COWLES FOUNDATION FOR RESEARCH IN
ECONOMICS Box 208281
COWLES FOUNDATION DISCUSSION PAPER NO. 1899 Adverse Selection and an Individual Mandate: When Theory Meets Practice Martin B. Hackmann, Jonathan T. Kolstad and Amanda E. Kowalski June 2013 We develop a model of selection that incorporates a key element of
recent health reforms: an individual mandate. We identify a set of key parameters for
welfare analysis, allowing us to model the welfare impact of the actual policy as well as
to estimate the socially optimal penalty level. Using data from Massachusetts, we estimate
the key parameters of the model. We compare health insurance coverage, premiums, and
insurer average health claim expenditures between Massachusetts and other states in the
periods before and after the passage of Massachusetts health reform. In the individual
market for health insurance, we find that premiums and average costs decreased
significantly in response to the individual mandate; consistent with an initially
adversely selected insurance market. We are also able to recover an estimated
willingness-to-pay for health insurance. Combining demand and cost estimates as sufficient
statistics for welfare analysis, we find an annual welfare gain of $335 dollars per person
or $71 million annually in Massachusetts as a result of the reduction in adverse
selection. We also find evidence for smaller post-reform markups in the individual market,
which increased welfare by another $107 dollars per person per year and about $23 million
per year overall. To put this in perspective, the total welfare gains were 8.4% of medical
expenditures paid by insurers. Our model and empirical estimates suggest an optimal
mandate penalty of $2,190. A penalty of this magnitude would increase health insurance to
near universal levels. Our estimated optimal penalty is higher than the individual mandate
penalty adopted in Massachusetts but close to the penalty implemented under the ACA. |
