Insurance choice can be bad
This is a followup to the previous post about health insurance elaborating on the fact that it can be bad to let individuals make choices about their insurance policy. I stated without much detail that “assuming sufficient options and perfect competition, the result of this individual choice would be exactly the same as if the insurers were allowed to use knowledge of .” The “sufficient options” assumption is important (and not necessarily realistic), so more explanation is warranted.
Imagine there’s a genetic test that predicts the occurrence of a particular disease with overwhelming probability. Let’s call this disease H (for Huntington’s disease or maybe HIV/AIDS). Further imagine that the disease is treatable, but the treatment is expensive (not true for Huntington’s yet, unfortunately). Say the price of treatment is .
If insurers are allowed to administer the genetic test and adjust policy prices accordingly, prices will converge towards being greater for those with . If you have , you’ll pay the entire cost yourself. This situation is clearly bad, so we’ll ban insurers from knowing about the genetic test.
However, individuals still know about the genetic test, and are allowed to make decisions accordingly. Let’s say an insurer provides two insurance policies, identical except that one pays for the treatment for and one does not. Anyone who knows that they’re -negative will buy the policy that doesn’t treat , and anyone who has will buy the other. If the insurer is allowed to charge different amounts for the two policies, they will adjust the prices to match the different expectations of cost. This different is .
Can we ban insurers from having one policy that covers and one that doesn’t? Possibly, but it’s hard. First, we have to choose all or none; if one insurer covers and a different one doesn’t, the non- people will flock to the second insurer, and the same thing happens. Second, the connection between and the treatment for may be far from obvious, and certainly can’t be expected to be known at the time we pass any particular law. For example, Down’s syndrome increases the likelihood of recurrent ear infections, so allowing policies to not cover recurrent ear infections would penalize anyone with Down’s syndrome. This might be harmless by itself, but a thousand similar options could add up quickly.
There are probably examples of insurance policy choices which wouldn’t be problematic, but figuring out which these are is an extreme subtle proposition. Moreover, this issue will become rapidly more important as our knowledge about genetic risk factors and relations between different diseases expands. I have no confidence that these nuances can be encoded in any kind of government regulation.
Does this mean we can only have one insurance policy for everyone if we want to be fair? Unfortunately to a first approximation, it seems like the answer is yes. I’d love to hear details if anyone knows of a type of policy choice which doesn’t suffer from this problem, though.
August 30th, 2009 at 3:43 pm
One case of this is pregnancy costs. Accidental pregnant is rare (scare stories about teens aside). Pregnancy is planned; yet I think most would insist upon its inclusion in any health plan. No not because they are concerned about accidental pregnancy but because they want the benefit.
In a cooperative pool, people will demand what they will consume and resist what they will not. From each according to his ability, to each according to his need.
August 30th, 2009 at 4:46 pm
Pregnancy costs are a good example. It’s unfortunate that you have to throw in the socialism reference, though. In an ideal world, we’d be able to separate the issue of insurance from the idea of progressive taxation, since they really are separate. However, but I’ll grant that this probably isn’t that world.
August 30th, 2009 at 6:08 pm
Regarding the marxist line, the qualifier “in a cooperative pool” is critical. A single payer system is one such example of such a pool, but so are more fragmentary constructions (such as are being proposed in some of the bills). I think these are distinct from ‘insurance’ more generally.
“cooperatives” would likely be apportionment of benefits (and “taxes”) by a political process–whereas, ‘insurance’ implies something based on actuarial science.
Clearly I’d like to make something work more like the latter than the former.
August 30th, 2009 at 7:16 pm
For better or worse, I think the conclusion of the argument is that “actuarial science” breaks down in the presence of sufficient individual information plus sufficient individual choice. At a minimum, it means that “actuarial science” has to mean “actuarial science plus game theory plus security analysis” in order to track knowledge and knowledge leakage. If these can be made to work, I’d prefer market mechanisms as well, but I don’t see how to target the regulations accurately enough.
Can you think of a natural set of regulations that would, for example, prohibit individuals from choosing different levels of insurance based on whether they plan to have children? Assuming you accept that it makes sense to insure against the costs of pregnancy, that is (which is an entirely subjective thing to accept).
Exotic solutions come to mind, such as allowing customers to craft their own insurance plans and running them through some kind of blind actuarial auction system, but that kind of thing is unattractive.