The Impact of a Public Option in the Health Insurance Market

We develop a framework where to examine the implications of the introduction of a non- profit "public option" in the U.S. health insurance market. In this model, a continuum of heterogeneous consumers, each facing unknown medical expenditures, and differing in their expectations of such expenditures, have to choose between two competing plans. One plan is offered by a profit-maximizing private insurer; the other by social-welfare-maximizing public option. The model is calibrated based on data of U.S. medical expenditures and estimation of a Bayesian hierarchical model. The Nash Equilibrium of the resulting market structure is solved using a numerical algorithm. In equilibrium, the distinct objectives of the two insurers induce adverse selection in consumer choice: the public option covers the less healthy consumers, yielding the more profitable segment of market to the private insurer. However, our empirical results suggest that both insurers will capture significant parts of the health insurance market.