Health Insurance and Competition in Health Care Markets

I study duopolistic market for differentiated medical products. Medical providers decide whether to sell on the spot market to sick consumers or to sell through competitive insurance market to healthy consumers. While shopping for insurance consumers know only the distribution of possible medical needs they may have if they get sick. Only when getting sick their actual medical need reveals and diagnosed. Hence consumers on the insurance market have lower taste differentiation than the sick consumers who are shopping on the spot market. I find that in equilibrium providers sell only on the insurance market, even though this intensifies competition because of lower taste differentiation. Competition between providers under insurance sales brings premiums low enough to motivate consumers buying insurance for both products. Insurance sales generate effi cient horizontal product differentiation, lower prices, and effi ciently higher quality. JEL Classification: : I11, I13, L1 Key-words: Insurance, Non-linear Pricing, Option Demand, Differentiation ∗Economics Department Auburn University , Auburn AL. Email: [email protected] . Tel: 716-867-9497. †Thanks go to Randy Beard and Aditi Sengupta for helpful comments and to Adeet Handel for challenging discussions. I also benefited from participants comments on presentations at Auburn University, the spring 2014 Midwest-Theory Conference at UIPUI and the ASHE 2014 conference at USC, and discussion comments by Ted Frech.