Community Rating and Vertical Price Distortions in Insurance Menus

How does community rating distort relative prices for vertically differentiated plans in insurance markets? We show that common community-rating approaches can distort price differentials in the opposite direction to the distortions in overall price levels. Partial age-based community rating in the U.S. private health insurance exchanges causes older individuals to pay marginal prices for generous coverage significantly above marginal cost, while younger enrollees are subsidized on the margin. These distortions are large enough that older individuals often face and sometimes choose dominated options. We present simulations and theoretical discussions of community rating’s impacts on efficiency and distributional outcomes.