Market Structure in the Presence of Adverse Selection

Competitive markets with adverse selection lead to inefficient allocations. These market failures come, in part, from firms that do not internalize the effect of their own prices on the consumers that purchase---and therefore the costs of---other products in the market. A monopolist does not suffer from this source of inefficiency---it internalizes the same marginal costs of all products in the market---but creates inefficient allocations by charging a markup. In this paper, I explore the trade-offs between these two sources of inefficiency and their interaction with policies commonly used to mitigate adverse selection. I use novel choice data from the non-group health insurance market and the HHS-HCC risk prediction model to estimate the joint distribution between preferences and cost and use these estimates to simulate the equilibrium effects of market structure. I show that under certain policy regimes, more concentrated markets can improve allocations for consumers with a high cost to serve and high willingness-to-pay. I also demonstrate how two policies---the individual mandate penalty and risk adjustment---are less effective in concentrated markets. In the case of the individual mandate, I find that it leads to premiums in the most concentrated markets---3.6% in Bronze plans, 0.8% in Silver plans, and 1.8% in Gold plans---the opposite of the intended effect. I find that risk adjustment improves average consumer surplus by $130 in the most competitive markets and $80 in the least competitive markets.