DHA 721 Week 3 Market Failure and Health Insurance Example

Who Buys the Rich Plan? Adverse Selection, Moral Hazard and the Uninsured in a Rural North Carolina Region

[Student Name]

University of Phoenix

DHA/721: Health Care Economics

Week 3 Assignment

[Instructor Name]

[Date]

The network's employee plans, enrollment shifts, uninsured counts and hospital figures are composites written for a model paper; research findings come from the sources cited.

The network's human resources committee proposed a change to its employee health benefits. Instead of paying a larger share of the premium for the generous preferred provider plan, the network would contribute the same dollar amount to each of its three plans, and employees choosing the richer plan would pay the full difference. The proposal promised savings. The regional vice president, asked to review it for the rural hospitals' 2,100 employees, recognized a risk that economists have long studied. This paper examines that risk and a second insurance problem, the region's uninsured.

What Market Failure Means

A market fails when, left to itself, it does not produce an efficient result. In health insurance, failure arises because buyers and sellers know different things, because insurance changes behavior and because some people cannot afford coverage whose benefits reach others, such as the hospitals that treat them without payment.

Adverse Selection Explained

Adverse selection describes a sorting problem: the people most drawn to generous coverage are those who expect to use it. If a plan's premium reflects the average cost of its members, and healthier people leave for cheaper plans, the remaining members are sicker, premiums rise and more healthy members leave. In the extreme, the plan collapses.

Evidence From a University's Reform

Harvard University made nearly the same change the network is considering. In the mid-1990s it moved from subsidizing more expensive plans to contributing an equal amount to each plan. Cutler and Reber found a strong short-run response, an elasticity of about -2, and substantial adverse selection that made the long-run response three times larger; they estimated the welfare loss from selection at 2% of baseline health spending but found that more competitive pricing cut Harvard's premiums relative to the Boston area by nearly 10%, enough to make the reform beneficial overall (Cutler & Reber, 1998). The savings were real, but so was the spiral: healthy employees left the generous plan, and it grew costlier for those who stayed.

What the Evidence Means for the Network

The network's proposal would likely produce both effects. Younger, healthier employees would move to cheaper plans, and older employees and those with chronic conditions would stay in the generous plan at rising cost. Rural employees, older on average, would feel the burden most. The committee's projection assumed enrollment would stay fixed, but the evidence suggests it would not. The vice president modeled a shift of 20% of healthy members out of the generous plan in the first year, which would raise its average cost per member by about 11% and push its premium up again the following year, repeating the cycle.

Moral Hazard Explained

Moral hazard is a different problem. Once insured, people face a lower price for care and use more of it. Some added use is low in value, such as imaging that would not change treatment. Much of it, however, is care people needed but could not afford, such as treatment for diabetes, depression or cancer.

The Region's Uninsured

The second problem is the uninsured. Before North Carolina expanded Medicaid in December 2023, about one in seven working-age adults in the region's counties lacked coverage. The four hospitals provided about $9.8 million a year in uncompensated care, and uninsured patients often delayed care until emergencies. Uncompensated care is itself a market failure: the cost of treating people without coverage is spread to insured patients and taxpayers through higher prices and public subsidies, and the hospitals that carry the most of it are often the least able to absorb it.

What Coverage Does: The Oregon Lottery

The best evidence on coverage comes from Oregon, which used a lottery in 2008 to offer Medicaid to some uninsured low-income adults. In the first year, those selected were about 25 percentage points more likely to be insured, used more care, including primary and preventive care and hospital stays, had lower out-of-pocket spending and medical debt and reported better physical and mental health (Finkelstein et al., 2012).

Moral Hazard or Valuable Care?

The Oregon results show why moral hazard should not be read as waste. Insured adults used more care, but they also had less medical debt and felt healthier. For the region, higher use by newly covered adults is largely the care they had been going without.

What Coverage Does: Mortality

Coverage may also save lives. Miller and colleagues matched census survey responses to death records and followed low-income adults in their fifties and early sixties. Once expansion began, deaths fell faster where states had widened Medicaid than where they had not; each year, about 0.132 percentage points fewer of these adults died, roughly 9.4% below the average, and the gap widened with each additional year of coverage as deaths from disease declined (Miller et al., 2021).

Other Market Failures

Insurance is not the only failure. Patients lack information on the quality and price of care, rural hospitals often face little competition and vaccination and infectious disease care benefit people beyond the patient treated. Each calls for a different remedy: public reporting for information gaps, oversight of prices for market power and public funding for care that protects the whole community.

Remedies for Adverse Selection

Remedies include risk adjustment, which transfers money among plans based on the health of their members, contribution rules that limit how much prices differ, limited enrollment periods and plan designs that reduce differences in generosity. Each reduces selection but may also reduce the savings from competition.

Remedies for the Uninsured

Public coverage is the main remedy. Medicaid expansion in North Carolina opened coverage to adults earning up to about one and a third times the poverty line. The region's task is to help eligible residents enroll and to prepare for greater demand. In the first year after expansion, Medicaid enrollment among working-age adults in the region's counties rose by about 9,000, and uncompensated care at the four hospitals fell by roughly a third, though demand for primary care appointments rose faster than the clinics could absorb.

Recommendation for the Employee Plan

The vice president recommended adopting equal contributions with protections: phase the change over three years, add risk adjustment across the three plans, cap the employee share for workers below a salary threshold and monitor enrollment and premiums each year.

Recommendation for Medicaid Expansion

The region should fund enrollment assistance at every hospital and clinic, add primary care capacity for newly covered adults and track uncompensated care, emergency visits and chronic disease control.

Measures

Measures include plan enrollment by age and health status, premium trends, uncompensated care, Medicaid enrollment in the region and primary care visits by newly covered adults.

Conclusion

Insurance markets fail in predictable ways. Evidence from Harvard shows how equal contributions can set off adverse selection while still producing savings. Oregon's lottery and national mortality data show that coverage increases use of valuable care, reduces debt and saves lives. With phased reform and support for Medicaid enrollment, the region can capture benefits while limiting harm.

References

Cutler, D. M., & Reber, S. J. (1998). Paying for health insurance: The trade-off between competition and adverse selection. The Quarterly Journal of Economics, 113(2), 433-466. https://doi.org/10.1162/003355398555649

Finkelstein, A., Taubman, S., Wright, B., Bernstein, M., Gruber, J., Newhouse, J. P., Allen, H., Baicker, K., & Oregon Health Study Group. (2012). The Oregon Health Insurance Experiment: Evidence from the first year. The Quarterly Journal of Economics, 127(3), 1057-1106. https://doi.org/10.1093/qje/qjs020

Miller, S., Johnson, N., & Wherry, L. R. (2021). Medicaid and mortality: New evidence from linked survey and administrative data. The Quarterly Journal of Economics, 136(3), 1783-1829. https://doi.org/10.1093/qje/qjab004