Premium subsidies for health insurance: excessive coverage vs. adverse selection

The tax subsidy for employment-related health insurance can lead to excessi ve coverage and excessive spending on medical care. Yet, the potential also exists for adverse selection to result in the opposite problem-insufficien t coverage and underconsumption of medical care. This paper uses the model of Rothschild and Stiglitz (R-S) to show that a simple linear premium subsi dy can correct market failure due to adverse selection. The optimal Linear subsidy balances welfare losses from excessive coverage against welfare gai ns from reduced adverse selection. Indeed, a capped premium subsidy may mit igate adverse selection without creating incentives for excessive coverage. Published by Elsevier Science B.V.