Health Insurance as a Two-Part Pricing Contract

Darius Noshir Lakdawalla, RAND
Neeraj Sood, RAND

Abstract

Monopolies appear throughout medical care markets, as a result of patents, limits to the extent of the market, or the presence of unique inputs and skills.  Economists typically think of such monopolies as necessary evils or even pure inefficiencies.  However, in the health care industry, the deadweight costs of monopoly may be much smaller or even absent.  Health insurance, frequently implemented as an ex ante premium coupled with an ex post co-payment per unit consumed, operates as a two-part pricing contract.  This allows monopolists to extract consumer surplus without inefficiently constraining quantity.  This view of health insurance contracts has several novel implications:  (1) Medical care monopolies may have smaller or no deadweight costs in the goods market, because insured consumers face low co-payments; (2) Since monopolists have incentives to seek low co-payments, price regulation of health care monopolies is inferior to laissez-faire or simple tax-and-transfer schemes that redistribute monopoly profits; and (3) Competitive health insurance markets or optimally designed public health insurance can eliminate static losses in the goods market while still improving dynamic efficiency in the innovation market.