Can risk-rating of incremental premiums improve consumer sorting across coverage options in mandatory health insurance markets?

Abstract

Several mandatory health insurance schemes include some consumer choice of coverage (e.g., in terms of deductible levels). Premiums in these schemes are typically community-rated per insurance plan. While community-rated premiums help achieve objectives of fairness, they can also lead to adverse selection across coverage options. Consequently, consumers may sort inefficiently across these coverage options resulting in forgone welfare gains. This paper aims to explore under what conditions risk rating of incremental premiums for more comprehensive coverage (compared to a basic plan) can improve consumer sorting. In a simulation analysis on Chilean data, results show that under perfect risk adjustment, risk rating of incremental premiums can improve consumer sorting. With imperfect risk adjustment, however, the effects of risk rating on consumer sorting are ambigous as incremental premiums will not just reflect the direct effect of more comprehensive coverage on healthcare spending, but also the under/overcompensation from the (imperfect) risk adjustment system. Moreover, we find that in the presence of imperfect risk adjustment, risk rating improves welfare over community rating but does not fully solve the problem of inefficient sorting.