Collusion in a One-Period Insurance Market with Adverse Selection

Abstract

We show how collusive outcomes may occur in equilibrium in a one-period competitive insurance market characterized by adverse selection. We build on the Inderst and Wambach (2001) model and assume that insurees must pay a minimum premium, which is a common feature in many health systems. In this setup we show that there is a range of equilibria, from the zero profit one in which low-risks implicitly subsidize high risks, to one where firms obtain profits with both types of consumers. Moreover, we show that rents only partially dissipate if we assume free entry.

Along these equilibria, high risks always obtain full insurance while the low risks coverage decreases as the firms' profits increase.

Keywords: adverse selection, collusion, insurance, capacity constraints

JEL Classification: I11, I18, L41