When Prices Hardly Matter: Incomplete Insurance Contracts and Markets for Repair Goods

Abstract

This paper looks at markets characterized by the fact that the demand side is insured. In these markets a consumer purchases a good to compensate consequences of unfavorable events, such as an accident or an illness. Insurance policies in most lines of insurance base indemnity on the insured's actual expenses, i.e., the insured would be partially or completely reimbursed when purchasing certain goods. In this setting we discuss the interaction between insurance and repair markets by focusing, on the one hand, upon the development of prices and the structure of markets with insured consumers, and, on the other hand, the resulting backlash on optimal insurance contracting. We show that even in the absence of ex post moral hazard the extension of insurance coverage will lead to an increase in prices as well as to a socially undesirable increase in the number of repair service suppliers, if repair markets are imperfect.

Insurance, Consumer Search, and Equilibrium Price Distributions

“…Finally, we have restricted insurance firms to a particular class of contracts (i.e., those that reimburse a constant percentage of realized expenses). We first note that coinsurance is a very common arrangement in practice (e.g., 64 percent of insured employees face coinsurance on hospital admissions, according to Kaiser Family Foundation, ) and in theoretical studies (e.g., Frech and Ginsburg, ; Ma and McGuire, ; Vaithianathan, ; Nell, Richter, and Schiller, ). Even so, a natural extension of the model would be to allow a broader class of contracts, including: copays or deductibles (where the household pays for the first dollars of a claim), payment caps (where the household is responsible for 100 percent of expenses above some amount), fixed payments (where the insurer pays a fixed amount on any claim, as well as coinsurance on actual expenses), or maximum out‐of‐pocket clauses (where coinsurance drops to 0 percent on any expenses beyond some threshold) .…”

“…Frech and Ginsburg (1975) and Vaithianathan (2006) also study moral hazard in consumption (service quantity is noncontractible), but a unique price in the service market is determined by a monopolist or Cournot competition, respectively. In Nell, Richter, and Schiller (2009), a unique service price is determined by spatial competition (as in Salop, 1979) among providers (location is noncontractible), while demand is inelastic as in our model.…”

“…The nature of this imperfect competition would greatly affect the equilibrium outcome. The latter issue is side‐stepped in the spatial competition model of Nell, Richter, and Schiller () by assuming an actuarially fair premium. In our context, that approach would give results in between the UM and PC contracts, approaching the latter as the number of insurers increases.…”

Behavioral insurance: Theory and experiments

“…In this situation, the fact that individuals are insured may lead to spillover effects in related health care or repair markets (Nell et al 2009). An important role of behavioral insurance is to explain some of the discrepancies found in studies of insurance markets through new behavioral theories or modifications of classical theory.…”

The Influence of Premium Subsidies on Moral Hazard in Insurance Contracts

“…Feldstein and Friedman (1977) explore both the issue of increasing insurance demand and rising cost of third party services (see also Nell et al 2009) in a simulation model of the health care market. They conclude that the impact is highly economically significant and might be responsible for some of the increased health care spending in the United States.…”