Analyzing the Effects of Insuring Health Risks: On the Trade-off between Short Run Insurance Benefits vs. Long Run Incentive Costs

Harold L. Cole, Soojin Kim, Dirk Krueger

NBER Working Paper No. 18572
Issued in November 2012
NBER Program(s):Economic Fluctuations and Growth, Health Economics, Public Economics

This paper constructs a dynamic model of health insurance to evaluate the short- and long run effects of policies that prevent firms from conditioning wages on health conditions of their workers, and that prevent health insurance companies from charging individuals with adverse health conditions higher insurance premia. Our study is motivated by recent US legislation that has tightened regulations on wage discrimination against workers with poorer health status (Americans with Disability Act of 2009, ADA, and ADA Amendments Act of 2008, ADAAA) and that will prohibit health insurance companies from charging different premiums for workers of different health status starting in 2014 (Patient Protection and Affordable Care Act, PPACA). In the model, a trade-off arises between the static gains from better insurance against poor health induced by these policies and their adverse dynamic incentive effects on household efforts to lead a healthy life. Using household panel data from the PSID we estimate and calibrate the model and then use it to evaluate the static and dynamic consequences of no-wage discrimination and no-prior conditions laws for the evolution of the cross-sectional health and consumption distribution of a cohort of households, as well as ex-ante lifetime utility of a typical member of this cohort. In our quantitative analysis we find that although a combination of both policies is effective in providing full consumption insurance period by period, it is suboptimal to introduce both policies jointly since such policy innovation induces a more rapid deterioration of the cohort health distribution over time. This is due to the fact that combination of both laws severely undermines the incentives to lead healthier lives. The resulting negative effects on health outcomes in society more than offset the static gains from better consumption insurance so that expected discounted lifetime utility is lower under both policies, relative to only implementing wage nondiscrimination legislation.

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Document Object Identifier (DOI): 10.3386/w18572

Published: Cole, Harold, Soojin Kim, and Dirk Krueger, 2019. "Analysing the Effects of Insuring Health Risks: On the Trade-off between Short-Run Insurance Benefits versus Long-Run Incentive Costs." Review of Economic Studies, 86(3): 1123-1169.

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