Public versus Private Insurance System with (and without) Transaction Costs: Optimal Segmentation Policy of an Informed Monopolist

Abstract

Computer mediated transactions allow insurance companies to customize their contracts, while transaction costs limit this tendency toward customization. To capture this phenomenon, we develop a complete-information framework in which it is costly to design a new market segment when the segmentation policy (number and design of segments) is endogenously chosen. Both the case of a private and a public insurer are considered. Without transaction costs, these two insurance systems are equivalent in terms of social welfare and participation. With transaction costs, this equivalence is no longer present, and the analysis of this difference is the subject of this article.

Keywords: Insurance, participation, transaction costs, mixed-integer programming, social welfare

JEL Classification: D02, D040, C610