Monday, August 31, 2009

Covering Insurance

A podcast with FEE on this topic is found here.

If you have a television or have listened to talk radio you cannot help but notice the large controversy surrounding the role of government in our health care system. Recently I heard one talk radio caller make the following comment: “I can see that doctors and nurses provide a service, but what does an insurance company add?” The implication was that since insurance companies are not adding anything “real,” they are simply parasitical and could be easily replaced with a government agency.

Today there is a general lack of understanding when it comes to insurance. The word “insurance” has been misused for decades. We have Social Security Insurance, Unemployment Insurance, Medicare Insurance, but none of these programs are actually insurance programs. Many people look at insurance as a Club Membership Discount Card. The thinking is “Once I get the card, I will get health care for less or even for free!” However, this is not what insurance is.

Insurance is about the mitigation and elimination of risk.

It begins with the idea of class risk. Class risk means that we know the statistical probability of an event happening to an individual in a group but we don’t know who in particular it will happen to. So we could know that a certain percentage of MOC students will get into a car accident or get cancer or have their house burn down, but we couldn’t point to someone and say that it would happen to a particular person.

If an individual can influence the probability of the event, then they change their risk class. So if you are a careless driver, then you are a higher risk. And this is why we do not pay insurance claims to arsonists who burn down their own houses.

Insurance is when we all put a small amount of money into a common pot. The winner of the pot is the one who suffers the tragedy. So the guy who gets into a car accident is the winner and gets to pull the money out of the pot. The guy who gets cancer is the winner and the winner is also the guy whose house burns down. The losers are those who are fine. They are not in car accidents nor have any other tragedy befall them. The money the “losers” put into the pot goes to the “winners.” The risk of not being able to pay for the catastrophic event is reduced or eliminated because of the existence of this pool of money.

Suppose that you and your friends have no insurance and there is no social safety net. As a result, you are exposed to risk. If something happens, you are fully liable for the full cost of whatever that has befallen you. Suppose that you are most worried about broken bones. You and your friends are a fairly safe group and the class risk for this group is that one person in the group will break a bone over the course of the year. We don’t know who will break their bone this year but we can predict that it will be one person. So if you and your friends come together and each put a small amount into a fund, then the winner, the person who breaks a bone, gets to pull the money out of the pot to pay the doctor. The small amount that each person puts in is the premium.

Now suppose that another group, a bunch of rugby and lacrosse players, want to join your insurance club. They are of a much higher risk class. They are much more likely to break more bones than anyone in your group.

If they are able to join and pay the same amount as you and your friends, then they will be subsidized by the “losers” of the club. The rugby players will pull money out of the pot at a much faster rate than before. So either the rate they pay will have to go up (because they are in a different risk class), or everyone’s rates will go up (thus transferring more wealth from the losers to the winners), or once the money in the fund is used up, that’s it, and no one can pull money from the pot.

We have moved away from using insurance according to the first choice. Instead, we have been raising rates across the board or have started to ration health care. A few years ago, Massachusetts created a law that requires all people to have medical insurance. Today 95% of the state’s population is covered. The result is that health care gets overused and healthcare gets rationed. The average wait time in the top 15 metro markets for a specialist is 20.5 days. However in Boston it is 49.6 days. (The next highest is Philadelphia with 27.0 days.) This result is even more surprising when it is discovered that Massachusetts has the highest number of doctors per capita in the nation. Rationing means longer waiting times. The waiting times in Canada and the U.K. have become ridiculous.

We have come to look at medical insurance as a discount card or entitlement. It is not surprising that people will use more health care services if they are not directly paying for it. If the funds come from a third-party payer, then why not run that extra test just to be sure or go to the emergency room and see the most expensive doctor? If someone else is footing the bill, then why should I be concerned with how much it costs? And if I do care, can I even find out?

If we decouple insurance from the idea of a free give away or entitlement and return to the idea of risk mitigation, the health care landscape would change for the better. Individuals would be able to buy insurance according to their own needs. If I am worried about broken bones and car accidents but not sickle-cell anemia, then I could get an insurance plan that covers me the way I desire.

Regular doctors visits are not something that insurance should cover because there is no risk to mitigate. As a result the responsibility of buying health services is placed back on to the customer. Consumers are better with spending their money than any bureaucracy. There is no grocery store insurance or clothing insurance and we see that these prices are competitive. And there is a diversity in the markets. On one end of the spectrum there are stores such as Whole Foods and Nordstrom and on the other there are Food Lion and Walmart. And just because you occasionally shop at Nordstrom doesn’t mean you can’t pick up some socks from Walmart.

Today if one has a preexisting condition, he cannot get insurance. Or if he can, it is extremely expensive. Why? It is because we do not have a free market in health care. There is blanket coverage in policies that are organized through employers. (Using employees of a firm doesn’t even make any sense normally. Why would a single firm’s employees all belong to the same risk class for broken bones, etc.? Yet they are all under the same plan!)

Imagine a person who has won the fight against breast cancer. It’s true that the risk of cancer returning is higher than the risk to another person (thus a higher premium for cancer insurance), but why shouldn’t this safety conscious person be able to buy health insurance for broken bones at the same rate as those in your club? Obviously we live in a very skewed system.

A truly free market for health care would have a great diversity in options for all. With consumers spending their own dollars, costs would come down just as they are in the relatively free markets of cosmetic and lasik surgeries.

Insurance companies in a truly free market reduce and eliminate risk; the risk that you will be unable to cover the costs of a medical event. The losers are those that pay in and nothing happens to them. And while the insurance winners are those are able to collect from the pool of funds, in a truly free market for health insurance we are the winners with falling costs and increasing quality. If we turn away from the market and adopt a system that is controlled by bureaucrats and politicians we will all be losers.

A podcast with FEE is found here.