Free market incentivizes adverse selection

Perhaps the most serious disadvantage of leaving the private insurance industry largely in place is that it pre serves adverse selection, which leads insurers to avoid insurance risks and limit their coverage. Adverse selection in health care occurs when a dispro portionate number of people in poor health select a particularly generous insurance plan.22 Where insurance companies compete as payers, they typically differ in the services they cover and in reimbursement rates. Suppose plan A covers outpatient psychiatric servicesw hile plan B does not, orA reimbursesm ore generously for such services. Patients with psy chiatric problems may gravitate to A, which results in A enrolling many people who need extensive services. This is very costly for the company that administers A. Given variations in different plans' terms, and given that patients may choose from among these plans, the threat of adverse se lection encourages health plans to offer less generous benefits and to ad vertise to wealthier, healthier groups, or to find other ways of avoiding those who most need health care. Now, a system could address the threat of adverse selection by requir ing that each plan cover the same ser vices and charge the same premiums, deductibles, and so on, and by guar anteeing that anyone can enroll in any plan. Standardization of the basic terms of each plan in a system of truly open enrollment tends to level the playing field. But if the terms of each . plan are to be uniform, why have dif ferent plans at all? A champion of competing plans might reply that each is to deliver health care, never merely provide in surance (as Blue Cross and Blue Shield do). Competition in delivery, the argument goes, will promote quality, thereby justifying higher ad ministrative costs. This may be cor rect. Note, though, that each move identified for avoiding adverse selec tion?standardizing prices and cov ered services, maintaining open en rollment, and requiring competing plans to deliver services?steps in the direction of a single-payer system. Later we will return to the prospect of merging single-payer financing with competition.