2009) are good examples of this approach. Chetty (2009) surveys a large literature in this tradition.…”

Optimal Mandates and the Welfare Cost of Asymmetric Information: Evidence From the U.K. Annuity Market

“… 1 More recently, several new working papers have presented additional attempts to quantify the efficiency cost of adverse selection in annuities (Hosseini (2008)) and in health insurance (Carlin and Town (2007), Bundorf, Levin, and Mahoney (2008), Einav, Finkelstein, and Cullen (2008), and Lustig (2008)). …”