ADVERSE SELECTION. Taunter Media (via Folkbum) analyzes the algebra of insurance company rescissions.

Half of the insured population uses virtually no health care at all. The 80th percentile uses only $3,000 (2002 dollars, adjust a bit up for today). You have to hit the 95th percentile to get anywhere interesting, and even there you have only $11,487 in costs. It’s the 99th percentile, the people with over $35,000 of medical costs, who represent fully 22% of the entire nation’s medical costs. These people have chronic, expensive conditions. They are, to use a technical term, sick.

In that breakdown is an argument for requiring everyone to purchase health insurance. Presumably the people who opt to do without health insurance estimate that they will not use any health services, and it's likely that a meaningful share of those people bet correctly. (On the other hand, pre-existing condition is not limited to people who change jobs: per corollary to the canonical business law question about the farmer who buys wind insurance as he sees a funnel cloud to his southwest ...) So far, I'm pleased to report that other participants in the Illinois plan are benefitting from my premium payments, as befits somebody whose only award in high school was for perfect attendance.

It should be fairly clear that the people who do not file insurance claims do not face rescission. The insurance companies will happily deposit their checks. Indeed, even for someone in the 95th percentile, it doesn’t make a lot of sense for the insurance company to take the nuclear option of blowing up the policy. $11,487 in claims is less than two years’ premium; less than one if the individual has family coverage in the $12,000 price range. But that top one percent, the folks responsible for more than $35,000 of costs – sometimes far, far more – well there, ladies and gentlemen, is where the money comes in. Once an insurance company knows that Sally has breast cancer, it has already seen the goat; it knows it wants nothing to do with Sally.

If the top 5% is the absolute largest population for whom rescission would make sense, the probability of having your policy cancelled given that you have filed a claim is fully 10% (0.5% rescission/5.0% of the population).

Conditional probability is nasty stuff. Insurance companies that offer a cash settlement in exchange for a patient waiving future claims make a similar calculation, which is why the best thing to do with such an offer, assuming the rescission option isn't in a desk drawer, is to decline it.

The substitution of a government insurance policy, or the enforcement of stricter conditions on rescissions, however, does not make the underlying problem of allocating scarce resources go away. There has to be a better way to debate the issue, however, than trotting out scary stories about rescissions on one side and death panels on the other, there being a significant overlap between being in the 99th percentile of incurring health expenses and being in the 99th percentile of your cohort predeceased you.