On Bundling in Insurance Markets

Abstract

This paper analyzes the welfare consequences of bundling different risks in one insurance contract in markets where adverse selection is important. This question is addressed in the context of a competitive insurance model a la Rothschild and Stiglitz (1976) with two sources of risk. Accordingly, there are four possible types of individuals and many incentive compatibility constraints to be considered. We show that the effect of bundling on these incentive compatibility constraints is such that bundling always yields a welfare improvement, and this result only holds when all four types have strictly positive shares in the population. Due to the competition between insurance companies, these benefits accrue to consumers who potentially have fewer contracts to choose from, but benefit from the better sorting possibilities due to bundling.