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Insurance vs insulation
Jul. 11th, 2011 09:48 pmThe insurance/health care/health industry is unbelievably complicated, so I'm going to be discussing it in very small chunks.
Insurance is, by definition, an attempt to limit risk by betting on a risky event. Perfect insurance leaves you indifferent to whether something bad happens or not, although usually insurance companies want to have something short of that to avoid moral hazard and costs arising from asymmetrical information. This means that what we usually call "health insurance", which covers preventative care and routine testing, is not insurance (except in the sense that the meaning of a word changes through use), it's insulation. This has nothing to do with the value of annual check ups, or PAP smears, or dental care. It's just that these things are not unexpected expenses. Insurance works by promising you $n for a thing that has chance p of happening, and charging you $n*p + u, where u covers the the insurance company's profits and expenses. It's worth it to pay u for insurance covering truly catastrophic things, because money has diminishing marginal returns, i.e. each dollar is worth less than the one before, i.e. whatever I could buy with the $100 I spent each month on insurance, it probably doesn't bring me as much joy as getting all the chemo I need. But that's only true when n is large and p is small. If the opposite is true- such as with vaccines- then you're going to pay the insurance company $n+u and only receive $n back.
There's an unfortunate complication in that insurance through work is paid with pretax dollars, and individual insurance and direct pay for care are paid for with post-tax dollars. You don't even pay payroll tax on them. It's possible that u is small enough, and taxes high enough, that you are better off going through the insurance company. This law is stupid and it should feel stupid. Luckily, it's changing: FSAs and HSAs let you pay for for care with pre-tax dollars, and just about the only part of the Obamacare I liked was that it introduced the taxation of employer plans (I wish they'd taxed it as income rather than introduced an excise tax, and I think the exception for union plans is criminally corrupt, but I like the idea of taxing employer insurance so much I'm willing to overlook that). So hopefully that distortion is going away.
There's the fact that the insurance company will pay less than you do for the same care. Since medicine doesn't really benefit from bulk purchasing, this is too stupid to tolerate. One of the reason it happens is that so much "direct pay" care is never paid for, and the only way to make that better is to lessen the obligation of doctors to treat people who can't pay for free. We can do this by not requiring them to treat them, or we can pay for it ourselves. Either way, it's not going to solve the whole problem. I think ultimately this will be solved by the doctors who leave the insurance system entirely.
There's another complication though: usually you have no idea what $n is. That gets its own post.
Insurance is, by definition, an attempt to limit risk by betting on a risky event. Perfect insurance leaves you indifferent to whether something bad happens or not, although usually insurance companies want to have something short of that to avoid moral hazard and costs arising from asymmetrical information. This means that what we usually call "health insurance", which covers preventative care and routine testing, is not insurance (except in the sense that the meaning of a word changes through use), it's insulation. This has nothing to do with the value of annual check ups, or PAP smears, or dental care. It's just that these things are not unexpected expenses. Insurance works by promising you $n for a thing that has chance p of happening, and charging you $n*p + u, where u covers the the insurance company's profits and expenses. It's worth it to pay u for insurance covering truly catastrophic things, because money has diminishing marginal returns, i.e. each dollar is worth less than the one before, i.e. whatever I could buy with the $100 I spent each month on insurance, it probably doesn't bring me as much joy as getting all the chemo I need. But that's only true when n is large and p is small. If the opposite is true- such as with vaccines- then you're going to pay the insurance company $n+u and only receive $n back.
There's an unfortunate complication in that insurance through work is paid with pretax dollars, and individual insurance and direct pay for care are paid for with post-tax dollars. You don't even pay payroll tax on them. It's possible that u is small enough, and taxes high enough, that you are better off going through the insurance company. This law is stupid and it should feel stupid. Luckily, it's changing: FSAs and HSAs let you pay for for care with pre-tax dollars, and just about the only part of the Obamacare I liked was that it introduced the taxation of employer plans (I wish they'd taxed it as income rather than introduced an excise tax, and I think the exception for union plans is criminally corrupt, but I like the idea of taxing employer insurance so much I'm willing to overlook that). So hopefully that distortion is going away.
There's the fact that the insurance company will pay less than you do for the same care. Since medicine doesn't really benefit from bulk purchasing, this is too stupid to tolerate. One of the reason it happens is that so much "direct pay" care is never paid for, and the only way to make that better is to lessen the obligation of doctors to treat people who can't pay for free. We can do this by not requiring them to treat them, or we can pay for it ourselves. Either way, it's not going to solve the whole problem. I think ultimately this will be solved by the doctors who leave the insurance system entirely.
There's another complication though: usually you have no idea what $n is. That gets its own post.
