The Two Margin Problem in Insurance Markets

66 Pages Posted: 31 May 2019 Last revised: 8 Jun 2019

See all articles by Michael Geruso

Michael Geruso

University of Texas at Austin; National Bureau of Economic Research (NBER)

Timothy J. Layton

Harvard Medical School - Department of Health Care Policy; National Bureau of Economic Research

Grace McCormack

affiliation not provided to SSRN

Mark Shepard

Harvard University - Harvard Kennedy School (HKS)

Date Written: May 3, 2019

Abstract

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.

Keywords: adverse selection, risk adjustment, mandate, subsidy

JEL Classification: I1, I11, I13, I18

Suggested Citation

Geruso, Michael and Layton, Timothy J. and McCormack, Grace and Shepard, Mark, The Two Margin Problem in Insurance Markets (May 3, 2019). Available at SSRN: https://ssrn.com/abstract=3385492 or http://dx.doi.org/10.2139/ssrn.3385492

Michael Geruso (Contact Author)

University of Texas at Austin ( email )

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Timothy J. Layton

Harvard Medical School - Department of Health Care Policy ( email )

180 Longwood Ave
Boston, MA 02115
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Grace McCormack

affiliation not provided to SSRN

Mark Shepard

Harvard University - Harvard Kennedy School (HKS) ( email )

79 John F. Kennedy Street
Cambridge, MA 02138
United States

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