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%-30% of average annual spending.