537. “Insurance Is Sexy.” Discuss. | Freakonomics

Intro

In this episode of the Freakonomics podcast, titled “Insurance Is Sexy,” host Stephen J. Dubner explores the world of insurance and its impact on our lives. Dubner interviews Amy Finkelstein, an economist at MIT, who shares her expertise and insights on insurance markets, selection problems, and the role of government in providing insurance. Through their discussion, they shed light on the challenges and potential solutions in the insurance industry.

Main Takeaways

The Importance of Insurance

• Insurance provides a measure of certainty in a dangerous and uncertain world.
• Amy Finkelstein, economist at MIT, is a true believer in insurance.
• Finkelstein’s love for insurance began when working on natural disaster, automobile, and unemployment insurance.

The Problem of Selection in Insurance Markets

• Insurance markets have a problem of selection, which is a subject of a lot of government policy but most people are not aware of it.
• Adverse selection is when the selection process gets overrun by exactly the people you don’t want.
• Insurance companies try to pick the low-risk customers, while the high-risk customers try to persuade the insurers that they are low-risk.

Solutions to Selection Problems

• A famous paper by economist George Akerlof called “The Market for Lemons” argues that a mandate is the best solution to fix the adverse selection problem in health insurance.
• Mandates are the most straightforward solution to selection problems.
• The Affordable Care Act is a classic solution to addressing selection problems.

The Challenges of Health Insurance

• The main problem with a mandate is that it doesn’t guarantee everyone will buy insurance.
• To get people into the market, you have to either put a big penalty on it or subsidize them in.
• The share of people in the United States without health insurance has fallen in half, but there are still 30 million Americans without health insurance.

Selection Problems in Other Insurance Types

• Life insurance and annuities are examples of longevity insurance, which pay out for every month or year that you live.
• Both life insurance and annuities are plagued by selection problems where insurers prefer to sell policies to younger and healthier people.
• Insurance companies are full of actuarial scientists who predict how long a person will live, but they are not always good at selecting healthier people.

The Role of Government in Insurance

• Governments play a significant role in insurance, providing insurance directly (e.g., Medicare) or requiring insurance to be provided (e.g., workers’ compensation insurance).
• Governments also offer discounts or subsidies for insurance and regulate insurance policies.
• Participation in some insurance programs is compelled, and those who pay in may not receive proportional payouts, leading to questions about whether it is truly insurance or redistribution.

Summary

Insurance and Selection Problems

Insurance markets face the challenge of selection, where high-risk individuals are more likely to seek insurance, while low-risk individuals may opt out. This can lead to adverse selection and instability in the market. Economists like Amy Finkelstein argue that mandates, such as those implemented in the Affordable Care Act, are a solution to address selection problems. However, mandates alone may not guarantee universal coverage, and additional measures like penalties or subsidies may be necessary to encourage participation.

The Complexities of Health Insurance

Health insurance, in particular, poses unique challenges due to its ties to employment and the need for comprehensive coverage. While the Affordable Care Act has reduced the number of uninsured Americans, millions still lack coverage. Increasing health insurance coverage often leads to higher healthcare spending, although proponents argue that preventive care can lead to long-term savings. Employers offering health insurance can help mitigate selection problems but also introduce new complexities. Insurance policies are often tied to specific enrollment periods to prevent individuals from waiting until they are sick to seek coverage.

Selection Problems in Other Insurance Types

Selection problems are not limited to health insurance. Life insurance and annuities, which provide coverage based on longevity, also face challenges. Insurers prefer to sell policies to younger and healthier individuals, making it difficult for older or less healthy individuals to obtain coverage. Actuarial scientists attempt to predict life expectancy but may not always accurately select healthier individuals. This highlights the limitations of relying solely on data and the importance of understanding individual risk assessments.

The Role of Government in Insurance

Governments play a significant role in insurance by providing direct insurance programs like Medicare and requiring insurance coverage in certain areas such as workers’ compensation. They also regulate insurance policies and offer discounts or subsidies to promote participation. However, government intervention can create complexities and trade-offs. Patchwork policies and availability of care can be confusing, discouraging individuals from purchasing comprehensive insurance. Balancing the need for universal coverage with individual choice and affordability remains a challenge.

Conclusion

The insurance industry faces various challenges, including selection problems and the complexities of different insurance types. While mandates and government intervention can address some of these issues, achieving universal coverage and ensuring the affordability and accessibility of insurance remain ongoing goals. By understanding the intricacies of insurance markets and actively designing policies to attract desired customers, the industry can strive for equilibrium and provide valuable security to individuals in an uncertain world.