The Two Margin Problem in Insurance Markets

Abstract

Insurance markets often feature consumer sorting along both an extensive margin (whether to buy) and an intensive margin (which plan to buy). We present a new graphical theoretical framework that extends the workhorse model to incorporate both selection margins simultaneously. A key insight from our framework is that policies aimed at addressing one margin of selection often involve an economically meaningful trade-off on the other margin in terms of prices, enrollment, and welfare. For example, 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 overall social welfare.

A Welfare Analysis of Competitive Insurance Markets with Vertical Differentiation and Adverse Selection

“…Following and Geruso et al (2019), it is assumed that high types are those with low costs. This allows one to illustrate curves corresponding to upward sloping supply and downward sloping demand curves.…”

“…7 A number of authors, including Handel et al (2015), Hackmann et al (2015), and , have provided estimates on the welfare effects of the mandate on the intensive and extensive margin. Geruso et al (2019) extends that analysis to measure the welfare effects taking account of the effect of the mandate on both margins. Azevedo and Gottlieb (2017) show that the insurance mandate has the largest effect on the extensive margin, but an increase in the mandate price also reduces demand for high-coverage plans.…”

“…They find that adverse selection may lead to full unraveling of the market, as Cutler and Reber (1998) found for the Harvard health plan. Geruso et al (2019) also study a two contract model to estimate the differential effects of regulation on the extensive margin (decision to buy insurance) and the intensive margin (the choice between a high-coverage and low-coverage plan).…”

“…Section 6 uses these ideas to illustrate the two-margin issue that has been explored in the health economics literature (Geruso et al (2019)). Section 7 extends the model to allow for the free entry of products with different qualities.…”

Health Insurance Menu Design for Large Employers

“…pocket maximums; the optimal coinsurance rate would likely be lower in other settings with greater overall risk exposure. 9 Second, we do not consider the extensive margin of selection into insurance, focusing only on households who enroll in coverage (Geruso et al, 2020;Saltzman, forthcoming).…”