Adverse selection under a voucher system: grouping Medicare recipients by level of expenditure

Third-party payers increasingly are offering insured populations a choice of health insurance packages. This paper addresses the issue of adverse selection: the tendency of high-risk and thus high-cost individuals to disproportionately choose comprehensive plans and low-risk individuals to disproportionately choose plans with limited benefits. The adverse selection issue is first analyzed as it applies generally to multiple-choice plans, and then a methodology is developed for avoiding adverse selection in the case of the Medicare voucher plan. Although developed specifically for the Medicare voucher plan, the proposed pricing system could be applied to any insured population that is offered a multiple-choice insurance plan.