When it comes to health care policy, two viable economic theories are battling it out across the left-right spectrum. On the right, the explanation put forth to explain poor outcomes in health care is something called âÄúmoral hazard.âÄù Moral hazard is the idea that shielding a party from the consequences of a behavior induces them to act differently than if they had not been shielded. The application to health insurance markets is simple: Insured individuals have little incentive to reduce their health care costs, and, as a consequence, they overuse medical services, undergoing expensive and unnecessary procedures. The moral hazard explanation, when followed to its logical conclusion, results in health care policies like Sen. John McCainâÄôs, which would have replaced the generous tax subsidy given to employers with a correspondingly generous tax credit to individuals. McCain would have ended the current system of health care (in which a third party âÄî employers âÄî covers insurance costs) and replaced it with a direct insurance market where if an individual wanted the type of insurance that would cover all their unnecessary tests and procedures, theyâÄôd end up paying for it through higher premiums. The idea was that by more direct linking of people to the health costs they incur, there would be more efficient rationing of health care, costs would go down and more effective health care would be available for everybody. On the left, the explanation put forth to explain poor outcomes in health care is something called âÄúadverse selection.âÄù Adverse selection is the idea that markets fail when there is unequal information between the two sides in a transaction. The application to health insurance markets is that insurance buyers know more about their own health and habits than insurance sellers. To illustrate: Suppose that there is a pathogen, called Disease X, sweeping the country. It is fatal within four weeks of the first symptoms being detected, but is easily and forever cured with a pill that costs $10,000. The population has varying degrees of vulnerability to Disease X such that the probability of contracting it is 10 percent at the first decile, 20 percent at the second decile, 30 percent at the third decile and so on. An insurance company looking to insure individuals against Disease X takes a look at the population and finds that the mean chance of contracting the disease is 50 percent, and so makes an offer: For $5,000, anybody can buy insurance against Disease X âÄî in other words, if you buy insurance and contract the disease, the insurance company will pay for the pill that cures you. Individuals know their personal risk of contracting Disease X, but the insurance company does not have this information. If everyone were to buy the insurance being offered, the insurance company would break even and all would be well. Unfortunately, with adverse selection, this doesnâÄôt happen. Only the people with a greater than 50 percent chance of contracting Disease X end up buying the insurance, and the insurance company finds that on average it pays out $7,500 per customer instead of the predicted $5,000. If the insurance company had offered the insurance at $7,500 per person, their average payout would have been $8,750 and so on. With no profitable way to provide insurance, the market is unstable and results in millions of uninsured. The left draws a conclusion that is almost entirely opposite that of the right. Direct markets for insurance donâÄôt work âÄî we need setups like employer-provided insurance if there is to be any stable market. Employer-provided coverage, nearly the sole vehicle for health insurance in the United States, works because it avoids the problem of adverse selection âÄî it is very rare for people to choose their employer based solely on the health benefits. The policy prescription from the left is insurance mandates. Making everyone buy insurance prevents people from adversely selecting to not buy insurance. During the campaign, President Barack Obama campaigned on a middle ground that simply doesnâÄôt exist. Although the problems facing health care are likely a mix of both moral hazard and adverse selection, ObamaâÄôs health care plan solves neither. Instead, he seems to view the task as if health policy were no more than an advanced form of welfare, a duty borne by the rich to fund the care and medication of the poor. But health care policy is more than a wealth transfer program âÄî itâÄôs a positive-sum game that should fix the fundamental problems threatening health insurance markets. There are two simple reasons why Obama should lean towards insurance mandates. First, insurance mandates solve the problem of adverse selection without precluding a solution to moral hazard. The managed care debates of the past few decades combined with something like prospective reimbursement could reduce adverse selection while curbing unnecessary procedures at the same time. Secondly, insurance mandates and other Democratic proposals will reduce administrative costs. A significant slice of insurance premiums go to cover actuarial costs. The billions of dollars spent in underwriting and paperwork represent a real loss to society âÄî avoiding them would be a happy side-effect of a mandate system. Shifting to the left on health care will be doubly painful for Obama: Not only will he be reneging on his commitment to bipartisanship, heâÄôll also be forced to eat the words he said on the campaign, when he ridiculed Edwards and Clinton for their support of mandates. But no one ever said that doing what is right would be easy, and it certainly would be a shame if health care policy was made to suffer because a president couldnâÄôt admit his own party was right. This column, accessed via UWire, was originally published in The Tech at the Massachusetts Institute of Technology. Please send comments to [email protected].