NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Adverse Selection and the Challenges to Stand-Alone Prescription Drug Insurance

Mark V. Pauly, Yuhui Zeng

NBER Working Paper No. 9919
Issued in August 2003
NBER Program(s):   HE   PE

This paper investigates a possible predictor of adverse selection problems in unsubsidized stand-alone' prescription drug insurance: the persistence of an individual's high spending over multiple years. Using MEDSTAT claims data and data from the Medicare Survey of Current Beneficiaries, we find that persistence is much higher for outpatient drug expenses than for other categories of medical expenses. We then use these estimates to develop a simple and intuitive model of adverse selection in competitive insurance markets and show that this high relative persistence makes it unlikely that unsubsidized drug insurance can be offered for sale, even with premiums partially risk adjusted, without a probable adverse selection death spiral. We show that this outcome can be avoided if drug coverage is bundled with other coverage, and briefly discuss the need either for comprehensive coverage or generous subsidies if adverse selection is to be avoided in private and Medicare insurance markets.

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Document Object Identifier (DOI): 10.3386/w9919

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