Krugman Blames Adverse Selection Problem on Government Regulation

Not long ago, Krugman chided economists like Mankiw for overlooking moral hazard and adverse selection, the supposedly insuperable textbook barriers to free-market health insurance.  I objected:

As long as rates are legally allowed to reflect risk, there is a lot of evidence that selection is actually advantageous rather than adverse.  Despite its massive citation count, Arrow’s paper is deeply wrong.  But even if Arrow were right about the empirical importance of adverse selection, government regulation doesn’t do much about it.  In fact, it often creates adverse selection problems that wouldn’t exist by imposing regulations that make it harder for rates to reflect risk.

I’m struck, then, that Krugman now seems to have covertly accepted my point!

The reason we have restrictions on interstate sales of health insurance is that a number of states regulate insurers. In particular, some states have a form of community rating, which basically says that insurers can’t deny you coverage or charge extremely high premiums if you have a preexisting condition. And community rating will be unsustainable if individuals can buy insurance from out of state; insurance companies in states that don’t have community rating will cherry-pick the healthy, good risk people, leaving the community rating states with only the highest-cost people.

Instead of bemoaning insurers’ inability to distinguish low- from high-risk customers, Krugman now admits that they’re quite able to do so.  By his own account, adverse selection arises because the natural free-market response – higher rates for higher risk – is illegal.

Alas, Krugman can’t just admit his mistake.  He has to toss in a new error:

And what are the results of competition there? The answer is that insurers compete by doing their best to deny coverage to anyone who might actually need medical care.

Nonsense.  Insurers compete to charge people rates that reflect the cost of their care.  If you can reasonably be expected to need 50% more care, they’ll be happy to sell it to you for 50% more.  Take a look at life insurance.  They don’t “deny coverage” to anyone over the age of 40.  But they do charge higher premiums.  Why is that the end of the world?

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