Research Seminar by Andre Veiga (Oxford University)
Speaker: Andre Veiga (Oxford University)
Theme: "Product Design in Selection Markets"
Abstract: We take a price theoretic approach to the design of insurance contracts: consumers are heterogeneous in cost and risk-aversion but insurers offer a single, parametric contract. An insurer’s incentive to use quality to sort for low-cost consumers appears only under multidimensional heterogeneity and is quantified by the covariance, among marginal consumers, between marginal willingness-to-pay and cost to the insurer. Under monopoly, standard forms of quality (e.g. lower cost-sharing, deductibles) disproportionately attract costly consumers. When the two dimensions of type are uncorrelated, we recover classic non-existence results for competitive equilibrium. However, realistic frictions of negative correlation and market power relax this result. If this correlation is sufficiently negative, competitive equilibrium with positive insurance can exist and is characterized by the quality level causing the sorting incentive to vanish. Moreover, market power increases equilibrium quality. In calibrations to previously published insurance data, we show that 1) a perfectly competitive symmetric equilibrium fails to exist but 2) when market power is sufficient to make premia 82% above cost, welfare is 98% and consumer surplus is 79% of their first best levels.
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