Product Diversification in Health Insurance with Comprehensive Coverage Benefits U.S. Health Insurers

Document Type

Article

Publication Date

1-2016

Abstract

This paper studies the relationship between product diversification and financial performance in U.S. health insurers during 2005 – 2014. We focus on diversification among different types of comprehensive coverage – termed related diversification. We use a modified Herfindahl-Hirschman Index (HHI) as a proxy for product diversification and measure financial performance by both return on assets and return on capital. We find a robust positive relationship between product diversification and performance. Moreover, the positive relationship still holds when the performance measures are adjusted for volatility. These findings support the theoretical foundation of economies of scope and risk-reduction, as adapted to the U.S. health insurance industry. We also develop two empirical proxies for the underwriting and asset investment risk taking of health insurers. For health insurers, the relationship between performance and risk-taking in product and asset management is similar to other types of insurers. A noteworthy finding is that the positive relationship between product diversification and performance is stronger during the financial crisis years than in the recent healthcare reform era. This suggests that diversification as a risk reduction strategy may be less effective when reform changes the healthcare environment.

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