This paper examines how market power affects coverage in a general class of insurance models. We show that market power decreases coverage for individuals who are less willing to pay for insurance but increases coverage for those with a higher willingness to pay. Under weak conditions, a monopolist always excludes a positive mass of customers, whereas competitive firms do not. However, to avoid cream skimming, competitive firms provide less coverage than a monopolist for consumers who are willing to pay more. The welfare comparison between competitive and monopolistic markets depends on whether the distortion at the bottom (higher under monopoly) exceeds the distortion at the top (higher under competition). Using simulations based on an empirical model of preferences, we find that both effects are quantitatively important although the effect at the bottom dominates. So, in our calibrated model, the market power distortion exceeds the cream skimming distortion from competition.
Financial Markets Group Discussion Papers DP 890