Adverse Selection Once Again
Adverse selection is an easy story to tell but a hard story to verify. In fact, empirical studies indicate that adverse selection is not an important (equilibrium) effect in the market for used cars, or used trucks, or of auto, life insurance or health insurance. See my earlier post, Adverse Selection is NOT the Problem, for reasons why markets handle asymmetric information better than most economists think.
In two excellent posts (here and here), Bryan Caplan further points out that the adverse selection model does not explain current regulations. Adverse selection, for example, implies that it's the low-risk consumers who drop out of the market so it's the low-risk consumers who need a mandate to buy insurance. But...
When you actually look at these regs, you'll notice some peculiarities:
1. Mandatory insurance is most prominent in the auto insurance industry. But these regulations don't target low-risk drivers. Their main purpose, contrary to the adverse selection model, is to make sure high-risk drivers get insurance.
2. Even more shocking: The regulations usually go on to somehow subsidize the rates that high-risk drivers pay. This is necessary because, contrary to the adverse selection model, insurance companies are able to detect high-risk drivers, and do not want to cover them at a loss.
3. Economists usually mention adverse selection in the context of health insurance. But in the market for individual health insurance - precisely where you'd expect adverse selection problems to be most severe - governments very rarely mandate insurance coverage. Instead, they focus on mandatory employer-provided health insurance, where the adverse selection problem is likely to be milder.
4. When governments do mandate health insurance, they almost always subsidize the rates that high-risk buyers pay. This is once again necessary because, contrary to the adverse selection model, insurance companies are able to detect high-risk customers, and do not want to cover them at a loss.
Bottom line: Real-world insurance regulation has little or nothing to do with economists' "moral hazard and adverse selection" mantra. The "intellectual" bases of real-world regulation of insurance are rather populism and paternalism: Big bad insurers won't cover people unless it's profitable, and simple-minded consumers don't care enough about their own health to pay for it themselves.
See also Tyler's post on this issue which makes many similar points.