Monday, August 24, 2009

The Expectation Value of Health Insurance

Two key concepts bubbled to the top for me over the last few weeks on this overly complex health care reform issue. These may be the two most important points of all, and until congress grasps these two items, any health care reform will do more harm then good. Let’s call these two concepts, the expectation value of health insurance, and the probability of success with a communist Russia type economy.

Let’s start with the first one. 46 million uninsured is the number that Obama loves to throw out there, but it is simply a lie. There are 36 million uninsured Americans (2007 census report), the rest are illegal aliens. Assuming that Obama knows the difference between the two of them, he is lying to help his cause with that number, but that is not what’s important now. Out of the remaining 36 million you have about 25 million called “indestructibles”. They are 18-28 year olds who could probably afford health insurance, but choose to not take it because they feel they are indestructible. After that you have about 10 million poor, who could qualify today for Medicaid, and say about 1 million others. So let’s forget about the 1 million others, and the poor who could already have coverage. That leaves us with the simple task of getting the indestructibles on health insurance to solve the alleged problem. So let’s ask ourselves a very simple question. Why do the “indestructibles” choose to not carry health insurance, and is this a rational economic choice for them as consumers. If you start to think about it at all, you can see that the system is set up to simply rip off indestructibles, and that their choice to stay out of the system is a +EV choice. You need to understand that the health insurance market is not free. It is highly regulated, and is the only insurance where the premiums can’t be set based on the individual policy risk. Think about that for a second. When you buy car insurance, your individual cost is based on numerous risk factors (value of the car, your driving record, how many miles you drive, where you live…). When you buy home/fire insurance, again it is based on individual risk factors (value of the home, type of roofing material, location of home). When you buy life insurance it is based on risk factors (your age and your health history). Health insurance could also use a multitude of risk factors as well (your age, your health history, pre-existing conditions, if you smoke, if you are overweight, if you are a heavy drinker, the size of your family...). The government simply does not allow this for heath insurance, and forces companies to “pool” people together to spread the risk, while charging each similar policy the exact same amount. So now we get back to our “indestructibles”. These guys are the lowest possible health insurance risk, but get charged exactly the same as a 75 year old with a history of heart disease and diabetes. They would have to pay 7-10k per year for health insurance they will likely not need for many years, unless they break a bone or something like that. Even if they can get the same coverage for 3k through there employer, it is still not worth it to them. The expectation value of buying insurance for them is -$3,000 (subsidized) or up to -$10,000 without employer help. The expectation value of not carrying insurance is much larger (less negative). Their only issue is variance. If you wanted this class of uninsured to choose to take insurance, you need to stop ripping them off, and make them pay what it actually costs to insure them. Yes, costs for high risk groups would have to go up, but it should for them. Take the car insurance analogy. A very bad driver who totals his car every other year, and has multiple speeding tickets, pays the exact same rate as a perfect driver with no accidents and no tickets. And if you allow pre-existing conditions, the bad driver can stay off insurance until he totals his car, and then sign-up to get all the good drivers to subsidize his risk and repair bill. The worst thing about the health care bill is it appears to make health insurance mandatory by law. The people most harmed by the bill are the 25 million uninsured (the problem according to Obama), who will be forced to take health insurance at complete rip-off rates for their individual level of risk.

Now on to the second concept. The argument that I hear over and over again is that the government can create a public, government run, option that can compete effectively with the health insurance industry to lower costs. The argument goes like this. The evil insurance companies are wasting marketing dollars advertising against each other, are inefficient because they can’t get economies of scale in processing claims, and on top of all of that make a profit that comes directly out of the care provided. If the government were to take over the entire system, they would not have to advertise or make a profit, and could set up one efficient system to process all claims. On the surface this seems to make sense to the average person, and I think that’s why this claim is repeated over and over by the many talking heads out there. There is a big problem with this argument though. The health insurance industry is really no different than any other competitive industry. So you really can make the same argument anywhere. Let’s look at personal computers for a second. We have Apple and all of the various Microsoft windows based PC vendors. There is tons of advertising going on and efficiencies that could be gained if we went to a single manufacturer. So the government should just take over the entire computer industry, because if they did we would get better and less expensive computers as a result. After they get done taking over the computer industry, they should do the automotive industry (already ½ way there), the banking industry, consumer electronics, clothing, the airlines and more. Doing all of this will save Americans money because the U.S. Government is a beacon of efficiency in a highly inefficient free market system. It starts to become absurd at this point, right? The government is simply not efficient at anything they do, and can’t compete on a level playing field with a profit motivated company. The profit motivated company will find ways to reduce costs, and improve their offering until they eventually displace the government competitor while still earning a profit. For an example of a country where everything was run by the state, look at communist Russia. Not exactly an economic powerhouse. If the government is really capable of out competing private industry, Russia would still be around, and the American economy would be near the back of the pack of all developed countries. The fact that after all of these years we are still an economic powerhouse under a free market system, and all other countries with more state ownership of the economy lag us economically, is simple proof that our system is the most efficient. Going to a government run health care system can only raise costs, and kill all innovation. The only way the government can compete with private industry is cheating by using tax payers to subsidize losses, or by changing the rules to the benefit of the government competitor. You can already see this with GM. Now that we own them, we start pushing their products with Cash for Clunkers and electric car subsidies, and then rewrite the EPA mileage standards so that a hybrid, plug-in car (The GM Volt), can get an absurd 250ish MPG rating when the gas engine on board will probably get less that 40 MPG.

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