Competition among differentiated health plans under adverse selection.

Market power and adverse selection are prevalent features of the market for pre-paid health plans. However, most of the literature on adverse selection considers extreme cases: either perfect competition or monopoly. If instead health plans are horizontally differentiated, then (i) profits derived from each low risk are higher than from each high risk and (ii) when the profits derived from each high risk are negative (cross-subsidization), a health authority as informed as the health plans can implement a Pareto-improvement. Both local and global deviations from cross-subsidization are addressed within a Nash equilibrium framework.