II. New genetic tests make it possible to predict, at low cost and with considerable accuracy, whether someone will get cancer, die young of a heart attack, etc. Consider three alternative scenarios. In each case, ignore complications associated with the fear of death--the possibility that people would not want to know their future, even though the knowledge would be useful, for fear the knowledge that they were likely to die young would make them unhappy. In each case, assume that the outcome of the test is not public information, even if the fact of the test is.
What will happen in each case?
Will people choose to be tested?
Will people buy more or less life and health insurance than before the testing was invented?
Is any scenario an economic improvement (in terms of efficiency as we have defined it) over a world without testing? Over other scenarios?
1. Insurance companies are forbidden to condition their rates on an individual's willingness to be tested or on the results of such tests; whether an individual has been tested is not public information.Adverse selection. Everyone gets tested, only the ones who have bad genes buy insurance--at a price appropriate for people with bad genes. Less insurance is bought, people are worse off so far as insurance is concerned, although they may be better off because of other gains from the information (better medical precautions).
2. Insurance companies are permitted, if they wish, to condition rates on test results and to require a test as a condition of insurance; whether an individual has been tested is not public information.
People with good genes get cheap insurance, people with bad genes get expensive insurance. The risk of having bad genes is now uninsurable (since if you try to buy insurance before being tested, the insurance company will suspect that you have been tested and got a bad result, and will charge you a bad gene price). This is an improvement over case 1, since good gene people can at least buy insurance at a good gene price, but (with regard to insurance only) a worsening compared to a world without testing.
3. Insurance companies are permitted to condition rates on test results, and to require a test as a condition of insurance; whether an individual has been tested is public information; anyone who wants to, including the insurance companies, can find out.
This is the best case. People who want to insure against bad genes buy insurance before being tested, at a price appropriate for someone who might or might not have bad genes (since the insurance company knows they haven't been tested). Everyone has the option he had in the world without testing, plus any benefits from testing (after buying insurance), so it is an improvement over the world without testing. Each person has the option of testing before buying insurance (although it is not clear that anyone will), so it is an improvement over the other two cases as well.