Should there be Vertical Choice in Health Insurance Markets?
Abstract: Choice over coverage levels - “vertical choice”––is widely available in U.S. health insurance markets, but there is limited evidence of its effect on welfare. For a given consumer, the socially efficient level of coverage trades off the value of risk protection and the social cost from moral hazard. Providing choice does not necessarily lead consumers to select their efficient coverage level. We show that in regulated health insurance markets, vertical choice should be offered only if consumers with higher willingness to pay for insurance have a higher efficient level of coverage. We test for this condition empirically using administrative data from a large employer. Our estimates imply substantial heterogeneity in efficient coverage level, but we do not find that households with higher efficient coverage levels have higher willingness to pay. It is therefore optimal to offer only a single level of coverage. Relative to a status quo with vertical choice, mandating the optimal single level of coverage increases welfare by $330 per household per year.