Most market approaches to containing high health care costs involve some use of competitive choice among insurance plans to bring about greater efficiency. There has, however, been fairly widespread concern that such arrangements might lead to undesirable results if adverse selection should occur. (Adverse selection refers to a situation in which the insured has better information about his risk level than does the insurer.) If adverse selection occurs, either the whole notion of a desirable market equilibrium is put in doubt or else fairly severe restrictions must be placed on the options the market can offer in order to prevent adverse selection. The propose research will provide empirical evidence on the existence and importance of adverse selection. Specifically, the primary objective of the research is to determine if adverse selection exists in employer-provided multiple option group health insurance, and if it does to determine its magnitude. In order to obtain accurate measures of adverse selection, it is necessary to control for moral hazard--the variation in use or expenditures that would be associated with different levels of insurance coverage even under uniform risk. To measure moral hazard, we will take account of the likelihood that employers or unions select the coverage they offer with a view to employees' preferences, and that employees select their jobs based in part on the insurance provided. The study will use a unique and superior data source--the enrollment and medical expenditure information for a large number of individuals and firms whose health insurance is managed by a single cooperative insurer. Two years of retrospective data will be used to specify and estimate spending (moral hazard) equations for single-option groups with the level of insurance coverage taken as endogenous because of group self-selection and adverse selection. In addition, two years of data generated from an experiment will be used to analyze plan selection and expenditure differences in multiple option plans, and ultimately to determine the degree to which expenditure differences between the high-coverage and low-coverage options are due to individual adverse selection.
