Not Enough Wrinkles
Atrios puts on his economist hat and sets out to explain insurance, with, based on the caliber of the explanations so far, way more disdain for his ideological adversaries than is warranted. The first item explains the principles of “insurance classic” (fire, auto and such), and saves health insurance for a second go-round. The major problem with the first is a relentless demand-side focus that will come back to bedevil him, and liberal approaches to the question of health insurance generally, in the second item. Simply put, profit is nowhere to be found:
So, consider something like fire insurance. Every year there’s a 10% chance that your house burns down and you lose $100,000 and a 90% chance you don’t. Because you don’t like the uncertainty, you’re willing to pay some amount to remove that uncertainty from your life. Since an insurance company can bundle up a large number of people, as long as fires are uncorrelated events (no entire blocks burning down), the law of large numbers ensures that the total losses (equal to total insurance payouts) are essentially predictable. That is, the insurance would pay out an average of $10,000 per policy per year.An actuarially fair policy would have an insurance premium precisely equal to the expected (average) loss, or $10,000 per year, and a competitive insurance market would result in a price of just about that.
Well let’s see how an insurance company with 100 customers does here:
Income: 100 x 10,000 = 1 million dollars per year
Outflow: 10 x 100,000 = 1 million dollars per year
We’ve eliminated not just profit but even overhead. There’s no money to pay for administering the program, which even a nonprofit or government insurance program would need. As for the other kind – an actual business – go ahead, invest your 401K in this one. I dare you.
Now I don’t want to overstate my case. Atrios probably thinks he’s tucked away a little for the providers somewhere between “a competitive insurance market” and “just about that.” Economic theory does say that profit should progressively vanish as markets mature. In the real world, though, it has to be worth it to provide a service, and the profit margin of an ongoing industry has a functional floor not too far below what you can get on a passbook savings account down at the bank.
I think the problem is lying in the weeds of his initial post on health insurance, where he misses the real problem of such insurance as it exists in the United States. Insurance classic is about the pooling of risk. Contemporary health insurance is that, but it’s also the pooling of certainties. Example: I was diagnosed with essential hypertension when I was 25 years old, and I’ve been on blood pressure medication ever since. That guarantees several hundred dollars in drug costs and a couple hundred more in office visits per year for someone. Most of it is paid by whichever insurance company I have. The law requires them to do this, even though it is in no way a risk – it’s a damn sure thing. Contemporary medical “insurance” is more like a service contract you would buy for your car than a classic risk management vehicle.
The money has to come from somewhere. Let’s imagine a system where I pay my own insurance premiums all by myself. For it to be worth the insurance company covering me, my premiums have to exceed (to provide profit) the actuarial risks that impinge on me, plus the certain expenses of my existing conditions. For there to be a profit to them on covering my blood pressure, I have to be paying them more than I would pay out of pocket, which is a bad deal for me.
So what can make covering my blood pressure medication worth it to the insurance company and me? Free money! Put “free” in sneer quotes, please. My employers pay more of my premiums than I do. That’s money that could be going straight to me, but for oddities of the tax code. There is another important source: my fellow employees. The healthier employees are paying to cover not just their own risks but my certainties.
There’s one further trick to this, but I’ve got to go to work. In the meantime, let me suggest that a Rawlslike “veil of ignorance” exists in classic insurance that is only artificially mandated in contemporary medical insurance. Much depends, in political terms, on it staying in place.
QUICK UPDATE: Michael Croft points out, via e-mail, that I’m ignoring volume purchasing power in the certainty-pooling aspect of medical insurance. (And after chiding Atrios for skipping over stuff.) It’s an important point, though I don’t think it vanishes the ethical “free money” issue to the extent Michael suggests. More tonight.
