The Two Margin Problem in Insurance Markets


Geruso, Michael, et al. Working Paper. “The Two Margin Problem in Insurance Markets”.
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Insurance markets often feature consumer sorting along both an extensive margin (whether to buy) and an intensive margin (which plan to buy), but most research considers just one margin or the other in isolation. We present a graphical theoretical framework that incorporates both selection margins and allows us to illustrate the often surprising equilibrium and welfare implications that arise. A key finding is that standard policies often involve a trade-off between ameliorating intensive vs. extensive margin adverse selection. While a larger penalty for opting to remain uninsured reduces the uninsurance rate, it also tends to lead to unraveling of generous coverage because the newly insured are healthier and sort into less generous plans, driving down the relative prices of those plans. While risk adjustment transfers shift enrollment from lower- to higher-generosity plans, they also sometimes increase the uninsurance rate by raising the prices of less generous plans, which are the entry points into the market. We illustrate these trade-offs in an empirical sufficient statistics approach that is tightly linked to the graphical framework. Using data from Massachusetts, we show that in many policy environments these trade-offs can be empirically meaningful and can cause these policies to have unexpected consequences for social welfare.


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Last updated on 07/01/2019