Adverse selection is a typical problem in the field of health insurance. If you offer coverage to individuals, you may want to set your premiums based on the average price of the group of people you plan to cover. At that price, however, the sickest patients are the most likely to buy insurance, and health insurers may pay more than expected.this may result in adverse selection death spiral. An alternative would be to make health insurance mandatory for all individuals, but government mandates are often unpopular, and the level of coverage that is mandated must also be determined.
a paper by Fisher, Frohlich & Landman (2023) To quantify the extent of adverse selection in individual hospital insurance schemes in Pakistan. Pakistan has a population of approximately 250 million and an annual per capita GDP of US$5,200 (CIA World Factbook). To measure the amount of adverse selection, the authors collaborated with the National Rural Support Program of Pakistan (National Research Program) provides different types of insurance to individuals in 83 different villages. Each village is eligible for personal insurance (P1) with an out-of-pocket cap of 15,000 PKR or more generous personal insurance (P2) with an out-of-pocket cap of 30,000 PDR. Other villages are assigned family insurance (P3), where all individuals in the household are required to be covered, and a ‘group policy’, where >50% of credit groups or community organizations (COs) are required to be covered. The following table summarizes these options.
Using this approach, the authors found that:
…a vast choice of individual policies, leading to welfare losses and the threat of market collapse.Bundling of insurance policies at the household or higher level virtually eliminates adverse selection, thereby mitigating its welfare consequences and promoting sustainable insurance supply
This result can be clearly seen in the figure below. It is worth noting that the average family size in the experiment was 5.99 persons. Thus, it is unclear whether adverse selection would be mitigated to the same extent in high-income countries with smaller family sizes.
full article available here.
