Unbiased Analysis of Today's Healthcare Issues

Adverse Selection and the purchase of in Medigap Insurance

Written By: Jason Shafrin - Sep• 08•06

Jason has insurance and his brother Nosaj does not.  Jason utilizes more medical services than Nosaj.  Is this situation occuring because Jason is truly sicker than Nosaj (adverse selection), or is this because since Jason has insurance, medical services are cheaper for him than Nosaj (moral hazard)?  Disentangling the problems of moral hazard and adverse selection is what Susan Ettner sets out to do in her 1997 JHE paper “Adverse selection and the purchase of Medigap insurance by the elderly.” 

Ettner motivates her paper by dividing individuals into four groups:

  • Group A: High propensity to use services; Employer does not offer Medigap coverage
  • Group B: Low propensity to use services; Employer does not offer Medigap coverage
  • Group C: High propensity to use services; Employer does offer Medigap coverage
  • Group D: Low propensity to use services; Employer does offer Medigap coverage

Ettner assumes that groups A, C and D will purchase Medigap and group B will not.  If individuals choose employment based on criteria apart from the quality of the firm’s health plan offerings, then groups C and D combined will accurately represent the population as a whole.  We can calculate the amount of adverse selection by taking the difference between the average utilization of group A versus groups C and D combined.  Moral hazard can be calculated by comparing the average utilization of group B versus groups D; however this not possible since empirically it will be impossible to separate out groups C and D.  Ettner says that comparing group B versus groups C and D combined will lead to an overestimate of moral hazard, but this will still be less biased then an estimator comparing uninsured (B) vs the insured (A, C, and D).

Data and Methodolgy

Ettner uses data from the 1991 Medicare Current Beneficiary Survey (MCBS) and runs a multinomial logit regression comparing individuals with employer Medigap, individual Medigap and Medicaid only policies.  In addition to usual demographic and socio-economic variables, Ettner uses state-level variables such as SSI income standard, a cost-of-living index and the price of the most comprehensive Medigap policy in the state. One problem is that individuals with a high propensity to consume medical services may elect not to choose Medicaid coverage since they know that if they become sick, they can ex post sign up for Medicaid and be covered.

The author proceeds to estimate moral hazard and selection effects on resource use.  The expected value of using a service ‘Y’ can be written:

  • E(Y)=P(Y>0)*E(Y|Y>0)

The probability term is estimated using a probit model and the conditional expected value term is estimated using OLS.  In this part of the paper, Ettner enriches the analysis by subdividing the regressions into basic Medigap and enhanced Medigap (eg: those with nursing care and/or prescription drug coverage). 


Ettner finds that overall, adverse selection is not a significant factor in the purchase of Medigap insurance.  There is some evidence of adverse selection (those with cardiovascular or musculoskeletal problems are more likely to purchase Medigap), but there is also evidence of favorable selection (individuals who are smokers or who rate their health to be poorer are less likely to buy Medigap policies). 

Regarding the utilization results, Ettner finds that the enhanced Medigap comparisons showed stronger moral hazard effects than those with basic Medigap policies.  If adverse selection is not controlled for, the paper demonstrates that the moral hazard estimates are biased upwards.

Ettner, Susan; (1997) “Adverse selection and the purchase of Medigap insurance by the elderlyJournal of Health Economics, Vol 16, pp. 543-562.

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