Obama's CEA on Adverse Selection
By David Henderson
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.