What is adverse selection anyway?

Let me again cite Alex’s strong arguments against the importance of adverse selection in insurance markets.  Here is Paul Krugman, and here is Brad DeLong, both of whom see adverse selection as the central health care problem.

How can we square these differing points of view?

When I argue that adverse selection is not the key, I hear a common response: "*You* try getting insurance after you have been diagnosed with an advanced brain tumor," or something along those lines. 

To be sure, this is a real point but it is not adverse selection.  Adverse selection requires asymmetric information, namely that I know more about my brain tumor than does my potential insurance company.  The more likely problem is that the tumor is common knowledge, or would be if I applied for insurance, and the company won’t sell a policy for any price cheaper than the costs of treatment.  There is no asymmetry of information, rather insurance simply is no longer possible.  In the limiting case, imagine that a predictor-demon could forecast your lifetime medical expenditures with certainty, and then blog them by your social security number.  Such a person, no matter how healthy, couldn’t buy insurance either.

Scream all you want, but that is not inefficient per se (don’t complain in the comments about the limits of the efficiency concept, and the cruelness of economists, I’m already on that one, scroll down to #7 under "microeconomics", alternatively you might make a complicated Rawlsian argument.)  Covering these people, by the use of government policy, is a transfer, not an efficiency improvement, with an added caveat for imperfect capital markets.

Defenders of the adverse selection argument in reality believe the following: if someone is going to face death, or a very bad medical outcome, and can’t buy their way out of it, government should put up the money, at least within limits.

Maybe yes, maybe no, but now we are comparing competing investments and which will bring the greatest utilitarian good and the greatest moral good.  I’m far from convinced health care access wins that race or even comes in second.

And that is a general point, it is not about the United States and whether we pay more to get less compared to Europe, and so on.  Please don’t bring up that comparison to distract yourself from the logical force of this point or to think you can get a free lunch.  If you wish, think of it as whether the Netherlands should subsidize as much health care as it does. 

The point is this: defenders of the single-payer system, by invoking adverse selection, wish to claim efficiency on their side.  If the single-payer system were more efficient, we would not have to worry about competing investments, in fact we could make more of such investments by moving to a single payer.

But what looks like adverse selection is in reality something just a wee bit different.  That wee bit, however, is an important bit.  The desirability of the supposed remedy follows from an ethical judgment, not the prospect of a Pareto improvement.  And then we are back to comparing alternative investments for scarce resources.

I see the big marginal gains in lifestyle and in pharmaceuticals, not in access to health care per se.  And that is another reason why I am skeptical of the single-payer arguments.  That is without even considering the possible secondary consequences of so much government involvement.

I haven’t dealt with the Rawlsian approach, which attempts to transform the ex post disaster into a case for ex ante insurance and thus returns us to the realm of efficiency.  But if you reread the paragraph immediately above, that Rawlsian move, even if it succeeds on philosophical grounds (I am skeptical), still won’t save the case for a single-payer system.


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