The Two Margin Problem in Insurance Markets

Insurance markets often feature consumer sorting along both an extensive margin (whether to buy) and an intensive margin (which plan to buy), but most research considers just one margin or the other in isolation. We present a graphical framework that incorporates both selection margins and allows us to illustrate the often surprising equilibrium and welfare implications that arise. A key finding is that standard policies often involve a tradeoff between ameliorating intensive vs. extensive margin adverse selection. While a larger penalty for opting to remain uninsured reduces the uninsurance rate, it also tends to lead to unraveling of generous coverage because the newly insured are healthier and sort into less generous plans. While risk adjustment transfers shift enrollment from lower- to higher-generosity plans, they also sometimes increase the uninsurance rate by raising the prices of less generous plans. We illustrate these trade-offs empirically using a sufficient statistics approach incorporating demand and cost curves for more- and less- generous plans from Massachusetts, showing that in many policy environments these trade-offs can be empirically meaningful and can cause these policies to have unexpected consequences for social welfare.