February 19, 2010 12:40PM

Krugman Don’t Know Health Insurance

When I debated Nobel Prize-winning economist Paul Krugman on health care reform, I asked him if he was familiar with the work of University of Pennsylvania economist Mark Pauly.  Pauly is a leader in the economics of health insurance.  He and his coauthors have shown that health insurance markets are way ahead of politicians -- and way ahead of economists -- in solving the problems that bedevil health insurance markets. I already knew the answer: only someone completely oblivious of Pauly's work could have debated as Krugman did.  (As Krugman himself demonstrated in that debate, you never want to ask a question to which you don't already know the answer.)

Krugman's column in today's New York Times tells me that he still has not read Pauly.

Krugman addresses the 39-percent premium increases that insurer Wellpoint planned to impose on its California customers:

WellPoint claims ... that it has been forced to raise premiums because of “challenging economic times”: cash-strapped Californians have been dropping their policies or shifting into less-comprehensive plans. Those retaining coverage tend to be people with high current medical expenses. And the result, says the company, is a drastically worsening risk pool: in effect, a death spiral.

Krugman then argues that if Wellpoint's explanation is accurate, then that demonstrates that free-market reforms would cause private insurance markets to collapse, and demonstrates further the need for government to impose price controls on health insurance and to force healthy people to purchase it.

Yet there are at least two major problems with Wellpoint's story.

  1. Healthy people dropping coverage would not lead to across-the-board premium increases in California, because California allows markets to set premiums.  Only when the government imposes the kind of price controls that Krugman wants does an "adverse selection death spiral" follow.
  2. Krugman may be thinking, "Even with market prices, once the healthy people drop out, insurers must raise premiums to cover the future costs of the sick people who remain." Yet Pauly and his colleagues show that insurers collect the money they need to cover those costs in advance by "front-loading" premiums.

There is still one way that Wellpoint's story could have some validity -- I'm curious to know if Krugman knows what it is -- but as University of Chicago economist John Cochrane explains in this Cato study, that particular problem is due to government failure, not market failure.

In an email to me, Pauly offers a more reasonable explanation for Wellpoint's premium hikes:

Individual insurance premiums are very volatile so you can always find some insurer jumping their premium a lot.  Consumers then usually move to the insurer that did not.  I know the ... California story: Wellpoint had tried aggressively to expand its individual business by setting low premiums, and I think realized the underpricing to gain market share did not make sense in a recession, so they put premiums back up where they should be.  Maine is heavily regulated so I do not know the story there but I bet these big hikes came after several regulatory refusals to increase premiums moderately -- so again we see a correction of underpriced coverage... I could be wrong but I think this is all political; you could have found this story at virtually any time in the last 10 years but it is more salient now.

The next time Krugman wants to interpret news about health insurance markets, he should do what I do: check with Mark Pauly.

Krugman also declines to consult the literature when he claims that allowing people to purchase health insurance across state lines would lead to a "race to the bottom" as states gutted their consumer protections.  (It wouldn't.)