"Ahem." Roderick checks the mike and waits for silence. The Old Ivy Political Economy Club meets tonight to hear part two of Roderick's paper on health insurance.
He continues. "In the first part of this paper, I discussed the heterogeneous nature of health care services, and drew a distinction between urgent care, care that is medically necessary but not urgent, and care that is truly discretionary. I pointed out that at the two extremes, one can argue that there is a robust market for discretionary services (such as laser vision surgery), but that it is difficult to speak of a market at all for urgent care.
"Turning attention to health insurance services (as distinguished from health care services), we should draw a distinction between those risks that are insurable and those that are not. Insurable risks have specific properties: they are (1) well-defined and specific; (2) measurable; (3) predictable in a large population, and (4) distributed at random in the population. This last point covers the concepts of adverse selection and moral hazard, which I will illustrate with examples.
"It is possible, for example, to write an insurance policy that indemnifies a homeowner from losses in a fire because the risk is well-defined, measurable and the insurance industry has lots of data about the incidence of fires. Such policies necessarily exclude coverage in the case of arson by the homeowner, just as life insurance policies generally exclude coverage in the case of suicide. Arson and suicide are examples of moral hazard, where the insurance beneficiary can influence the probability of a claim.
"Insurance pools that do not prevent moral hazard will be subject to adverse selection, or the tendency to attract high-risk individuals. In other words, a fire insurance pool that does not exclude arson will attract a disproportionate number of potential arsonists and soon run out of money. This is true regardless of who underwrites the policy; the principles of insurance apply to government-issued insurance and private insurance alike.
"Health insurance is particularly susceptible to moral hazard. As previously noted, there is an entire class of health services that is discretionary, and entirely within the control of the beneficiary. There are other kinds of moral hazard in health insurance that are more subtle. For example, doctors are more likely to prescribe expensive medical treatments when they know that the patient has a generous health care insurance plan. Studies have shown that there are patterns in the distribution of medical diagnoses that are best explained as profit-maximizing by health service providers.
"In the political debate about health insurance, much attention is given to the question of insurance for those with pre-existing conditions. This is considered the acid test of any credible policy proposal, and it is the justification for the individual mandate. Aside from the fact that the actual incidence of this problem is greatly exaggerated, the most important thing to consider is that while this is a political and social question, it is not an insurance question at all. A person who is already diagnosed with Huntingdon's Disease, for example, does not face the risk of high medical expenses; they face the certainty of high medical expenses. It is not possible to write an insurance policy that will cover the cost of treatment for Huntingdon's Disease among the population of those already diagnosed with the disease, for the simple reason that such an insurance pool would rapidly become insolvent unless premiums are set so high to make it too expensive for anyone to purchase.
"In other words, it is not possible for anyone -- for-profit companies, charitable institutions or the government -- to insure against the cost of health care for previously diagnosed conditions. The only possible course of action is to subsidize the cost of these policies."
Roderick notices that Lily, who is exceptionally hot tonight in her low-cut and tightly fitting black cocktail dress, is motioning to him and pointing to her watch.
"Looks like I'm out of time here, so I'll deliver part three in another session." Roderick takes his papers and steps away from the podium, to polite applause.
Lily steps to the podium. "Thank you, Roderick, I'm sure we're all looking forward to that. Next on the agenda tonight, I would like to welcome fourth-year student Rodney Tinklestein, whose paper is titled "Bitcoin: The New Reserve Currency."
Rodney, who is something of a rock star among fourth years, steps to the podium amidst thunderous applause.
Backstage, Roderick calls Mr. Smiley. "Hello, Mr. Smiley, it's Roderick."
"Hello, Roderick."
"I just delivered the second part of my paper about health insurance."
"That's nice." Mr. Smiley doesn't really understand health insurance. In Smileyville, you go to the doctor when you are sick, and somebody else pays.
