A Welfare Analysis of Competitive Insurance Markets with Vertical Differentiation and Adverse Selection

W. Bentley Macleod

No 28565, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: A feature of many insurance markets is that they combine vertical differentiation (all consumers prefer high to low-coverage policies) and adverse selection (high cost customers prefer high-coverage plans). Building on Novshek and Sonnenschein (1978) and Azevedo and Gottlieb (2017), this paper characterizes the competitive equilibria in a vertically differentiated market characterized by adverse selection. This provides a simple, dynamic model of the market, along with their welfare consequences over time in response to policy changes. The model makes predictions consistent with recent evidence on the ACA exchange in the US (Frean et al. (2017)). Moreover, it provides a complete characterization of the health insurance “death spiral”. The death spiral leads to an inefficient outcome, but does not lead to a complete breakdown of the market. Rather, it predicts a large number of plans, with coverage that falls with an individual’s willingness to pay. It is shown that introducing a minimum coverage standard combined with an insurance mandate cannot restore efficiency. The optimal system depends on both the valuation of public funds and the social value of insurance. Depending on these parameters, a number of different types of systems may be optimal, including a single payer system with mandatory participation for all, such as the Canadian system, a mixed private-public system, as one sees in many countries, or a pure, free market system.

JEL-codes: D01 D21 D41 I11 I13 L15 (search for similar items in EconPapers)
Date: 2021-03
New Economics Papers: this item is included in nep-com, nep-hea, nep-ias and nep-ind
Note: EH IO TWP
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.nber.org/papers/w28565.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:28565

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w28565

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().