Insurance

Insurance works if

  1. You have a sufficiently large population of people at risk of some loss.
    • Otherwise, the insurance company can’t get started, since it can’t earn enough in fees to pay off the loss when it happens.
  2. The loss is large enough that most people are unable or unwilling to take a chance on having it happen to them.
    • Otherwise, most people simply self-insure. E.g., most people do not buy insurance for their bikes, because they can afford to buy a new bike if necessary.
  3. The loss occurs unpredictably.
    • Otherwise, the only people who buy insurance will be those who are likely to suffer the loss, and so the insurance company is forced to charge fees commensurate with the loss, violating clause 2.
  4. The loss occurs to a sufficiently small percentage of the population.
    • Otherwise, the insurance company again must charge fees commensurate with the loss.

Health care meets conditions 1 and 2, but fails to meet conditions 3 and 4. As people get old, they predictably require health care. As people get old, they all require health care. Therefore, health case is not amenable to an insurance solution.

There is an aspect of health care which is amenable to health insurance: young and healthy people are unlikely to require much health care, but they are vulnerable to catastrophic events (in the U.S., typically a car crash or similar major accident). Therefore, there is a valid insurance market in providing catastrophic health coverage for the young and healthy. This would cover all health care charges after some large deductible.

However, using “health insurance” to cover routine care, and using it to provide coverage for people who are old and/or sick, simply isn’t insurance. What we call health insurance is in effect a tax on the young and healthy to provide health care to the old and sick. However, it is a very inefficient tax because it is collected by private for-profit companies which have a strong incentive to increase premiums and reduce payouts, and which in turn requires regulation which is paid for directly by taxes. And, of course, it leads to massive social inequity in that sensible preventative health care—i.e., routine doctor and dentist visits—is simply not available for poor people.

There is a role for private enterprise in health care, of course. There is nothing wrong with having private doctors and private hospitals. But private “health insurance” companies really makes no sense.

As an aside, pregnancy raises another set of predictable costs not amenable to an insurance solution.

This argument seems perfectly straightforward to me. The U.S. only uses private health insurance due to a historical accident: wage freezes in World War II led employers to pay for health care as a benefit to attract workers. Why are so many in the U.S. fixated on continuing a scheme which almost by definition can not work?

The bill which recently passed in the house addresses clause 3 above by simply requiring everybody to purchase health insurance. But it does not address clause 4. Since nearly everybody eventually requires substantial amounts of health care, health insurance premiums must be high, or people must find some other way to pay for their health care. That “other way” winds up being Medicare, which is funded by taxes. So how does health insurance help?

And then there is Medicaid. As long as we are not willing to let people simply die in the streets, poor people without health insurance will get their health care from emergency rooms, where it is vastly more expensive. We all pay for that through our taxes. Getting rid of the tax imposed by private health insurance companies, and paying directly for routine medical care for the poor, will actually reduce our overall tax burden.

If we could strike the word “insurance” from all discussion of health care in the U.S., I think our long-term health care needs would be much better met. Unfortunately, the health insurance lobby is large and powerful.

9 Comments »

  1. graydon said,

    November 9, 2009 @ 8:48 pm

    I hear this argument a lot. I don’t understand how people can state it, it seems totally wrong. I mean, I love my wonderful Canadian public health care, I don’t disagree with your desire to get the private insurers out of the game. But it’s plainly insurance any way I can look at it.

    The cost of showing up for a routine checkup, or having someone come check on you, are predictable. Sure. But those costs are trivial. The specific illnesses discovered, the specific costs of treatment for each individual, the response or complications in each case, are completely unpredictable. You can’t tell, when you go in for a checkup, whether you’re going to be found perfectly healthy or dying with some exotic disease that is only just barely surfacing. Do you have a rash or a blood disease? An allergy or a failing organ? A bump or a tumor? Beyond a point in a probability distribution, you have no idea. And you certainly won’t know what you’ll find 10 or 50 years from now. That’s why you go for the checkups!

    The fact that old people happen to have sharper probability curves for a lot of illnesses means nothing as far as allocating money for each *specific* ageing person; this is like saying that houses further south burn down more often in wildfires. So? You still treat the unpredictable like insurance. I’ve known old people who dropped dead suddenly and old people who stayed in care homes for 20 years. How were we supposed to price their “predictable” need for age-related health care?

    Am I somehow missing the method by which specific illnesses can be predicted by those who will suffer them?

  2. Ian Lance Taylor said,

    November 9, 2009 @ 10:43 pm

    You can’t predict specific illnesses, but that’s irrelevant to the argument. You can absolutely predict that people will get ill and die. It’s as though you were selling fire insurance in a town where every house burned down approximately every 70 years. You wouldn’t know when a particular house would burn down, or how, but you would know that it would burn down. If anybody sold fire insurance in such a town, they would make sure to cancel it after 60 years.

    It’s true that some people suddenly die with little health care expense. But it’s not common. It’s certainly not common enough for an insurance company to base their profits on.

  3. graydon said,

    November 9, 2009 @ 11:40 pm

    Who said anything about profits? Set that aside[1]: I’m not suggesting any form of profit-making here, just risk-sharing. The fact is that you face a risk of *unknown* form. It will strike at unknown time and cause you unknown grief before it’s complete, and will cost those around you unknown time and money to adapt to. All you know for sure is that you’ll die; the how-and-when very much do matter. If you die 1-5 years into your retirement due to a cheap and quickly-terminal illness, you may be able to pay the medical bills out of pocket. Assuming you were wealthy enough to have savings. If you die 20 years in after a series of winters spent fighting seasonal flus in extended hospital stays (as many go), you’ll cost a huge amount more. This is not “freak rare expense scenario” I’m talking about: that’s the *normal range of variation* in expectations of death, that people are concerned about insuring themselves from having to face the worst of on savings alone. Nobody chooses either of those paths. They Just Happen.

    And beyond death, a whole lot of people — many? most? — wind up with one or more “surprise” illnesses of somewhat serious cost during their lives. They don’t choose these, despite being “predictable”, again in aggregate. I Browse through http://en.wikipedia.org/wiki/Category:Diseases_and_disorders and see how many of these you think you can see coming. We know 128 or so people will get St. Louis encephalitis this year. We have no idea who. The odds it’s me are slim. Who should pay for my treatment if I get it? That’s one of thousands and thousands of disorders. People don’t budget for things too myriad and improbable to account for individually: they buy blanket insurance policies and let the actuaries figure out a sensible price for the whole basket. In my country, depending on province, it may be called a price, a fee, a premium or a tax. The name doesn’t change what it is.

    [1] If you really can’t swallow a non-profit, public collective enterprise, and are convinced of the necessity of reducing human activity to one-dimensional profit motive, note that insurance requires overcapacity to be safe, and the excess can be used for a little lower-risk investment, turning insurers into capital lenders (as many are). This gives them plenty of profit motive if they’re permitted to use it, and they can be legislatively prohibited from any other discriminatory policies and/or excessive premiums. The same way food companies can’t sell you crack cocaine and/or recycled tire chips (which they gladly would, if “profitability” were allowed to dictate policy). Though I really can’t believe this sort of thing has to be debated.

  4. Ian Lance Taylor said,

    November 10, 2009 @ 12:07 am

    I’m essentially arguing that if health insurance genuinely covered every health condition for every person, that the premiums would be too high for most people to afford. That’s what I mean by saying that health insurance violates clauses 3 and 4 in my original post. I don’t see anything in your comment which demonstrates that that is false.

    You seem to be assuming that a good percentage of people die of a “cheap and quickly-terminal illness.” I have argued that that is not common enough to make an insurance plan work. In the U.S. health system, people die in very expensive ways. A stay in the intensive care unit at a hospital can routinely cost $10,000 per day.

    I don’t know why you are accusing me of reducing human activity to a one-dimensional profit motive. I’m just arguing that health care is not amenable to an insurance approach. To be clear, I do think that in the ideal world health care would be handled through a non-profit, public collective enterprise. Like, say, the government. But that’s not an insurance system. That system works not by charging people insurance premiums, but by making wealthy people pay much more than poor people into the collective pool.

    We may be talking past each other; I’m not sure. If you want to argue that we can handle health care via insurance, then I think you need to argue that my original 4 clauses do not reasonably describe insurance, or you need to argue why health insurance actually does follow those clauses. Maybe you’ve made those arguments, but I’m having a hard time seeing them.

  5. graydon said,

    November 10, 2009 @ 8:57 am

    Ok. I agree it seems like we’re talking past one another, and I’m sorry for perpetuating that. I’ve seen this argument several times and it always looks like it’s taking an irrelevant point (whether to call something “insurance”) and using it as a bad-faith attempt to dismiss all those who use the word “insurance” while failing to address all the real matters. Real matters such as: non-universality of coverage; withdrawn coverage when sick; or premiums, deductibles and co-pays that are *currently* too high to meet for many people, bankrupting them in the process of “getting health care”.

    I don’t see your original 4 points as necessary conditions for using the term “insurance” and I don’t see why you think that anything would get cheaper if you avoided it. Suppose your private insurance companies became “private medical service trustees” to whom you were required to pay a “levy” rather than a premium. Would they be less abusive? Hardly. Without specific legislation, they’d reject all the same “customers” due to their pre-existing conditions, cancel customer relationships they weren’t making money on, still make you sign an agreement that the care you were receiving only covered the cheap stuff, that you had to pay for expensive stuff out of pocket, still make up dozens of unrelated “fees” to jack the price up, etc. etc. Just like any other for-profit corp.

    Maybe I should ask: where do you think the term “insurance” — if inappropriate — is genuinely a cause of any of the perceived *problems* with the current system, rather than just “abusive business practices”?

  6. Simetrical said,

    November 10, 2009 @ 9:37 am

    It matters that our current health care system is not insurance. Because people think of it as being like any other type of insurance, the system is set up in a way that works well for actual insurance, but not for routine expenses.

    If a cost is predictable, it makes no sense whatsoever to pay a third party who will then predictably pay you back, with a markup. Let’s say you know you go to your GP once a year and it costs you $150. The current system has your employer pay your insurance company some amount (probably in excess of $150) so that it in turn pays your doctor, with much paperwork and headaches all around. It would make far more sense for your employer to just give you the $150 (in fact more) to begin with, so that you can pay your doctor directly and pocket the overhead. This is currently illegal: in many cases, health care must cover routine doctor appointments, and you cannot opt out. You’re required to waste your money on middle-men. Mandatory public health insurance would make this worse.

    Moreover, the wealth redistribution caused by health care plans is inequitable. In most things, we require the rich to subsidize the poor; in health care, we require the healthy to subsidize the unhealthy (by requiring that they be charged the same premiums in many cases, due to anti-discrimination laws and such, despite the difference in payouts). It makes much more sense for the wealthy to subsidize the poor, because money is worth less to the wealthy than to the poor. The healthy poor should not subsidize the unhealthy rich. To the contrary, the unhealthy should have to pay more if anything, all else being equal, since they impose a burden on society, and bad health should be discouraged.

    You cite practices that you object to, like rejecting customers who are too high-risk. But these practices stem precisely from the fact that health insurance is treated as insurance. Insurance is about amortization of risk, and there’s no point in insuring someone who’s too high-risk. If you build your house in a location that will almost certainly have a serious earthquake within ten years, no one will sell you earthquake insurance. There’d be no point; the premiums they’d have to charge would be so high that you might as well take the risk yourself. It’s not a matter of profit, it’s just that insurance is not a form of wealth redistribution: you’re losing money on average in exchange for more predictable expenses.

    We do not require insurance companies (or government insurance agencies) to cover our routine expenses of food, electricity, clothing, housing, water, heating, cars, or anything else in the world. Some of these things are even more essential than health care, but all of them we pay out of pocket. If (and only if) someone is too poor to afford routine expenses for these necessities, the government steps in to provide subsidized housing, food stamps, or the like. In some of these cases, we can also privately purchase insurance (for houses, cars, etc.) to protect against unforeseeable catastrophes that will probably never happen, just to be safe. But this is a *totally unrelated thing*.

    So forget about the entire health insurance system. It’s conceptually broken. Throw out all health insurance regulation, and regulate it like any other private insurance: people (not their employers) choose whether to buy insurance and what company to buy from, and it covers only unforeseeable catastrophes that will probably never happen to you (like car accidents or cancer). Routine costs are paid for out of pocket, and the government provides extra support for those who can’t pay their own routine medical expenses. Consumers are no longer insulated from costs by insurance companies, so health care providers begin competing on price, and health care becomes drastically cheaper. Everyone wins except maybe the insurance companies (who are much less regulated, but pull in much less money).

    But nobody seems to be seriously advocating this, alas. It’s too drastic a change.

  7. graydon said,

    November 10, 2009 @ 10:39 am

    On the contrary: that is what *everyone* presenting your argument advocates. And I dislike it as a “solution”; it makes sense only for people who are extremely wealthy, and have (or think they have) perfect self control and foresight. It’s a classical libertarian solution carrying all of the classical faulty assumptions about rational human nature and the lack of systemic concerns.

    You keep changing your argument about where money actually comes from and why that’s bad. The plain fact is that some of the current system — in every country — is healthy-subsidise-unhealthy and some is rich-subsidise-poor and some is simply temporal displacement of yourself (your healthy or rich days subsidise your sick or poor days). None of this is intrinsically inequitable, and all of it is (IMO) exactly like any other kind of insurance, with the exception that it’s *so* important to ensure universality that policy has been set up to prevent citizens from shooting themselves in the foot (or having their insurer get them to sign forms that shoot themselves). Some information we think is legal to discriminate-on gets baked into the premiums, some which we think it is not legal to discriminate-on gets legislatively excluded from per-customer premiums, turning into blanket fees applied to everyone (or thrown further out, to general taxation).

    The health care reform that’s afoot in the US is doing — and should be doing — two things: banning the practices that are abusive, including the parts that fail to extend coverage to citizens, and setting up a stable, not-for-profit, legislatively guaranteed version of the private funds so that citizens have somewhere to turn if the private fund operators find new loopholes or otherwise misbehave.

    A stronger version would ban the private funds or exclude them at least from the entire arena of medically-necessary care (my preference, and how it works here) but it depends on having more of a dislike for market failures and corporate collusion that it seems the citizens of America possess.

  8. Simetrical said,

    November 10, 2009 @ 8:23 pm

    There’s nothing libertarian about my solution. It’s a standard liberal regulated-free-market idea. It’s exactly how every other necessity is provided for in our society. Why should health care be any different from housing, say, other than historical accident? The libertarian approach would be to not have the government help anyone, and just let sick people die if they can’t get help from the private sector. I don’t support that at all.

    Being wealthy or having foresight has nothing to do with it. The government can provide health care for the poor, just as it provides them with food and housing. Foresight isn’t any more relevant than it is for car or home insurance. Since the insurance would only cover events that are unlikely to ever occur to you, you’re fairly safe even if you’re too short-sighted to buy health insurance.

    Healthy-subsidize-unhealthy is bad, rich-subsidize-poor is good. Money has less utility to the rich and more to the poor, so there’s net gain to society if you move it from rich to poor. That’s the idea behind wealth redistribution. Anytime society needs money, it should come mainly from the rich. You should not have to pay extra money if you’re healthy: you should be encouraged to be healthy, by lower health care costs. Rich people can be made to pay more money (up to a point) without discouraging people from becoming rich, because a rich person after 40% marginal tax is still richer than he would be if he hadn’t earned the extra money.

    None of this is at all like any other type of insurance. This is fundamental. In every type of insurance other than health insurance, you amortize *your* risk. That’s it; no one else’s. You don’t pay to help out other people. If you buy fire insurance for your house, you pay based on your own risk with no regard to anyone else’s. The insurance company does not charge its less risky clients more than their risk warrants, and use that to reduce costs for riskier clients. Everyone contributes to the pool precisely in proportion to their own risk. There’s no redistribution of wealth. Just amortization of risk.

    I’m really not seeing how you can think that health insurance remotely resembles any other type of insurance in practice. Let’s draw some straightforward analogies:

    If car insurance were like health insurance, your insurance company would have to charge you the same liability insurance whether you drive a Jeep or a motorcycle. The insurance would be required by law to cover gas and tune-ups; offering insurance that only covered serious accidents would be illegal. And you could buy insurance after you crashed the car, at no higher premium, and the insurer would be required to pay to repair the car after the fact. (Or at least, some would like this for health insurance.) And, of course, your employer would choose what car insurance you get, docking the premiums from your pay and not letting you choose a different plan.

    If health insurance were like car insurance, it would cover only serious and unexpected illnesses, like cancer or being hit by a bus. It would not cover routine medical appointments or prescriptions. You would expect to only have to actually file a health insurance claim a few times in your life, rather than multiple times per month. You would be the one to choose your insurer, and your employer would neither know nor care what plan you chose. You would be charged an amount determined by actuaries based on your personal risk, with no regard to fairness, just like in any other business transaction.

    You can replace car insurance with most other types of insurance there: home insurance, property insurance, and so on. (Okay, there are some other oddballs like life insurance, which isn’t really insurance either.) There’s a really radical difference. I’m not sure why you see them as being at all similar.

    By the way, just to make things clear: I’m in favor of universal health care. Poor people who cannot afford routine health care should have their health care paid for by the government, and the government should also step in to defray the costs of uninsured catastrophic health problems (or just require people to get insurance for catastrophic events, as it requires them to get liability insurance for their cars). But paying routine expenses by giving money to an organization that then gives it to your care provider makes no sense and provides no benefit. Just give it to them directly. What’s the point in paying someone to predictably pay your doctor $150 a year rather than just paying yourself directly?

  9. graydon said,

    November 11, 2009 @ 12:02 am

    What? No, a normal insurance policy amortizes the risks borne on average by the entire pool of policy-holders. The whole point is that the pool has enough collective cash to handle the collected-and-averaged risks of everyone, even though a single policy-holder may well not contribute enough over their life to pay for the worst that might befall them.

    Take my apartment. It doesn’t burn down this year. My apartment-insurance premiums finance the payout to the poor guy across town whose apartment did burn down this year. The healthy apartment financed the sick one. By design.

    Anyway, I grow tired of this. We disagree somehow, it’s probably not important, and it’s late.

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