Abstract
One of the principal justifications for publicly provided or mandated insurance is the so-called adverse selection problem by which risk classes are indistinguishable to the insurer and therefore, like Gresham's Law, bad risks drive out good risks by raising rates.1 The government, by forcing good risks to buy more insurance, or preventing bad risks from buying too much, can lower rates for everyone. The purpose of this paper is to examine the conditions, in a simple model of adverse selection, under which public insurance will be Pareto superior to the competitive outcome.2 Since the model considers only two different risk classes, we treat separately the cases where the amount of public insurance is chosen by each of the risk classes. In general, good risks are likely to choose less insurance than bad risks. While the model is most applicable to traditional insurance problems, such as medical insurance, it could be extended to general income redistribution
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