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    Health Insurance - The Smoke and Mirrors Industry
    By Gerhard Adam | August 5th 2009 05:36 PM | 11 comments | Print | E-mail | Track Comments
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    Before we consider the issue of health insurance it is useful to examine the basis of insurance, generally, and how revenue is generated within that business model.  The basic premise is that a group of individuals will pay premiums which will provide a reserve of funds which can be used to pay out claims to any member of the group for whatever has been insured.  The model is relatively straightforward when it comes to car insurance, homeowner's, and even life insurance.

    In effect, the business model is a gambling enterprise where the insurer is gambling that only a minimal number of claims will ever need to be paid, whereas the insured is gambling that they will be filing claims that need to be paid.  Consider the case of life insurance where premiums
    tend to be quite low when the individual is young because the insurance company is betting that you won't die, while you're betting that you will.  

    The latter position may seem counter-intuitive, but if you really believed you wouldn't die, then there would be no incentive for you to obtain life insurance, so the point remains.

    One of the key factors that goes into insurance is that most of the protected resources have finite limits on value (including life insurance), so there is a clear ability to calculate the odds and costs of a pay-out and the period of time over which such a risk extends. When this is coupled with a high number of insured individuals that may never file a claim, then the pattern is set so that revenue flows in from premiums and is offset by claim pay-outs.

    It is easy to see that it is in the insurance company's best interest to minimize the real risk they are absorbing, hence the strict controls regarding individuals that have had car accidents for car insurance, or aging individuals regarding life insurance (and pre-existing health conditions).

    Even so, we've seen how the insurance companies may have difficulties honoring their commitments when too many claims occur at the same time, such as with Hurricane Katrina.  A curious consequence of such mega-catastrophes is the dependence on federal money to supplement insurance industry capacity.  Personally, I'm not clear on why an industry should be allowed to profit by selling policies which it requires federal assistance to honor, which brings us to the health insurance industry.

    The first problem we encounter is that there is literally no cap on the amount of money that might need to be paid out.  Consequently there is no reliable mechanism for correlating the premiums paid with the potential claims being filed.  Therefore there is increased business pressure to ensure that the preferred individuals are those with minimal health risks, so pre-existing conditions are ruled out. In many cases, the paid claims far exceed any expectation of recovery based solely on the premiums paid during the life of the insured.  

    More importantly it is virtually guaranteed that every insured individual will need to file a claim at some point in their lives, so there is little or no margin wherein premiums can be collected to help offset the costs of coverage by individuals that will never file a claim.  It's kind of like being a car insurance company where every person you insure will be guaranteed to have a crash during the life of the policy and often, multiple crashes.

    It doesn't take much imagination to see that such a business model is doomed to deficits, since it is impossible to construct a scenario where one can reliably make a profit unless one is absolutely ruthless about ensuring that risks are minimized.  

    However, this brings us to another point regarding insurance.  The purpose of insurance is not to allow a company to make a profit, but it exists precisely to offset risks that an ordinary citizen could never handle.  In effect, paying a smaller loss now in the form of premiums, against a larger loss later (claims).  Therefore we have to confront a fundamental issue about insurance companies, especially in the realm of health care.  If they cannot reasonably cover the risks that an average individual is going to encounter, then there is no reason why they should be allowed to profit by only taking the "safe bets".

    We might all be better off eliminating the health insurance companies and negotiating directly with doctors, hospitals, and pharmaceuticals to obtain better prices.  In fact, a strong argument could be made, that the costs of health-care are artificially high because the health industry knows that their bills will be paid by insurance companies.  If they had to bill ordinary citizens for these services at the ruinous rates charged, there is little doubt that most would never get paid, and the health industry would have to rethink the supply/demand relationship with its "customers".

    In effect, the insurance companies act as a buffer that can neither fulfill the obligation to the insured effectively, and prevents the health industry from directly interacting with their customers and therefore any "competition" or price adjustments never occurs.  This is another
    instance of where businesses enter into a market to profit from customers, while extending their maximum efforts at avoiding delivery of their services.  

    While some may argue that it is an unfair charge to make because insurance companies can't be expected to absorb the risks of high claims payments when they can never recover those costs through premiums.  If we accept that argument, then the overriding question that follows is;
    why is there so much resistance to providing coverage to those the insurance company doesn't want to cover anyway?  

    Comments

    Steve Davis

    Gerehard, you're asking questions that will upset a lot of important people. I like that!

    I haven't had time to think this through, this is only a quick comment, but if the govt has to subsidise private health insurance firms then surely a scheme such as we have in Australia, where all pay a levy for universal care, is the sensible approach. Private health providers are part of the scheme, so it's not a denial of choice or a production line approach, its quite flexible.

    Gerhard Adam
    I'm sure there are lots of possible solutions, but until the health industry has the incentive to investigate how it conducts business, there will be nothing done.
    Mundus vult decipi
    Wayne Turner
    And that incentive will never exist, because in the absence of public policy that mandates such a re-examination, the current health insurance profit models work well for them. They have socialized risk, minimized their exposure and privatized their profits.
    Steve Davis
    They have socialized risk, minimized their exposure and privatized their profits.

    That's a description of the entire financial system.
    kerrjac
    Good article.

    I find insurance fascinating&someday I want to learn much more about it. At its core is a game of statistical averages of the likelihood of risk occurring. Where those risks are predictable, insurance works like a charm. 
    In effect, the business model is a gambling enterprise where the insurer is gambling that only a minimal number of claims will ever need to be paid, whereas the insured is gambling that they will be filing claims that need to be paid.
    Building off of Steve's last comment, you might conceptualize any financial transaction as a "bet". That doesn't make it a form of gambling, which is one-dimensional in nature. If one year Hurricanes hit 50% of an insurance company's clients, then sure the company would be in trouble. Just as Wal Mart would be in trouble if suddenly people stopped buying their goods.
    However, this brings us to another point regarding insurance.  The purpose of insurance is not to allow a company to make a profit, but it exists precisely to offset risks that an ordinary citizen could never handle.  In effect, paying a smaller loss now in the form of premiums, against a larger loss later (claims).  Therefore we have to confront a fundamental issue about insurance companies, especially in the realm of health care.  If they cannot reasonably cover the risks that an average individual is going to encounter, then there is no reason why they should be allowed to profit by only taking the "safe bets".
    Insurance "offsets risks that an ordinary citizen could never handle" by having the majority of citizens pay for risks that they never do handle, be it in the span of a year or their lifetime. In its ability to fund move around liquid funds its not unlike an analogy for the economy as a whole.

    The question I think you're getting at is what occurs when costs of these health risks increases so much - or becomes so unpredictable - that they can't possibly be insured against.

    It's a mind-bending puzzle if you ask me. I think you're right to propose that the answer maybe less insurance. If too many people are at such high immediate risk for certain costly health problems, then it may force you to redefine "risk". The situation becomes doubly complicated when you factor in supposed medical risk factors, such as obesity and hypertension. Certainly there is a point whereby specific risks are so prevalent that there is no need to insure against their occurrence, as their prevalence alone would insure that an economy of scale lowers their cost. Think of cold medicine. Lumping everything together, it would seem, is incredibly inefficient. But you could only go so far with insurance reform before having to deal with other policies. Many medical risks maybe as common as the cold but still legally require a doctor's visit and prescription to treat.
    Gerhard Adam
    Good points, and I still think that the primary problem with health care is that the health care system doesn't actually have to market or deal with their "customers" directly.  By having someone in the middle pay the bill, there is no incentive to bring costs under control or develop alternate ways of handling medical issues.

    After all, in the insurance business (except for life insurance, generally) all the liability being protected is typically against the financial institutions that have a stake in the property being insured.  There is no such offset in health insurance, so the "value" is purely subjective with providers able to charge anything they like. 

    As unpalatable as it seems, if we are going to use health insurance then someone is going to have to determine what a human life is worth.  Is it worth doing a heart transplant on a 90 year old patient?  Is it worth extensive treatments to prolong someone's life by six months?  These are questions that people need to ask and answer, because it is clear that society cannot commit all of its resources to saving everyone simply because we want to ignore the question.
    Mundus vult decipi
    kerrjac
    By having someone in the middle pay the bill, there is no incentive to bring costs under control or develop alternate ways of handling medical issues.
    To a degree. Certainly there are other areas where having someone in the middle has less of a negative effect on costs. Car insurance/auto repair comes to mind.

    As unpalatable as it seems, if we are going to use health insurance then someone is going to have to determine what a human life is worth.  Is it worth doing a heart transplant on a 90 year old patient?  Is it worth extensive treatments to prolong someone's life by six months?
    Putting a price on a human life is near impossible; much more practical is putting a price on a heart transplant.

    The underlying factor in all this is the shortage of doctors, largely due to the small number of medical schools, small classes, and AMA's unrealistic standards. B/c of this, the public's health needs can fluctuate in any which direction, and healthcare providers don't have to - or won't be able to - meet their needs. Instead, if patients flock to a particular area of medicine, it will just freeze up due to practical scheduling limits&possible civil suits from taking on too much work.

    The shortage inflates the price of healthcare; this makes insurance more necessary b/c just dealing w/a dr. costs much more than dealing w/your avg. highly skilled professional.

    Doubling back to the risk that insurance supposedly insures against, it's not just the physical risk of suffering from a medical condition, but it's also the risk of then incurring a large expense from seeing a dr., be it for surgery or for a few antibiotics.

    Reform when it comes to health policy or insurance may help; but it's the shortage that's causing the problem.
    Gerhard Adam
    I would agree that there is a contrived shortage that is aggravating the situation.  I also agree completely that one of the first things that needs to be done is to increase the number of doctors (although I suspect that this would also incur howls of protest).
    Certainly there are other areas where having someone in the middle has less of a negative effect on costs. Car insurance/auto repair comes to mind.
    Not so, because when the damage is too extensive, the car insurance simply declares it a total loss which caps the expense at the value of the vehicle.  Since there is no end to the value placed on a human life, there is no "cap" and consequently health insurers are liable for indeterminate costs.  Therefore their only business strategy is to minimize risk, resulting in the complaints we have today.
    The shortage inflates the price of healthcare; this makes insurance more necessary b/c just dealing w/a dr. costs much more than dealing w/your avg. highly skilled professional.
    This is precisely where the misunderstanding comes from.  This tends to view insurance like a "bank" where their purpose is to pay impossible costs.  There is no viable means of providing insurance in the absence of a value cap, so there is no reasonable way for an insurer to claim to provide coverage if they are not prepared to declare a "value" for a human life.  I'm not arguing whether this is a good or bad thing from a humanist perspective, but it is a simple reality of business and this is what needs to be addressed.  I am irritated with the insurance companies, because they know full well that they cannot possibly cover the claims that are needed and yet they persist in this fantasy because they are profiting by insuring those that don't need it while playing bureaucratic games with those that do.  This exacerbates the problem because it's a "smoke and mirrors' play since everyone knows that it is a non-viable business model, but no one wants to change it.
    Mundus vult decipi
    kerrjac
    I am irritated with the insurance companies, because they know full well that they cannot possibly cover the claims that are needed and yet they persist in this fantasy because they are profiting by insuring those that don't need it while playing bureaucratic games with those that do.  This exacerbates the problem because it's a "smoke and mirrors' play since everyone knows that it is a non-viable business model, but no one wants to change it.
    This has been a good discussion to help wrap my mind around healthcare insurance.

    The problem I think is that the price of healthcare fuels the need for health insurance. This is understandable from both parties: This makes the customer concerned about the costs of future health problems, and it makes him willing to invest today for problems that he may or may not face in the future; and it makes the insurer willing to act as middleman, not just paying all or most of his health bill, but funding it through other people like him who are not facing any health problems.

    The crux however is that there is a near permanent shortage of doctors (and medical resources). When more people seek healthcare, its price rises, b/c the same short supply of doctors is even more in demand.

    Insurance may have a signficant role as a middleman who skews price higher. But at the same time, I'd imagine that demand for medicine - or for services from most of its fields - is pretty inelastic. Meaning that as outside factors change - eg, people have less money to spend in a recession, healthcare's price changes, people have insurance or they don't - demand for it remains pretty constant. I'd imagine that if we simply did away with health insurance, then in the short-term some or many costs may go down. But in the long-term, I'd think it would jump back up. People will still need to go to doctors, many will do so regularly. And as more people go to doctors, costs would again stabalize at a high level.
    There is no viable means of providing insurance in the absence of a value cap, so there is no reasonable way for an insurer to claim to provide coverage if they are not prepared to declare a "value" for a human life.
    I see you point, but only to a degree. Health insurers are not responsible for continuing human life, they're responsible for insuring against medical risks. In order to do this, they define the risks,&subsequent procedures should they occur, ahead of time. This is not quite putting a value on human life. The problem is that as those risks become more costly, there is more of a need from the customers perspective to insure against them.
    Hank
    If Obama loses Camille Paglia, he loses the country.
    There is plenty of blame to go around. Obama's aggressive endorsement of a healthcare plan that does not even exist yet, except in five competing, fluctuating drafts, makes Washington seem like Cloud Cuckoo Land. The president is promoting the most colossal, brazen bait-and-switch operation since the Bush administration snookered the country into invading Iraq with apocalyptic visions of mushroom clouds over American cities.
    and
    House Speaker Nancy Pelosi, whom I used to admire for her smooth aplomb under pressure, has clearly gone off the deep end with her bizarre rants about legitimate town-hall protests by American citizens.
    Now, Paglia has spent her whole life telling people to resign and no one ever listened before so they won't now, but Pelosi is kooky even for California.   Kookier than Barbara Boxer.  
    As with the massive boondoggle of the stimulus package, which Obama foolishly let Congress turn into a pork rut, too much has been attempted all at once; focused, targeted initiatives would, instead, have won wide public support. How is it possible that Democrats, through their own clumsiness and arrogance, have sabotaged healthcare reform yet again? Blaming obstructionist Republicans is nonsensical because Democrats control all three branches of government. 
    Now we get to see why the Founding Fathers actually didn't want it that way.
    Gerhard Adam
    I don't disagree with you, but it's hard to feel that anything is progressing when it seems that policy is supposed to be conducted while running a gauntlet of people that simply want to argue and shout.  Let me also say that I'm not trying to make excuses for politicians or some of the bad choices that they have made, but in viewing the general public, even I'm starting to feel sorry for the constituents these politicians are being forced to represent.  You can almost see some of them looking at people thinking that they must be insane.
    Mundus vult decipi