Cowen Gets Caplanian
When was the last time Tyler Cowen and I agreed? Let’s just say it’s been a while. But he’s just hit the adverse selection nail on the head:
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.
Economists often imagine that adverse selection arguments provide intellectual underpinings for populist resentment against the insurance industry. But the true lesson of adverse selection arguments should make populists cringe: In an efficient world, the link between risk and rates would be even stronger than it already is.