Sources of Advantagenous Selection: Evidence from the Medigap Insurance Market∗

We find strong evidence for advantageous selection in Medigap insurance market. Using Medicare Current Beneficiary Survey (MCBS) data, we regress total medical expenditure on medigap status and other controls. We find that (1) if we only use gender, age and State (three variables used in the pricing of Medigap), then those with Medigap incur about $4,000 less in total medical expenditure than those without Medigap; (2) however, if we add controls for observable health variables, then those with Medigap spend about $2000 more than those without Medigap. The only way to rationalize the two results is that those with better health are more likely to purchase supplemental coverage. We interpret this as strong evidence of “advantageous selection.” We then combine MCBS and Health and Retirement Study (HRS) to investigate the sources of advantageous selection. We find that advantageous selection has multiple sources: besides the usual suspect of risk aversion, we find that cognition, income, education, and longevity expecation all contribute to advantageous selection.