Understanding Insurance

It is clear to me from reading public reaction to arguments made in the Supreme Court this week on the constitutionality of the new healthcare law, that many people do not understand the concept of insurance.

Insurance is a means for a group of people to share the financial burden from losses that are unpredictable for the individual members, but predictable for the group as a whole. All members of the group contribute to a pool of money that is used to pay for individual losses when the need arises. Insurance is not a means for getting other people, corporations, or governments outside of the group to pay for losses. It is the members of the group that pay for losses and share in the benefits.

Insurance agreements work best when the loss events are truly random occurrences for individuals, but have well known probabilities so that the loss rate for a large population is a known quantity. I cannot know for certain if my house will be struck by lightening this year, but I do know that it is a certainty that someone's house in my community will be struck by lightening. If everyone contributes a small amount to an insurance pool so that the total equals the expected communal cost of lightning strikes, then those that do experience lightening strikes will not suffer a catastrophic loss. Not knowing who among the group will suffer a loss that is almost certain to occur, motivates everyone to contribute to the insurance pool.

Unpredictability is what makes an insurance contract possible. Whenever loss events become predictable, the entire concept breaks down. There are two ways that predictability can enter the system.

•People's behavior: The likelihood of an auto accident is partly random and partly the result of a driver's skill and tolerance for risk. Because these traits tend to correlate with demographics, market pressures arise for insurance pools to either exclude, or demand higher payments from people who fit certain demographic profiles. As a result, teenage boys pay more for auto insurance than middle-aged moms. A person with a history of traffic infractions and accidents might not be able to purchase auto insurance. Even though in the auto insurance market people are treated differently solely because of age, gender, and prior history, these pricing practices are not considered discriminatory.

• Past events: Obviously you cannot insure the past or else no one would contribute to the insurance pool for the future. Unlike the future, the past is entirely predictable because it has happened. No state would sell lottery tickets after the drawing. No bookie would accept bets on a football game after it has been played. No auto insurance company will sell a policy to someone after that person crashed. If this were allowed all these businesses would be broke in a matter of weeks.

I feel like I am stating the obvious, but many people in the healthcare debate do not understand these points. My people are outraged that the new law forces everyone to buy health insurance, and at the same time support the provision in the law that forbids insurance companies from denying coverage to people with pre-existing conditions. But if no one bought health insurance until it was needed, no pool of money would exist to pay for claims. The insurance model would breakdown quickly and no one would have insurance. The belief that it is possible to have universal healthcare coverage without a universal mandate to contribute is completely irrational.

In fact, without the new healthcare law the insurance model will breakdown in the near future. Too much concerning an individual's need for healthcare is predictable. Age and prior history are big factors in predicting healthcare costs for an individual, and just like for auto insurance, market pressures have arisen to exclude older and sicker individuals from insurance pools, either by barring them or pricing the insurance out of reach. But, unlike auto insurance, for which most states mandate coverage in order to drive, there has not been a health insurance mandate, so there is little incentive for the young and healthy to contribute to insurance pools that pay the cost of care for the aged and ill. Financing the healthcare system through a patchwork of private insurance plans simply isn't working because the predictability of the need for healthcare undermines the entire concept of insurance.

Opponents of the new healthcare law argue that mandated health insurance is different from mandated auto insurance because people can choose not to own or operate motor vehicles. Therefore it is possible to opt out of paying for auto insurance. But the irony is that as a consequence of our mortality, the need for healthcare is truly universal. Even though many people would prefer not to pay for health insurance and to opt out of the healthcare system, that choice is not possible. Almost everyone will need healthcare at some point in his or her life and federal law already requires that emergency rooms treat all patients. That means that healthcare is already socialized.

Unfortunately the emergency room is the most expensive and inefficient place to provide healthcare, and many uninsured are using emergency room services and not paying because they have no other choice. This practice further drives up insurance costs for those that do pay and prices more people out of the health insurance market. The current system is spiraling out of control. Eventually when so few people are insured that the healthcare system can no longer cover its overhead, it will experience a financial crisis with an unpredictable outcome.

The demand for healthcare is universal and government works best when addressing universal needs. The ideologues who denounce all government interventions ignore the fact that without government action there would be no Interstate highway system, no universal electrical service, no universal phone service, no Internet, no national defense, and the list goes on. Private enterprise could not have provided these services that we regard as essential to the modern functioning of our society. The loud voices denouncing all government intervention in the marketplace ignore reams of facts. Conservatives may long for a simpler past, but I doubt many of them would be willing to go back and live in the past, and give up all the modern conveniences they take for granted today.

Obama's affordable healthcare law is not a perfect solution, but first attempts to solve complex problems always need modifications. Scrapping the law and doing nothing leaves in place a healthcare financing system that is unsustainable. It is time to stop the shouting and have a serious, informed, and reasonable discussion on how to move forward with our nation's healthcare policies. Unfortunately in our current political climate, characterized by fear mongering, rigid ideologies, insatiable greed, and blind irrationality, I don't see that happening.

The Public Option for Healthcare: Logical Flaws in the Argument Against

I am mystified by the arguments presented by opponents of the “public option” for health insurance. Their line of reasoning has a rather obvious logical flaw. The gist of the argument against the public option is that it would lead to a government take over of the entire health care system because private insurers couldn’t compete with the government. Opponents of the public option say that would be a bad outcome because government-run-health care would not be able to provide the kind of health care services people want and need. Their underlying assumption is that any health care plan run by the government would be an inferior product compared to private health insurance.

But, that assumption is the source of the logical flaw. Since when is it a competitive advantage to offer an inferior undesirable product? If public health care were really as bad as opponents claim, why would anyone choose it? It seems that the real fear opponents of the public option have is that many people might find it an attractive choice. But, if it’s an attractive choice, why is that a problem?

Actually the market place is full of examples where private, for-profit companies compete successfully against government-run or non-profit entities.

My job at a private college is not threatened by the existence of cheaper public schools.

Rural electric cooperatives are not a threat to for-profit electric companies because those companies do not find it profitable to serve the rural market.

Package delivery services provided by private companies such as UPS and FedEx compete successfully against the “public option” of the U. S. Postal Service.

The existence of member-run credit unions did not put private banks out of business.

In fact the banks managed to fail by themselves; no outside competition was needed. That fact calls into question the entire assumption that privately-owned equals competent and efficient while government-run equals inept and wasteful. To borrow the title of a recent book on the collapse of Lehman Brothers, “a colossal failure of common sense ” permeates the management of many privately run companies.

No organization, public or private, is immune from ineptness and mismanagement. But, if I worked for an organization that I perceived as incompetent, I would work to fix the problems or find another job. I would not contribute to the problems just to prove my point that the organization is dysfunctional. Unfortunately, many members of Congress work for the government solely to prove that government doesn't work.

Actually, private and non-profit health insurers already compete head-to-head in the marketplace. My health plan through my employer is with a non-profit company. Its existence hasn’t put the private for-profit health insurers in my state out of business. I fail to see how public health insurance for people not currently served can be a threat to the existing private insurance system.

No one has suggested that private insurance and private health care be outlawed. This being America, I have no doubt that those who have the jobs and income that provide adequate health care will continue to receive the kind of care to which they are accustomed. The issue is how do we as a nation provide care for the tens of millions of fellow citizens who are not served by the current system. Many of the uninsured have zero options available. Every other developed nation in the Western world takes care of its citizens. How can the richest nation of them all, claim it cannot afford to?

Joseph Ganem is a physicist and author of the award-winning The Two Headed Quarter: How to See Through Deceptive Numbers and Save Money on Everything You Buy