The Effects of Rate Regulation on Demand for Supplemental Health Insurance

Many developed countries have a market for private health insurance that supplements publicly funded, universal coverage. Government regulation of the supplemental market, including the extent to which insurers are permitted to adjust premiums based on individual characteristics such as age, sex, and health status, varies across countries (OECD, 2004). Proponents of rate regulation argue that the resulting crosssubsidization

from low to high risks is necessary to maintain the affordability of coverage

for high risks. Economic theory, however, raises the concern that the inability to adjust

premiums to reflect individual risk could create adverse selection by driving low risks from the market (Michael Rothschild and Joseph Stiglitz, 1976). Little empirical evidence exists to determine the optimal role of rate regulation in private, supplemental insurance markets. Existing studies of the consequences of rating restrictions focus on markets for primary health insurance and find that these laws have had surprisingly little effect on overall rates of coverage (Simon, 2004).

In this paper, we study the effects of rate regulation in supplemental health insurance

markets by examining the market for individually purchased coverage that supplements

Medicare among the elderly in the United States. While the publicly financed Medicare

program provides nearly universal coverage of a standard set of benefits for those 65 and over, beneficiaries are exposed to significant financial risk due to the cost sharing associated with covered services and a lack of coverage for some important services. The vast majority of Medicare beneficiaries obtain supplemental coverage through a complex system of publicly and privately funded sources. State Medicaid programs provide publicly financed supplemental coverage for low-income and disabled beneficiaries, and employers provide highly subsidized retiree supplemental health insurance for other beneficiaries, but the remainder rely on highly regulated, private insurance markets.

Medicare's Part C managed care plans are a voluntary, private replacement for traditional Medicare, while Medigap coverage is a private policy, bought by about 30 percent of Medicare beneficiaries, that provides only supplemental benefits (Franklin J. Eppig and George S. Chulis, 1997). Our study examines the effects of regulations limiting the information on individual characteristics insurers can use in setting premiums for Medigap coverage.