Regulation of Insurance with Adverse Selection and Switching Costs: Evidence from Medicare Part D

Abstract

I take advantage of regulatory and pricing dynamics in Medicare Part D to explore interactions among adverse selection, inertia, and regulation. I first document novel evidence of adverse selection and switching frictions within Part D using detailed administrative data. I then estimate a contract choice and pricing model that quantifies the importance of inertia for risk sorting. I find that in Part D switching costs help sustain an adversely-selected equilibrium. I also estimate that active decision making in the existing policy environment could lead to a substantial gain in annual consumer surplus of on average $400–$600 per capita—20 percent to 30 percent of average annual spending. (JEL D82, G22, H51, I13, I18)