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...fashion) be paid for this insurance--and even the availability of insurance at any premium--vary with the insured unit's risk level. There is tension here: to cover their costs and to avoid adverse selection, insurers need to collect premiums tailored to each buyer's expected expense. But policymakers tend to regard payment of higher premiums by higher risks as unfair, and individual consumers realize that their risk level may change over time, as chronic (though not necessarily permanent) illnesses strike.
Along with several colleagues, have been investigating both theoretical models of efficient insurance markets when risk varies (both across individuals at a given point in time and for a given individual over time) and empirical evidence on how premiums and the securing of coverage vary with risk. The theoretical point of departure is that, from a lifetime perspective, the great bulk of people who are initially low risk will want protection against large current costs and protection against "premium risk," the risk that premiums will jump at the onset of chronic illness. Howard Kunreuther, Richard Hirth, and I (1) have shown, as has John Cochrane, (2) that there is a theoretical solution to this problem: markets can furnish incentive-compatible insurance with % longer time perspective," in Kenneth Arrow's words using the policy provision labeled "guaranteed renewability at class average premiums." We also have been interested in pursuing another of Arrow's insights: that institutional arrangements other than explicit and direct market transactions may emerge to deal with this problem as with others in health care and health insurance; the main candidate for this role is employment-based group health insurance. We therefore have been investigating the extent to which premiums paid vary with risk in competitive, largely unregulated insurance markets, and the underlying arrangements that support risk pooling. This investigation has largely been one of first discovering some empirical evidence and then working backwards to understand the supporting arrangement and the theory that explains their existence.
Individual Insurance Markets
Our primary empirical finding is that, in...
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