Arnold Kling  

Preference Heterogeneity and Insurance

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David Cutler, Amy Finkelstein and Kathleen McGarry write,


Standard theories of insurance, dating from Rothschild and Stiglitz (1976), stress the role of adverse selection in explaining the decision to purchase insurance. In these models, higher risk people buy full or near-full insurance, while lower risk people buy less complete coverage, if they buy at all. While this prediction appears to hold in some real world insurance markets, in many others, it is the lower risk individuals who have more insurance coverage. If the standard model is extended to allow individuals to vary in their risk tolerance as well as their risk type, this could explain why the relationship between insurance coverage and risk occurrence can be of any sign, even if the standard asymmetric information effects also exist. We present empirical evidence in five difference insurance markets in the United States that is consistent with this potential role for risk tolerance. Specifically, we show that individuals who engage in risky behavior or who do not engage in risk reducing behavior are systematically less likely to hold life insurance, acute private health insurance, annuities, long-term care insurance, and Medigap. [emphasis added]

Translation: some people lack insurance because they do not want it.

UPDATE: Mike Moffatt adds,

Most people lack the ability to accurately determine how much of a health risk they are or how bad their driving is. Being able to unbiasedly assess one's own characteristics is one of the hardest things a person can do. So the information asymmetry likely runs the other way - your car insurance company likely is a better judge of your driving abilities than you are.


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COMMENTS (7 to date)
AMW writes:
Translation: some people lack insurance because they do not want it.

And/or some people lack insurance because it's very expensive, but refuse to forego risky behavior.

Eric Crampton writes:

David Hemenway made the same argument. QJE 1990. He called it "Propitious Selection": the more risk averse are more likely to buy insurance. His empirical evidence is more "here's a bunch of studies that are consistent with my hypothesis", but the basics seem to be all there. Not sure why it wasn't cited in the Cutler et al piece.

Rue Des Quatre Vents writes:

I live and work in MA, and refused to take the insurance my company offered. It would have cost me $2500 on the year. (I'm not sure of my legal status. I'm currently uninsured, but I don't know if that's allowed in this state anymore.)

What I find most interesting is the response people have to the choice I made. They think I'm crazy. I admit I'm taking a risk. But come on! Relax!

Floccina writes:

Rue Des Quatre Vents what I find funny about peaple's reations ("They think I'm crazy") is that most hospitals will give you terms. It is therefore often a questiom of paying more now or less later.

Chuck writes:

One tenet? proposition? principle? of libertarianism is "You should be free to do what you want as long as it does not interfere with my freedom to do what I want."

When I apply that to health insurance, the way I look at it is: were my brother in law to decide to forgo insurnace, and then get a serious illness, I would be (for all practical purposes) obligated to help him in what ever way I could.

That is going to likely involve money. If he goes into tremendous debt fighting the illness and survives, I'll certainly be called upon to help him put his financial life together in some way - help pay rent, cosign a loan for a car or property, etc.

So, the way I see it, when people choose to go without life insurnace, they are making a choice that is placing an obligation on me. Granted, it is a social obligation rather than a legal one, but I choose to live in the real world where in many ways social obligations are compelling.

So, I think some simple form of universal coverage isn't indefensible from a libertarian point of view.

Randomscrub writes:

Chuck: I disagree wholeheartedly. Just because something is good and/or salutary (you helping your uninsured brother, or your brother insuring himself) does not mean it should be mandated. You could make precisely the same argument for forcing people into buying unemployment insurance and preventing them from investing in risky endeavors.

I think it is highly corrosive to one's moral character to create a legal obligation on someone else which is intended to prevent them from forcing one's self into fulfilling a moral obligation.

Floccina writes:

When democrats speak of adverse selection don't they mean by the insurers. I always thought that they meant that you cannot get insurance if you are not healthy.

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