James A. Ligon

The Formation of Mutual Insurers in Markets with Adverse Selection

The size distribution of mutual property-liability insurers has a larger proportion of relatively small companies than the size distribution of stock property-liability insurers. Small mutuals are unlikely to offer risk-sharing advantages over conventional insurance, so these firms must offer their members other advantages. This article develops a theoretical model showing that these mutuals may offer advantages over conventional insurance in addressing problems of adverse selection. When adverse selection exists, conventional insurers may coexist with small mutuals. Small mutuals may be strictly preferred by low-risk individuals. The size of the mutuals is limited by asymmetric information problems.

MORAL HAZARD IN RISK POOLING ARRANGEMENTS

The authors examine risk pooling arrangements with moral hazard. Because of the nature of the risk pooling arrangement, full nominal coverage is shown to be optimal, despite the presence of moral hazard, and positive loss-prevention effort levels are induced even at full nominal coverage. When marginal utility is convex and higher-order utility effects are sufficiently small, as the number of members in the pool increases, the effort levels of members decrease and, as the pool size approaches infinity, effort levels approach zero. The latter result suggests that moral hazard may define an optimal size for risk pooling arrangements.

Lease Financing and Corporate Governance

Lease financing is a well-recognized mechanism for reducing the agency costs of debt. This study examines whether firms that attempt to control the agency costs of equity through strong governance structures, including Chief Executive Officer compensation alignment and board structure, are more likely to use an agency cost reducing debt structure, such as leasing. For a sample of large firms, we find that firms who use more incentive compensation and have more outside directors also tend to use more lease financing, suggesting these agency cost reducing measures are complements.

Information Asymmetries and Informational Incentives in Monopolistic Insurance Markets

This study considers a single-period monopolistic insurance market with adverse selection and moral hazard. We find that, where the distortions introduced by moral hazard are sufficiently moderate, the insurer can use price-quantity contracts as a mechanism to simultaneously deal with both information asymmetries. When no information regarding type is available, the problem is one of moral hazard with imperfect information regarding loss prevention productivity. We consider the consumers incentive to acquire information regarding type and find that, with multiple types and nonzero optimal effort levels in the market, both pre-contract and post-contract information are valuable to consumers. Post-contract information cannot be used to separate types but does allow consumers to choose an optimal effort level. Although pre-contract information creates the adverse selection problem, consumer welfare increases because information allows modification of effort level and contract choice.

Moral Hazard and Background Risk in Competitive Insurance Markets

We examine the effect of background risk on competitive insurance markets with moral hazard. If policy-holders have non-negative prudence, then background risk does not decrease effort and, when effort increases, expands the set of feasible policies. However, the effect of background risk on equilibrium is indeterminate. We analyse the choice between stock and mutual insurance; mutual insurance is equivalent to a fair policy plus background risk. Our results imply that competitive insurance markets with moral hazard should be dominated by stock insurers.

The Organizational Structure of Insurance Companies: The Role of Heterogeneous Risks and Guaranty Funds

We examine a market with observably heterogeneous risks and a government sponsored guaranty fund and consider whether it is optimal to form a single insurer or separate insurers for each consumer type. Given the economic environment, pooling never dominates the formation of separate insurance companies. This result provides an incentive for the phenomenon of insurance fleets.

The Effect of Health Insurance Cost Sharing Within Episodes of Medical Care

Moral Hazard Control It has long been recognized that health insurance can inflate medical care expenditures by introducing moral hazard into the medical care consumption decision (Pauly, 1968; Feldstein, 1971; Feldstein, 1977). By forcing consumers to share in the marginal cost of care, health insurance deductibles and copayments are conventionally considered an effective means of combating moral hazard (see Rejda, 1989, pp. 84-87). However, the effectiveness of consumer cost sharing may be limited to controlling the frequency of a consumers contact with the medical care system and, possibly, the frequency of hospitalization (Manning et al., 1987; Keeler and Rolph, 1988). The consumer seemingly controls the initial contact with the medical care system. Hence, deductibles and copayments would be expected to influence the likelihood of a patient contacting a physician and, thus, affect overall expenditures. For example, Lohr, et al. (1986) find that patients subject to cost sharing under their insurance contracts are less likely to make contact with the medical care system than patients with full insurance coverage. Choices regarding hospitalization generally fall into two categories: those involving elective procedures, where the decision to be hospitalized is the consumers, and those involving serious illness, where the decision regarding hospitalization is the physicians. One would expect, then, that the effectiveness of consumer cost sharing in controlling inpatient expenditures would depend upon the type of hospitalization involved. Presumably, some degree of discretion exists regarding outpatient treatment at the margin (e.g., performing an additional lab test, increasing a prescription dosage). The extent of consumer control over such marginal outpatient expenditures is not clear. If physicians match particular treatments to particular health states without regard for the consumers tastes for the intensity of treatment or the consumers ability to pay and if consumers acquiesce to the treatments prescribed, deductibles and copayments will not be effective at influencing outpatient expenditures within an episode of care. An episode of care is defined as all treatment for a particular condition or symptom arising out of an initial contact with the medical care system (see Keeler and Rolph, 1988, for example). Fee-for-service (FFS) physicians generally have marginal revenue greater than or equal to zero for each additional service performed. Health maintenance organization (HMO) physicians generally have marginal revenue less than or equal to zero for each additional service performed. As long as the value of the physicians time is greater than zero, expenditure of additional time without additional marginal revenue is costly to the physician. The HMO delivery system, in effect, imposes cost sharing on the physician. HMOs have been advocated as a means of controlling consumer moral hazard. Several studies have shown HMOs to have lower expenses than FFS care, primarily because of reduced hospitalization rates (see, for example, Luft, 1981; Manning et al., 1984). One would also expect the financial incentives associated with HMOs to affect the delivery of outpatient care. This study tests the influence of cost sharing on marginal outpatient expenditures within individual episodes of medical care. The empirical tests go beyond previous work by comparing expenditures for consumers with the same diagnosed condition in both FFS and HMO contexts.(1) The effects of physician compensation systems and consumer characteristics, including insurance coverage, upon outpatient expenditures of individuals over the age of 14 are compared across 39 diagnoses.(2) The Data and Empirical Design Data The data set used in this analysis is from the Rand Health Insurance Experiment (RHIE), conducted by the Rand Corporation from 1974 to 1982. The experiment was a controlled trial in health care financing funded by the U. …

Fee-for-Service Versus HMO Outpatient Expenditure Patterns

This study compares the higher moments of fee-for-service (FFS) and health maintenance organization (HMO) expenditure distributions in connection with outpatient episodes for randomly assigned patients over 39 diagnoses. The results indicate that the variance and skewness of the unexplained variation in expenditure is much greater for FFS health care than for HMO health care. The results may be attributable to the construction of the dependent variable or to physician financial incentives.

The capital structure of hospitals and reimbursement policy

Empirical research has shown that hospitals have higher than average leverage, the extent of leverage is related to the extent of cost-based reimbursement, and not-for-profit hospitals are not as highly levered as their for-profit counterparts. Previous theoretical work does not unambiguously predict all of these results. This article develops a model of reimbursement policy and proves that, if reimbursement follows the indicated pattern, the Modigliani-Miller capital structure irrelevance theorem fails to hold and given reasonable restrictions upon the utility functions of not-for-profit donor/investors, each of the empirically observed results would be expected ex ante.

The informational value of insurance purchases: Evidence from the property-liability insurance market

Abstract The purchase of insurance provides a potentially finer informational partition over the distribution of post-loss resolution wealth that may allow favorable adaptation of intermediate consumption, investment, or other decisions. Such a positive informational value does not require consumer risk aversion. Lines of insurance with longer resolution periods should impact relatively more decisions and have higher informational value. Under standard assumptions on preferences, in the absence of informational value, risk premiums paid for insurance by risk averse consumers should not increase as the loss resolution period increases. Empirical tests using data from the property-liability insurance market suggest that the willingness to pay per dollar of coverage (as measured by relative market demand across lines of insurance) is greater for lines of insurance with longer resolution periods consistent with a positive informational value of insurance. The results suggest that other financial assets may also have differential informational value.