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 a 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. Using data fromMassachusetts, we illustrate these trade-offs in an empirical sufficient statistics approach that is tightly linked to the graphical framework we develop.

Supply, demand, and selection in insurance markets: Theory and applications in pictures

“…Finally, in Section 5, we analyze an extension of EFC to markets in which there are two distinct exogenously fixed insurance policies that individuals can buy and over which firms compete. We show that the welfare effects of a subsidy in such markets hinge critically on the nature of the competition-effectively extending the basic one-margin conclusions of Weyl and Veiga (2017) to the case, a la Geruso et al (2021), where there are two choice margins for insurance consumers.…”

“…A few preliminary remarks and definitions will be useful before we turn, in Sections 5.1 and 5.2, respectively, to comparing and contrasting properties of equilibrium in the sequential and simultaneous contracting environments. First, these subsections are closely related to recent literature, most Weyl and Veiga (2017) and Geruso et al (2021). Like us, Weyl and Veiga (2017) compare equilibrium properties in sequential and simultaneous contracting environmentswhich they refer to as "incremental pricing" and "total pricing" frameworks.…”

“…Unlike in our analysis, however, they follow EFC and Handel et al (2015) in assuming universal coveragethat is, that all buyers either buy L or H coverage, so there is only one choice margin for insurance buyers. Geruso et al (2021), focus specifically on the implications of having a second margin by allowing individuals to opt out of coverage entirely. They do so specifically in the simultaneous contracting case; our discussion of that case replicates the basics of their analysis.…”

The interplay between risk adjustment and risk rating in voluntary health insurance

“…Our work also relates to Geruso et al (2021) and Saltzman (2021) who both demonstrate how risk adjustment reduces selection by consumers on the intensive margin (i.e., selection by consumers within the market across high and low-value plans) but increases selection by consumers on the extensive margin (i.e., selection by consumers in and out of the market). Our focus differs from these previous papers in two ways.…”

“…Such "selection by consumers" is driven by gaps between expected spending and premiums from the viewpoint of consumers. A vast amount of literature describes how selection by consumers can threaten fairness (e.g., when upward premium spirals result in affordability problems; Van Kleef et al, 2018) and violate efficiency (e.g., when risk-averse low-risk people do not take up insurance coverage; Akerlof, 1970;Einav & Finkelstein, 2011;Geruso et al, 2021;Saltzman, 2021). An intuitive policy remedy for mitigating selection by consumers is to allow (some) risk rating.…”