The Welfare Impact of Long-Term Contracts

Abstract:

We present a dynamic model of health insurance with one-sided commitment to assess the welfare impact of long-term contracting. We use a rich data set with individual-level data on health risk, health status transitions, insurance choices, and consumer demographics to empirically study equilibrim these dynamic contracts and assess their positive and normative implications. We compare these outcomes under (i) spot contracts (ii) long-run contracts with two-sided commitment (iii) long-term contracts with one-sided commitment and (iv) ACA-like markets with spot contracts and community rating. Empirically, dynamic contracts with one-sided commitment achieve close to the first-best, relative to spot contracts, for consumers with flat income profiles who are happy to front-load payments to facilitate long-run insurance. Consumers with steeper income growth over their lifetimes get a lower benefit from these contracts because front-loading payments is relatively costly.
Dynamic contracts are preferred to the ACA-like markets we investigate for consumers with flatter income profiles, but not preferred for consumers with steeper income profiles.