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Friday, December 03, 2010

Insurance Soup Recipe - Add Some Premium Memory

Hopefully, now that the balance of power in Congress is not completely lopsided, we will be able to have a reasonable discussion of health care and what to do about it. It seems to me that the single biggest problem of our system is that consumers are only able to purchase insurance for discrete segments of their lives, and whenever a person has to change their insurance carrier or plan, they are essentially treated exactly the same as every other prospective policy purchaser, regardless of whether they have been insured their entire lives or not at all.

Insurance companies make money by charging premiums that are high enough to cover the expenses + expected losses of the insured entity and leave enough left over to make a profit. (I am ignoring investment income for simplicity). Because a company cannot know exactly what the losses on any given policy will be, they make informed guesses based on the characteristics of whatever it is they are insuring, and then get a lot of the same type of entity to insure so that the law of large numbers smooths out wide fluctuations caused by any single insured and the whole soup turns out results close to what they predicted.

If we apply this to health insurance, it makes sense that health care through an employer is affordable, more or less, for any given person, whereas purchasing a policy as an individual may not be. The insurance company gets to use their law of large(er) numbers with a group policy, but not with the single purchaser. While there is nothing stopping the company from making soup out of a large number of individual policies, it turns out that people quite often fail to purchase insurance as an individual unless they have some pressing need for it (i.e. a pre-existing condition.) By doing this, they break the Insurance company's law of large numbers, because there are not enough healthy-people policies in the soup to offset all the sick-people policies - and the soup turns out to be way too salty. (This is why the government is so hot and heavy to mandate health insurance - they need the healthy people in the soup to make it work financially.)

There is another way to spread the risk and achieve the benefit of the large numbers law, and that is to calculate a policy's profitability over the life of the insured - multiple years. So if I buy insurance with Acme Health when I am 20, and pay my little premiums like a good girl every year, Acme can build up a stash of cash paid in just by me in my younger healthy years, which it can use to pay for my care in my older, sickly years. It can then pool me with other responsible policy holders to further spread the risk.

The problem with our current system is that there is no mechanism with which to accrue my lifetime premiums paid, which produces the undesirable situation wherein the lifelong premium payer is in the same boat as the person who has never paid a dime towards health insurance. This is patently unfair, and is responsible for all of the squirly outcomes we are getting in the form of Obamacare.

Instead of forcing everybody to buy insurance, we should be focusing on creating a market structure which rewards responsible insurance buying choices by differentiating between Peter-Persistent-Policy-Holder and Ima-Always-Uninsured. I am not quite sure how to do this, but it should be possible. Paula-Pre-Existing-Condition will look mighty different to Acme Insurance when she comes with 10, 20 or 30 years of accrued premium as well as her condition. Then there is no need to mandate insurance, for those who purposely avoid purchasing insurance will be sent packing, and rightly so, while the responsible folk will always be able to buy themselves insurance.

Talk about freedom. Imagine not having to plan your life around how to best get health insurance. That alone should provide for a better allocation of resources in our economy and should give our overall competitiveness a boost.

That is what I have to offer on the troublesome topic of health insurance.


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