Publication Date: January 2020
Reclassiﬁcation risk is a major concern in health insurance where contracts are typically one year in length but health shocks often persist for much longer. We use rich individual-level medical information from the Utah all-payer claims database to empirically study one possible solution: long-term insurance contracts. We characterize optimal long-term contracts with one-sided commitment theoretically, derive the contracts that are optimal for consumers in Utah, and assess the welfare level that a full implementation of these contracts could achieve relative to several key benchmarks. We ﬁnd that dynamic contracts perform very well for the majority of the population, for example, eliminating over 94% of the welfare loss from reclassiﬁcation risk for individuals who arrive on the market at age 25 in good health. However, dynamic contracts instead provide very little beneﬁt to the worst pre-age-25 health risks. Their value is also substantially lower for consumers whose income growth with age is relatively high. With pre-age-25 insurance in place, consumers with flat net income prefer dynamic contracts to an ACA-like environment, but consumers with steeper income proﬁles prefer the ACA-like environment. Overall, we show that there are scenarios in which dynamic contracts can provide substantial welfare beneﬁts, but that complementary policies are crucial for unlocking these beneﬁts.
JEL Classification Codes: L5, I1, D0