The Role of Insurance

John posted a comment on Sept. 24 discussing insurance and this post is a result of his comment.

Does insurance siphon off money that could otherwise be used for providing direct health care services? Yes. Is this a bad thing? No. The cost of operating an insurance program consumes resources that could otherwise be used for other purposes. However, insurance exists for many things (cars, homes, businesses, etc.) for good reason. Health insurance is no accident, but a response to economic forces. Here's why.

The purpose of insurance is to minimize the cost to a single insured by sharing the risks and costs across a wider group of insureds. The insurance firm "bets" that only a fraction of the insureds will require payments to them, while the great majority of insureds will be paying in. It also bets that claims will be spread over time and not concentrated too heavily in a short period. By accumulating many small payments and building up a reserve, the insurance company can distribute a few large payments to handle claims. The more claims that are made and the higher the value of each one, the more income the insurance company needs to cover those claims. That gives rise to higher premiums. If you can belong to an insurance pool of individuals who file only a few small claims, then you can enjoy lower premiums. That explains why insurance companies want to exclude sick people (pre-existing conditions, dropped coverage, etc.). By eliminating potentially expensive claims, they control the premiums charged and hold onto other subscribers. Sounds harsh, but it is just basic business. It is why homeowners' insurance is not underwritten by some firms in hurricane-prone areas. It is why accident-prone drivers pay higher premiums. It is why smokers pay more for life insurance.

The risk inherent in health gives rise to the use of health insurance. If you could predict constantly good health, you would not need insurance. It is both the unpredictability (disease, accident, etc.) and the potentially high expense that causes us to seek protection through insurance. Insurance spreads the risk. In exchange for many "smaller" payments, you get the security of being covered if you experience a major expense.

It is true that adding an "extended" warranty for repairs to your regular "collision / comprehensive" auto insurance would increase the total premiums paid. This happens because the insurer must now cover more frequently occurring expenses. If you want to get more benefits, you pay more for them. If you have a problem-prone car, you should get the extra warranty. If you have a high-quality car, it is a waste of money. If you are healthy, buy coverage with a high deductible and save on the premiums.

Health, however, is not as predictable as auto repairs and typically more costly for major items. The cost of a major auto repair is usually under $3,000. While problematic, most auto repairs are manageable by most families. Not so for health repairs. The cost of repairing a heart versus repairing an engine is not even close. Only wealthy families could forego insurance and handle such expenses out-of-pocket. The rest of us seek shelter through insurance. Poor, uninsured, sick people either must find charity care, or live with their ailments.

Increasing insurance to cover more routine services and to cover the currently uninsured will cause an increase in payments to providers for increasd services. That increases costs. Only by increasing payments into the system (higher premiums and/or taxes), or by cutting costs across the entire process, can we cover the increased outlays. One suggestion is to cut $500 billion from the costs of Medicare and Medicaid in order to expand coverage. Is this realistic or wishful thinking? Because cost cutting projections often fail to materialize, expecting increases in rates is not unwarranted. Just as "there is no free lunch," there is no free healthcare.

There is criticism of the health insurance industry over their cost of operations, in particular salaries paid to top executives. Can insurers operate more efficiently? Probably. Are some execs getting paid unbelievable amounts? No doubt. Is wringing costs out of the insurance industry a good thing to do? Yes. How does that happen? Competition.

No matter how you arrange it, handling health care expenses for a large population will require insurance or its equivalent under a different name. Everyone will contribute to a pool that will be used to pay for those in immediate need of care. The more care dispensed (preventive in addition to curative), the more money must go into the pool. Call it insurance or call it an association or simply a pool, it will require administration to collect and distribute the funds. It will be defacto insurance in how it behaves. Unless everyone can pay their own way for all their health care costs over a lifetime, then , "Yes, Virginia, we will need an 'insurance' arrangement."