Endogenous Information and Self-Insurance In Insurance Markets: A Welfare Analysis F. Barigozzi University of Bologna D. Henriet Ecole Centrale Marseille, GREQAM and IDEP Health Economics and the Pharmaceutical Industry Toulouse, January 2008

2 Motivation Standard assumption in insurance markets: consumers are perfectly informed about their loss probability (risk), insurers are not  adverse selection In practice consumers have only a vague perception of their risk Consumers can learn information about their risk before purchasing the insurance contract.  information is endogenous.

3 In health insurance: Genetic tests for over 1000 diseases are offered: genes that imply an elevated risk of several types of cancer, cardiovascular diseases, Alzheimer’ and Huntington’s disease, cystic fibrosis, etc., can be detected Genetic tests allow for efficient secondary prevention (early detection of disease): ex. mammography for BRCA1 and BRCA2 genetic mutations and colonscopy for HNPCC.

4 When consumers are uninformed they face two different risks: The first risk is standard and is related to the monetary equivalent of the negative health shock. The second one is associated to the risk of being a high-risk and, thus, corresponds to the risk of paying a high premium (classification risk). In the real world we do not observe insurance policies against the classification risk (genetic insurance). The market seems not able to provide such insurance policies.

5 The basic trade-off in our model Information has decision-making value = benefit of information in terms of more efficient actions (secondary prevention). Information leads to the classification risk. Decision-makers’ choice to learn information on their risk is influenced by the reaction of insurance market to such information.

6 Thus, the choice whether to acquire information also depends on the features of the insurance market: the observability of decision-maker’s information status by insures the market regulation Question: does the insurance market provide incentives to acquire information under different regulatory structures?

7 The debate on the use of genetic testing in the insurance market Insurers’ point of view: if consumers can secretly take the test and conceal it  adverse selection Consumers’ point of view: If insurers can oblige consumers to take a test before policy purchase  risk of discrimination (potentially a class of uninsurable individuals). If genetic testing regulation affects consumers’ choices on whether to perform the test or not, consumers can loose important prevention opportunities because of fear of risk discrimination.

8 Current regulatory conditions in the different countries: 1) Laissez-faire approach  insurers are free to request new tests and disclosure of existing tests. Spain, Portugal. 2) Disclosure duty.  applicants have to disclose the result of existing tests, at the insurer’s request, but cannot be required to take additional tests. (full information) Germany, UK. 3) Consent law  applicant are not required to divulge genetic tests results. If they do, insurers can use this information (asymmetric information). Netherlands, Switzerland 4) Strict prohibition  insurers cannot request any genetic test and cannot use genetic information for rating. France, Italy.

9 Related literature Doherty and Thistle (1996) JPubE information has no decision-making value two information structures analyzed: 1) information status and test result are not observable 2) information status and test result are not observable but decision-makers can show the test result to insurers Doherty and Posey (1998) JRI primary prevention for high risk information status and test result are not observable, In both papers some people already informed ex-ante

10 This paper: Secondary prevention All consumers are uninformed ex-ante information structure: disclosure duty and consent law approach Tractability: welfare analysis is possible

11 Plan of the presentation Introduction: motivation The model The ex-ante and interim optimal allocations Equilibrium in the insurance market for different information structures: symmetric (disclosure duty approach) and asymmetric information (consent law) Comparison of welfare losses and the value of information Conclusion with policy implications

12 The Model Decision-makers Wealth w subject to a loss L(a) with probability, p H > p L a is the level of secondary prevention : L(0)=L>L(1)=l –action a is taken before the realization of the risk –it is observable (ex-post verifiable) –utility cost Ψ(a), with Ψ(0), = 0 and Ψ(1) = Ψ. p H and p L are fixed : no ex-ante moral hazard Proportions of high- and low-risk : λ and (1- λ) respectively: p U = λ p H + (1- λ)p L vNM utility function u The test is costless

13 Timing and information –Date 0 : decision-makers do not know their risk ex- ante. The loss probability of uninformed individuals is p U –Date 1 : Risk neutral (competitive) insurance firms propose contracts to decision-makers. According to the information structure they can observe or not decision-makers’ information status and test result. –Date 2 : Information can be (voluntary) gathered without cost by performing a genetic test. If the test is performed, decision-makers also choose whether to show the test result to insurers. –Date 3 : contracts are accepted and prevention choice is taken

14 Ex-ante optimal allocation –First-best implies full insurance with uniform premium: Where Insurance against classification risk decentralizes FB only if social planner obliges people to insure before testing (to prevent adverse selection); Tabarrok (1994)

15 Welfare in the ex-ante optimal allocation and in the case of no-information

16 Interim optimal allocation Allocation such that consumers performed the test and the test result is public information. Consumers are fully insured at the fair premium. Prevention choices are efficient

17 Disclosure duty approach Insurers are free to request new tests and disclosure of existing tests (symmetric information). No insurance against classification risk available Insurers propose 3X2 types of full fair insurance contracts whose premiums are: - for uninformed - for informed high-risk - for informed low-risk

18 Disclosure duty approach, result Two types of equilibria: –Either no information is always preferred (type 1) –Or information gathering is chosen for intermediate values of prevention cost (type 2). Prevails when classification risk is low (p H -p L low) and/or prevention efficacy is high (L-l is high). Prevention choices are efficient only in type-2 eq. and for intermediate values of prevention costs

19 Consumers are not required to divulge genetic tests results. If they do, insurers can use this information (asymmetric information). No insurance against classification risk available Informed low-risk has incentive to show the test result Informed high-risk pretend to be uninformed. They receive the same contract. Consent law approach

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21 Consent law approach, result Insurers offer to uninformed consumers and to informed high-risks a (partial insurance) contract which assures to high-risks the same utility they would receive if they show the test result (i.e. full insurance at a fair premium).  Result: consumers gather information and low-risks show the test result. Both types receive full insurance at a fair premium.  the interim optimal allocation is obtained and prevention choices are interim efficient. Intuition: by performing the test consumers can always obtain the same policy as uninformed or they may be able to choose a strictly preferred policy.

22 Welfare comparison between different equilibria Equilibrium allocations under diclosure duty (full information) always (weakly) dominate the equilibrium allocation under consent law (asymmetric information). Private information is detrimental to consumers.

23 The value of information (disclosure duty approach ) Private and social value of information are the same. –In equilibrium of type 1 the value of information is always negative. –In equilibrium of type 2, the value of information is positive for intermediate values of prevention costs and negative elsewhere.

24 The private value of information is positive. When p H -p L is high and/or L-l is low, the social value of information is always negative. When the opposite holds the social value of information is positive for intermediate values of prevention costs and negative elsewhere. The value of information (consent law approach)

25 Conclusion and policy implications We analyzed the welfare properties of equilibria allocations in insurance market with endogenous information and self- insurance under different regulatory approaches. From a social welfare point of view a disclosure duty approach weakly dominates a Consent law one even though under the first prevention choices are less efficient. This depends on the fact that insurance policies do not cover the classification risk. Under disclosure duty the insurance market does not provide incentive to information gathering, whether the consent law approach leads to information gathering and disclosure. Thus, insurers should not be concerned about adverse selection under (partial) regulation of genetic information.