Working Paper: NBER ID: w28565
Authors: W. Bentley Macleod
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.
Keywords: insurance markets; adverse selection; vertical differentiation; welfare analysis; healthcare economics
JEL Codes: D01; D21; D41; I11; I13; L15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Minimum coverage standard + Insurance mandate (G52) | Does not restore market efficiency (G14) |
| Single high-quality plan (I18) | Optimal social value of health care provision (I14) |
| Distribution of consumer characteristics (D12) | Welfare implications of market structures (D69) |
| Policy measures (E64) | Market performance (G10) |