Information frictions and adverse selection: policy interventions in health insurance markets

Despite evidence that many consumers in health insurance markets are subject to information frictions, approaches used to evaluate these markets typically assume informed, active consumers. This gap between actual behavior and modeling assumptions has important consequences for positive and normative analysis. We develop a general framework to study insurance market equilibrium in the presence of choice frictions and evaluate key policy interventions, designed to combat adverse selection or to combat poor choices. We identify sufficient relationships between the underlying distributions of consumer (i) costs, (ii) surplus from risk protection and (iii) choice frictions that determine whether friction-reducing policies will be on net welfare increasing, due to improved consumer matching, or welfare reducing, due to increased adverse selection. We show that the impact of insurer risk-adjustment transfers, a supply-side policy designed to combat adverse selection, depends crucially on how effective consumer choices are, and is generally complementary to choice-improving policies. We implement our approach empirically, show how these key sufficient objects can be measured in practice, and illustrate the theoretically-motivated link between these objects and key policy outcomes.