Perfect Competition in Markets With Adverse Selection

Abstract

This paper proposes a perfectly competitive model of a market with adverse selection. Prices are determined by zero‐profit conditions, and the set of traded contracts is determined by free entry. Crucially for applications, contract characteristics are endogenously determined, consumers may have multiple dimensions of private information, and an equilibrium always exists. Equilibrium corresponds to the limit of a differentiated products Bertrand game. We apply the model to establish theoretical results on the equilibrium effects of mandates. Mandates can increase efficiency but have unintended consequences. With adverse selection, an insurance mandate reduces the price of low‐coverage policies, which necessarily has indirect effects such as increasing adverse selection on the intensive margin and causing some consumers to purchase less coverage.

Selection in Health Insurance Markets and Its Policy Remedies

“…Even if uninsurance can be removed from the choice set with some combination of penalties and mandates, minimum coverage can in principle induce a death spiral for other plans in the market: specifically, as more healthy consumers are required to purchase a medium coverage contract, the price of that medium coverage contract drops, inducing some (relatively healthy) consumers who would have chosen a high coverage contract to inefficiently move to the less-generous minimum coverage (Azevedo and Gottlieb 2017).…”

“…More recent theoretical work has examined screening when there are many types of consumers (Azevedo and Gottlieb 2017) and when markets are imperfectly competitive . In some cases, this type of adverse selection may lead to some types of consumers being unable to purchase insurance with any level of coverage (Hendren 2013).…”

Multidimensional private information, market structure, and insurance markets

“…Azevedo and Gottlieb () propose an equilibrium concept for competitive insurance market where consumers may have multidimensional heterogeneity, and insurance companies compete for consumers by choosing contracts from a compact space and setting their corresponding prices. Their equilibrium concept, which relies on perturbations, guarantees existence.…”

Measuring efficiency of health plan payment systems in managed competition health insurance markets

“…In RS, since premiums are valued equally by the good and bad risks, and “coverage” is valued more by the bad risks, plans (inefficiently) reduce both the premium and coverage to attract the good risks. Azevedo and Gottlieb (2017) and Veiga and Weyl (2016) generalize the RS model to show that under more general conditions adverse selection always results in some consumers getting less-than-efficient levels of coverage in equilibrium. Glazer and McGuire (2000) applied the RS model to markets for managed care health insurance.…”