Does Adverse Selection Matter?

The empirical evidence of adverse selection in insurance markets is mixed. The problem in assessing the extent of adverse selection is that insurance coverage also give rise to moral hazard. With private information— on which agents act— generally being unobservable to the researcher, is is di¢ cult to distinguish adverse selection from moral hazard. Unique micro data is here used to provide a direct test of selection. The setup of the insurance makes it possible to observe a proxy for private information. Interestingly, results di¤er across the distribution of observable risk, with direct evidence of both adverse selection and advantageous selection: the paper shows that within a single insurance market there can be di¤erent types of selection. This dual selection can explain the limited empirical evidence for adverse selection in the literature: the two e¤ects may balance out on the aggregate level. Keywords: Asymmetric information, Adverse Selection, Advantageous Selection, Health Insurance. JEL codes: D81, D82, G22, I11. The paper has bene…ted from suggestions and comments by Magnus Johannesson, Douglas Lundin, Georges Dionne, Mark Pauly, Per Johansson and seminar participants at Stockholm School of Economics, ENTER Jamboree 2003, Venice Summer Institute 2003 and EEA Congress 2003, LuCHE 2006, and COST a23 Meeting in Essen. I am grateful to the National Dental Service in Värmland, Sweden, especially to Jörgen Paulander, for providing data and odontological expertise, and to AnnBritt Emilsson for generously answering questions on registration practices. Financial support from Apoteksbolagets Fond för Forskning och Studier i Hälsoekonomi och Socialfarmaci is acknowledged. Centre for Health Economics, Stockholm School of Economics, P.O. Box 6501, SE-113 83 Stockholm, Sweden, e-mail: [email protected]