Adverse Selection in Health Insurance

Front-page article today in the NYT on young adults who choose not to buy health insurance.

What's wrong with this?

When I teach about adverse selection in Fin 6025, students usually suggest that the big problem is uncompensated care. Uncompensated care happens when an uninsured person gets sick or is injured, and then seeks treatment (usually at an ER), and then can't pay.

But uncompensated care is actually quite a small part of overall health care costs. According to a recent survey by leading health care economist Jon Gruber, uncompensated care is only $30 bn out of the $2 trillion US health care spending. That's 1.5%.

A bigger problem is that when healthy people jump out of the pool of the insured, then insurers figure that you must be pretty sick to want to buy health insurance. This is called adverse selection, because the "selection" of people who choose to buy insurance is "adverse" to the interests of the insurer. And this raises the price of insurance, and causes more of the relatively healthy to jump out of the insured pool.

So we end up with risk-averse people choosing not to buy insurance, because the price of insurance reflects the _average_ cost of insuring those who choose to buy, not the specific cost of insuring that person.

This sort of adverse selection problem can lead to market failure --- that is, it can lead to a situation where everyone's well being could be improved by changing the market outcome.

And this part of why markets don't do as well at allocating health care resources as they do at allocating, say, tin.

And this is why governments (around the world) are so heavily involved in the provision of health care. Health care is no more a "basic human right" than, say, food, but governments play a comparatively small role in the provision of food.