Health insurance as a two-part pricing contract

•Health insurance limits deadweight losses from market power in health care.•Market power among health care firms does not affect insured consumers.•Market power among health care firms may boost rates of uninsurance.•Data from the pharmaceutical market supports these predictions.•Pharmaceutical patent expirations have little value in heavily insured segments.

Monopolies appear throughout health care. We show that health insurance operates like a conventional two-part pricing contract that allows monopolists to extract profits without inefficiently constraining quantity. When insurers are free to offer a range of insurance contracts to different consumer types, health insurance markets perfectly eliminate deadweight losses from upstream health care monopolies. Frictions limiting the sorting of different consumer types into different insurance contracts restore some of these upstream monopoly losses, which manifest as higher rates of uninsurance, rather than as restrictions in quantity utilized by insured consumers. Empirical analysis of pharmaceutical patent expiration supports the prediction that heavily insured markets experience little or no efficiency loss under monopoly, while less insured markets exhibit behavior more consistent with the standard theory of monopoly.