Lock-in in Dynamic Health Insurance Contracts: Evidence from Chile

Abstract

Long-term health insurance contracts have the potential to efficiently insure against reclassification risk, but at the expense of other limitations like provider lock-in. This paper empirically investigates the workings of long-term contracts which are subject to this tradeoff. Individuals are shielded against premium increases and coverage denial as long as they stay with their initial contract, but those that become higher risk are subject to premium increases or coverage denials upon switching, potentially leaving them locked-in with their original network of providers. I provide the first empirical evidence on the importance of this phenomenon using administrative panel data from the universe of the private health insurance market in Chile, where competing insurers offer long term contracts. I fit a structural model to yearly plan choices, and am able to jointly estimate evolving preferences for different insurance companies and supply-side underwriting in the form of premium risk-rating and coverage denial. To quantify the welfare effects of lock-in, I compare simulated choices under the current rules to those in a counterfactual scenario with no underwriting. The results show that consumers would be willing to pay around 13 percent more in yearly premiums to avoid lock-in. Finally, I study a counterfactual scenario where long-term contracts are replaced with community-rated spot contracts, and I find only minor general-equilibrium effects on premiums and on the allocation of individuals across insurers. I argue that these small effects are the result of large levels of preference heterogeneity uncorrelated to risk.

The Welfare Effects of Long-Term Health Insurance Contracts

“…We also show that these optimal contracts can be equivalently o¤ered as guaranteed premium path contracts, and when o¤ered in this form are self-selective, in the sense that consumers with di¤erent lifetime income paths and risk preferences prefer the contracts designed for them. 3 We apply this model empirically using an individual-level panel data set on the medical claims of the employees (and their dependents) of a large …rm. The key data are diagnostic codes of each individual in the sample, which we combine with professional software designed to predict future medical expenditures to produce a measure of an individual's health status.…”

“…This occurs because the extent of front-loading at any point in time depends on both the current health state and the implications of that current state for future states (measured through our estimated health status transition matrix). Good health draws can a¤ord the front-loading better, while bad 3 Guaranteed premium path contracts contractually specify the path of future premiums at which the consumer can continue coverage if she has not previously lapsed. These are distinguished by their premium guarantees from what are called "guaranteed renewable" contracts.…”

Long-Term Health Insurance: Theory Meets Evidence

“…Besides Chile (cf. Atal, 2019), Germany is the only country in the world with an existing private long-term health insurance market. About 8.8 million enrollees in Germany are long-term insured on this market (Association of German Private Healthcare Insurers, 2019b).…”

“…10 Second, premiums are higher for enrollees who joined the GLTHI later in their life, as the expected yearly future expenditures increase with age. 11 Third, because of the initial risk rating, high-risk types (the "sick") pay higher premiums throughout their lives, relative to the low-risk types (the 8 Such front-loading creates a 'lock-in' effect, in addition to the lock-in induced by guaranteed renewability (Nell and Rosenbrock, 2008;Atal, 2019). To strengthen consumer power and reduce this lock-in, the German legislature made a standardized portion of these old-age provisions portable across carriers for contracts signed after Jan 1, 2009; see Atal et al (2019) for an evaluation of this reform.…”

“…Several papers, including Hendel and Lizzeri (2003), Herring and Pauly (2006), Finkelstein et al (2005), and Atal (2019), investigated empirically the workings of long-term contracts in different contexts. Our paper also contributes to this empirical literature by introducing in Section 5.1 a method of discrete classification of health risks.…”