3 commentsHealth insurance and card games
The majority of the healthcare reforms being discussed are actually health insurance reforms. I think it’s important to take a step back and think about what insurance is, since there’s more confusion about that than you’d expect.
Insurance is a way to protect against an unlikely, catastrophic event. Yes, health insurance does more than just that, but this is the core of any insurance. The way this works has a lot to do with expected value. The expected value of an event is the probability of that event happening multiplied by the value (or cost) of its occurrence.
A deck of cards can provide an easy example. Let’s say we play a game where you pull a card from a deck, and if that card is an eight of clubs, you have to pay $200,000 (or some infeasible amount). It’s a crappy game, I know, but that’s life. But instead of risking the 1 in 52 chance of financial ruin, you can buy insurance. The cost of this is based upon expected value: there’s a 1.9% chance of the catastrophic event, and that event costs $200,000. Thus, insurance would cost about $3,846 (the product of those numbers) for the insurance company to break even given enough people/time.
You, the insurance customer, benefit from the insurance because you no longer have to worry about complete ruin from the game. The insurance company charges a bit more for both profit and overhead, and if their estimates of the expected value are good and they have enough customers so that the law of large numbers takes effect, they do well.
What effect does profit have? You’d think that since Insurance company A is charging [expected value + some profit/overhead] and B is charging [expected value + some other profit/overhead], eventually the profits would just drive down to zero and you’d just want to create a co-op non-profit insurance group. In other words, why wouldn’t I want to just compute expected values myself and pool money with the people at my workplace, university, or whatever? Well, I’ve clearly oversimplified the problem, because an important part of the service provided by any insurance organization (government or private) is a verification of the claims when they’re paid out. If nobody is stopping people from claiming all sorts of expenses in our insurance, the costs rise for the honest people. Insurance companies are supposed to control costs.
Different people have different probabilities of these catastrophic events, of course. So, returning to the analogy, let’s say you were given a bad deck and have a proclivity for the event for some reason and there are now 2 eights of clubs. Thus, you have a 3.8% chance of failure, and your expected value is $7,692. If you have an increased chance of pulling the bad card, the insurance company needs to charge you more. If the insurance can’t know if you have this increased risk, they need to charge everyone slightly more to account for this (even those with a regular deck).
A real preexisting condition, like someone applying for health insurance when they already have cancer, breaks this whole system, though. In the analogy, this situation would be one in which the eight of clubs was the only card in the deck. Thus, the expected value is $200,000, and the insurance company has to charge at least that much to break even. So, the entire insurance proposition now makes no sense for everyone involved. There’s no reason for you to get insurance in this case, and an insurance company wouldn’t be able to provide a worthwhile product.
Thus, the people with known conditions like this can’t really be covered by insurance, but if we as a card-game-playing society decide that nobody should have to lose the game like that, the cost could be amortized among the insurance payers over time, raising their costs. It seems like all of this applies no matter how public or private the insurance options are.
So, to review, here are the things I think about insurance right now:
- Insurance provides a valuable service to customers.
- Insurance organizations (public or private) are responsible for keeping costs under control and curbing abuse.
- Insurance organizations seeking to reduce costs or increase profits have an incentive to deny payouts that may be legitimate.
- Insurance doesn’t make sense for people who have expensive preexisting conditions.
I know that this is very simplistic, but if my understanding is fundamentally wrong, please let me know.
3 comments
Your analysis is entirely correct in that it accurately describes the (initial) purpose of insurance. This does not, however, correspond very well to what people actually expect or are getting out of health insurance. If we still intended health insurance to be about spreading out the risk of catastrophic events, then most health insurance plans would have high deductibles, high maximum benefits, and not cover pre-existing conditions. Instead, it seems that most people expect health insurance to cover routine medical care and to not “discriminate” against people with pre-existing conditions. Essentially, it has become about spreading out costs rather than spreading out risk. This may be entirely reasonable to the extent that a person cannot control their genetics or luck, and thus could expect that it would be fair for them to have no costs that the person lucky enough to be healthy does not. It seems to me, however, that insurance is a poor mechanism to ensure this fairness. (And some parts of a person’s health are at least partially under their control.)
You can see the same kind of shift in the life insurance industry. The idea that many young people with promising careers pool their money to support the families of the one who is unfortunate enough to die early is reasonable, but now life insurance is marketed to the elderly as a way to help their descendants pay the cost of their funerals. In this case there is no real risk to spread around; all of the applicants are going to die within the next decade, and the insurance is no more than paying someone to force you to save a portion of your income.
Wow… I really liked Chad’s analysis of life insurance– I never looked at it this way.
And, yeah, the only criticism I have of Matt’s argument is his statement that “insurance doesn’t make sense for people who have preexisting medical conditions”…
As Chad described, the system is really about spreading costs around—therefore, it seems that modern insurance is specifically designed to support these individuals.
@Chad
I am interested in your statement that “insurance is a poor mechanism to ensure this fairness”. I am curious as to what would be a better system… I read the article on your blog, but to be honest, I think your analysis is far more symplistic than Matt’s here and sometimes just wrong. To use life expectancy and cost as your two values is absurdly simplistic, as is your rainforest analogy, and your personal preference that you would rather die in two months than suffer through two years (it’s an absurd, heroic, macho bullshoot statement I doubt any sensible person would make— or you would make for your wife for that matter)– paticularly when suffering is relative and your hypothesis ridiculous.
I think Matt’s approach that we look at other healthcare systems in the world, compare them to WHO’s more complex analysis, and determine which values are really important to American society are really key to ensuring we develop a better healthcare system here. Does England, for example, have better healthcare than America because they have “less healthcare?” If that’s the case, or some other country, then I could see me supporting your argument…
The people who commented on your post— about preventive healthcare— were really, I think, getting at the heart of the problem here (especially concerning the great shortage of primary care doctors we are expecing to see in 10 years or so). Alas, my critique..
Yes, I agree that the analogy is very limited, and I think it muddied the definition of preexisting condition. I meant to apply that to someone who has HIV, for example, and then applies for insurance. I think most people expect the current system to “discriminate” against these applicants, and for good reason (the expected value problem I described).
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