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Evaluating Solutions to Adverse Selection in Insurance
A country's individual health insurance market is failing. Because insurers cannot distinguish between high-risk and low-risk individuals, they charge a single premium based on the average risk of the population. This premium is too high for healthy, low-risk people, so many of them choose not to buy insurance. As a result, the pool of insured individuals becomes increasingly high-risk, forcing insurers to raise premiums further in a cycle that threatens to make insurance unaffordable for everyone.
The government is considering two policy proposals to address this specific problem.
Policy 1: The Individual Mandate Require all citizens, regardless of their health status, to purchase a government-approved basic health insurance plan.
Policy 2: Perfect Risk-Based Pricing Allow insurance companies full access to individuals' health records and genetic information to enable them to charge each person a premium that accurately reflects their specific health risks.
Evaluate which of these two policies more directly and effectively solves the market failure described. In your answer, justify your choice by explaining how it addresses the core information problem. Also, briefly discuss one significant economic or social trade-off associated with the policy you have chosen.
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