David R. Henderson  

Obama's CEA on Adverse Selection

PRINT
Wolfers, Ehrenreich, Misery, a... Great Moments in Health Econom...

Back in July, Bryan had an excellent post on adverse selection, pointing out that the textbook idea that adverse selection is an important problem in insurance is simply wrong. Krugman seemed to go back and forth on the issue, but at least Krugman recognized what adverse selection is.

What are we to make of the June report of Obama's Council of Economic Advisers? They say the following about adverse selection (pp. 16-17):

The most important market failure causing inefficiently low coverage is adverse selection. An insurance company will not price individual health insurance at the average cost of covering the uninsured. If it did, the individuals who purchased the policy would be disproportionately those who knew they were likely to have high health care costs, and so the company would lose money. To address adverse selection risks, most insurers use medical underwriting and incorporate a risk premium into the actual price of coverage. As a result, the price of health insurance that a typical person would face in the individual market greatly exceeds the average cost of covering him or her. Moreover, a significant proportion of individuals may be uninsured because they are denied coverage as a result of medical underwriting.

The first sentence says that adverse selection is not just a, but the, most important market failure. But then the next three sentences deny that adverse selection is a problem: under adverse selection, people of different risks tend to be charged the same premium--that's what leads to adverse selection. But the CEA notes correctly that insurers are not so ignorant--they use medical underwriting. That is, they seek and get information. The fifth sentence doesn't follow at all. If the CEA believes sentences two, three, and four, it should say:

As a result, the price of health insurance that a typical person would face in the individual market equals the average cost of covering him or her plus a loading fee.

The last sentence is speculative. It might be true and it might not. I would bet a more-accurate statement is:

Moreover, a significant proportion of individuals may be uninsured because many of them are charged high rates as a result of medical underwriting and many of them choose not to pay those rates.

When I was the health economist at the CEA, I never would have signed off on this. I wonder who the CEA health economist is now and whether he/she agreed.


Comments and Sharing





COMMENTS (9 to date)
John Seater writes:

David asks what we are to make of the CEA report. I think that's an easy one. The report is not an economic analysis, though it pretends to be. It is a political document written to justify a policy that President Obama (the CEA's boss) wants to see enacted. Whatever has to be said will be said. Whatever has to be mangled will be mangled. These people are political agents acting in a political sphere.

wm13 writes:

Is that really true, that Prof. Henderson would have let himself be fired, in an economy with 10% unemployment, rather than write some misleading sentences requested by his employer? That's commendable if true, but that kind of courage is very rare in academia or government, professions that tend to attract people with a high desire for security. So I am skeptical, and in any case not surprised that most other economists don't work that way.

Tom West writes:

To address adverse selection risks, most insurers use medical underwriting and incorporate a risk premium into the actual price of coverage.

I read this as 'because there's a danger of accurately gauging medical risk, most insurers *also* add a hefty surcharge just in case'.

Under such a reading their conclusion might make more sense.

Still, I do agree to some extent, there's a big problem with people who don't "choose" to buy expensive insurance for existing conditions (like the guys earning 20K 'choosing' not to pay 10K for insurance :-)).

David R. Henderson writes:

wm13,
Don't put words in my mouth. I said I wouldn't have signed off on it. Maybe the CEA's health economist didn't agree either. That's why I said I wondered.

Dr. T writes:

John Seater is correct. This sentence is the reason for the report: "As a result, the price of health insurance that a typical person would face in the individual market greatly exceeds the average cost of covering him or her." This is the rationalization for government intervention in health care insurance.

The government could do the same thing for groceries (Grocers in bad neighborhoods in the inner cities have high overhead costs due to security guards, security equipment, and theft. Consumers in these neighborhoods pay much higher prices than average for groceries.)

It already did the same thing for home mortgages (and look how well that worked).

I'm trying to think of an aspect of the economy that the government doesn't want to alter or control, but I can't name one.

Bob Calder writes:

David,
I sympathize. What I wonder about is why the debate on this issue. Nobody is going to have to deal with an individual market. Discussing it in retrospect is fine, but worthless. Hopefully we will never again have to.

Adverse selection always seemed to me to be a kind of evolutionary issue that affects health filings as they age and become less competitive for a variety of reasons, one of which is adverse selection.

Policy discussions about it are destined to go nowhere. Trying to frame it, as the statement does is simply silly. You're right. They're blathering and have lost focus.

gnat writes:

Seems to me you are questioning essentially positivist statements:

-Insurance companies cannot just price at average costs due to adverse selection;
-They have to evaluate each insured (very expnesive)and apply a high risk premium to reflect downside risk uncertainties.

You may not agree with the normative solution but why dispute the facts?

dullgeek writes:

I'm certain that I don't understand something, but consider the truth of this sentence:

As a result, the price of health insurance that a typical person would face in the individual market greatly exceeds the average cost of covering him or her.
If this is true, why would anyone ever buy health insurance? What keeps people from figuring out that health insurnace is a more expensive form of healthcare and just buy healthcare directly?

Is the answer "Well that's why the individual market for health insurance is so small."

But that implies magic to me. That the price 100 individual insurance policies can magically drive costs down when those 100 individuals are in a group, without somehow also reducing the services consumed by that group.

It's like saying that if you're driving your own car at 50mph, it'll take 2 hours to go 100 miles, but if you get on the bus with 20 other people and going 50mph, you'll get there in only 1 hour. There's some magic there that I simply don't understand.

gnat writes:

"If this is true, why would anyone ever buy health insurance? What keeps people from figuring out that health insurnace is a more expensive form of healthcare and just buy healthcare directly?"

One indication that it is true is that the federal blue cross plan with the broadest coverage of medical providers is raising is premiums by about 15% this year. Employees have taken broader coverage plans because employers have picked up a substantial portion of the costs and cost increases in the past. HSA and FSA plans that allow the individual to play with his/her own money are becoming more popular.

Comments for this entry have been closed
Return to top