Consider a Hypothetical Large University Which Employs Thousands of Employees

Consider a hypothetical large university which employs thousands of employees as in the Cutler and Reber (1998) study of Harvard University's health insurance coverage. Faced with increasing health insurance costs, the university has cut its subsidy to employees and instituted a "new" cost schedule. There are two plans, the HMO and the PPO. The PPO provides relatively more generous choices and coverage.

$\begin{array}{c}\begin{array}{|c|c|}\hline \text { Type}& \text { Cost}\\\hline\\\hline \text { PPO }&8,000\\\hline \text {HMO}&6,000\\\hline\end{array}\begin{array}{lll}\hline\text{ Employee Payment } \\\hline\text{Old}& \text{New }\\\hline2,400&4,800\\\hline1,800&2,400\\\hline\end{array}\begin{array}{|c}\hline\text{ Enrollment }\\\hline\text{ Year 1} &\text{ Year 2}\\\hline16\%&13\%\\\hline84\%&87\%\\\hline\end{array}\end{array}$


Use the concept of adverse selection to explain how the enrollment changes from year 1 to year 2 could cause the university to abandon the PPO by year 3 .