The Meaning of Health "Insurance"

Megan McArdle has a column I am going to excerpt at great length (sorry Ms. McArdle).  This is great article on a topic I have tried to explain many times here

After all, the insurance company has to make money.  That has to mean that the expected value of the claims they pay out is lower than the expected value of the premiums their customers pay in.  In some sense, then, the expected value of your insurance premium is negative.

But insurance does make everyone better off, because it covers very large costs that most people would have trouble paying.  Even most really good savers would have a hard time replacing the value of their house, or paying off a $250,000 judgement for an auto accident.  The expected value of those incidencts is very, very negative--more than just the value of the cash, you have to factor in the horror of being homeless or bankrupt.  When you factor in the homelessness, the bankruptcy, and so forth, the slighly negative expected financial value is more than outweighed by the positive value of being protected against personal catastrophe.  Not to mention the peace of mind one gets from not having to worry about homelessness, etc.

This is the magic of risk pooling.  But notice that it's the catastrophe which makes insurance a good deal.  You wouldn't get much value from buying "grocery insurance".  At best, you'd be paying an extra administrative fee to route your routine expenses through an insurer, rather than paying them directly.  At worst, you'll end up with bills skyrocketing as all sorts of perverse incentives appear.  After all, if the insurer is paying all your grocery claims, why not load up on filet mignon instead of ground turkey?

But insurers try very hard never to sell insurance for less than the cost of your expected claims.  If you expect to buy $10,000 worth of groceries next year, it will not charge you less than that for a "grocery policy".  And if we all drive up the costs of grocery insurance by consuming more, the insurer can do one of two things: raise everyone's "insurance premiums" to cover a filet mignon budget, or create a list of "approved groceries" that it will cover, and start hassling anyone who tries to file an excessively expensive claim.

Sound familiar?

This is why you should always have liability insurance, but should think twice about collision damage coverage.  It's why high deductibles are a good idea--for small expenses, it's better to self insure.  And it's why "catastrophic" health plans, which only cover the sort of extremely expensive events that most people would have difficulty financing, are a much better deal than the soup-to-nuts plans that most people get through their employers.  Those plans are expensive, both because they're paying for a higher percentage of your expenses, and because they drive up utilization--which means that they drive up next year's premiums even more.  Imagine what your car insurance would cost if it covered gasoline, routine maintenance, and those little air freshener trees you hang from the rearview mirror.  Then stop asking why health insurance costs so much.

But Kathleen Sebelius, the Secretary of HHS, thinks that catastrophic insurance isn't really insurance at all.

At a White House briefing Tuesday, Health and Human Services Secretary Kathleen Sebelius said some of what passes for health insurance today is so skimpy it can't be compared to the comprehensive coverage available under the law. "Some of these folks have very high catastrophic plans that don't pay for anything unless you get hit by a bus," she said. "They're really mortgage protection, not health insurance."

She said this in response to a report from the American Society of Actuaries arguing that premiums are going to rise by 32% when Obamacare kicks in, as coverage gets more generous and more sick people join the insurance market.  Sebelius' response is apparently that catastrophic insurance isn't really insurance at all--which is exactly backwards. Catastrophic coverage is "true insurance".  Coverage of routine, predictable services is not insurance at all; it's a spectacularly inefficient prepayment plan.

The last two lines are why I knew from the very beginning that the promise I would get to keep my health insurance was a lie.  Because I have true insurance, rather than a pre-payment plan for incidental health-related expenses, and the folks who wrote Obamacare think of insurance as pre-paid medical care (in fact, I believe they think of private insurance as a Trojan Horse for all-inclusive single payer government health care).

  • http://www.facebook.com/profile.php?id=1427958016 Orion Henderson

    I heard Sebelius say this on the radio the other day: "We need the 32 year old single Mom working at Wal-Mart to buy health insurance to cover the 55 year old with health problems." Yes, she said this. The reporter apparently thought nothing wrong with that at all. It was the most honest and disturbing comment I can remember hearing from a public official.

    The uninsured mother of 2 working at Wal-Mart has a tough life. By all means, lets take more of her money to fund the 55 year old, who may or may not have had a tough life. Let's make sure they both use as much healthcare as they can. For better or worse, both have catastrophic coverage in the form of ER's with an open door policy. Most states are at least covering the children with some basic level of care. Of course, access is limited for state plans. That's a whole other story.

  • Eris Guy

    Wow. You and McArdle are the only two people I’ve met outside my family who understand the word “insurance."

  • marque2

    Small point, on major insurance - Auto and Home the insurance companies actually make most of their money, not by keeping some of the premium - it all gets paid out. The get it from the interest on the money they keep in reserve.

    Health "insurance" is a different animal, since it has become an accounting/budgeting program, so it takes 20% off the top to make sure you aren't spending too much for the services.

  • marque2

    It is true - that compared to the old days the elderly are quite wealthy. They have had their whole lifes to collect goods (like a house) and to save, and expenses have gone down since the kids have grown up, plus their salaries are, in real terms, probably twice what they were when they started out young. The 28 year old just a few years out of school needs the money to purchase that first house, pay for the kids, and start the savings process for retirement, and all with half the salary of the 55 year old.

    The progressives always claim they are trying to help the poor, but in this case they are transferring money from the poor to subsidize the rich. I think they are using the old trope which hasn't existed since the 50's that old people are generally poor.

  • Paul

    I am 100% with this and I have a $3000 deductible health insurance policy, so I practice what I preach, I've never received a penny in repayment in the years I've had it, but if I have a stroke tomorrow I'm good (well, except for the stroke bit).

    If everyone was required (i'm not sure how far I want to go on the "required" bit) to have catastrophic health care insurance, and if only that component of employer-paid health insurance was deductible, we'd be a lot closer to how I think health care should work.

  • perlhaqr

    I've tried to make this point to people, especially when they rail against not being able to get "insurance" to cover "pre-existing conditions".

    "Insurance" is a bet against things that may or may not happen. Trying to get "insurance" to cover your monthly medications just means trying to get someone else to pay for your stuff. There's no bet involved. Who would "bet" on the results of last year's Superbowl, today?

  • Jerry

    Actually Sebelius comment is doubly stupid in that she doesn't understand what true insurance is and that getting hit by a bus would probably be covered by the bus company.

  • LarryGross

    well a couple of thoughts.

    1- employer provided heath insurance is often of the kind that "covers" just about everything and this is what many people think insurance "ought to be" - something that covers their family for any/all health care and protects them from unexpected illnesses and the like....

    2. - people who do not visit the doctor on a regular basis do not catch disease in the early stages and something that would have been cheap caught early turns into "catastrophic" ..... so when some people say "quality health insurance" this is what they mean - that it covers the typical screening things that people who don't have insurance or only catastrophic won't usually pay for.

    Catastrophic does not necessarily cover everything "catastrophic" either... some of those policies are carefully written..to limit the exposure of the insurer (as one might expect if they are a profit-making operation).

    in talking about the "poor" or "rich" seniors... keep in mind that Medicare Part B is entirely voluntary and does require a monthly premium but without it - most seniors at some point in their lives - often towards the end - would have most of their assets taken to pay for late-stage care.

    Medicare also does not cover nursing homes and a pretty good number of seniors and their kids try to transfer assets prior to going into a nursing home.. and let MedicAid pay for it. MedicAid has gotten tighter on that issue now requiring (I think) 5 or 7 years windows prior to going into a nursing home where the assets cannot be transferred or they will be clawed back.

    the irony here is that we talk about the "crushing" debt that Medicare will pass on to "the kids" but "the kids" are often engaged in trying to receive/transfer the assets of their parents when they go into a nursing home.