Being clear about the terms Care and Insurance when it comes to US health.
The issue for the day is the distinction between health CARE and health INSURANCE.
As we all know, they are not the same thing. But, as we all have noticed, the two are often confused and the distinctions ignored by many, if not most, in the media, Congress, and the White House.
Health Care and Health Insurance are certainly interdependent. But it helps first to separate the two and take each in turn.
Let’s start with health insurance. And let’s think of it first as just any “insurance,” like a policy on your house or car.
What is insurance? It’s a contract that you buy to limit your losses if a bad event happens, even though the likelihood of the bad event occurring is usually very low.
How do insurance companies set the price and the conditions of the insurance policies they sell to you? And that you can choose to buy or not? And that we often shop around for until we find the policy that has the right payoffs for the right price?
Well, the insurance companies are for-profit entities. The price they set for the policy has to cover their costs. (and I’m ignoring the messier pricing issues of co-pays, deductibles, details on what is covered and under what circumstances…)
The problem is, they don’t know their actual costs when they set the price, because they do not know for sure how many claims will be filed over the term of the policy, or how large those claims will be. The likelihood of a policyholder filing a claim is driven by the chance of some natural event occurring (like a flood or a lightning strike) and by the behavior of the policyholder.
The insurance company controls neither of these. They must devise a policy that reflects their best guess as to the likelihood of the natural event or the risky behavior of the policyholder or their covered dependents.
At the beginning of the policy period, the policyholder is happy to have the insurance. If, by the end of the period, the policyholder had to make a claim and the policy covered the losses, they would be very satisfied with the service.
But, if at the end of the period, no claims were necessary, the policyholder may feel ripped off or that they overpaid… which is a really good example of buyer’s remorse: “I didn’t need that insurance policy anyway! I should have never bought it.” But the whole point is that we are buying a service today that limits our losses from a bad, but very low probability, future event.
In the last month or so, as I’ve commented on the health care reform debate on various websites and blogs, I’ve been accused of being a paid operative for the insurance industry! I’d like to make it clear here — just in case anyone was wondering — that I am not. I am an economics and finance professor, and the modeling behind the optimal pricing of insurance contracts (where “optimal” means that it is best for both the buyer and the seller) is very interesting to a nerd like me — it involves real options pricing, and more closely mirrors the actual behavior of the market than the usual cost-plus or net-present-value approaches.
So I find it very interesting for sure. But that doesn’t mean I’m speaking for (or against!) the insurance industry!
Health care insurance companies face these same pricing issues, except that they often deal with a benefits officer instead of the final consumer of their service. When the insurance company deals with company representatives, the information they get on the likely behavior and risk profiles of the employees is necessarily more generalized. And the policy will apply to future, now- unknown employees as well, which is a significant additional complication.
But the economic issues are basically the same as above: the insurance company must set a price (and co-pays, deductibles, lifetime limits, etc.) that covers their actual costs over time because, if they don’t, they will lose money, go out of business, and the service won’t be offered by that company any longer.
If no other insurer can survive, then the service will not be offered; no one would get health insurance. If some other insurer does a better job of forecasting risks, writing contracts that mirror actual behavior, and offering the types of coverage that customers want and are willing to pay for, the company will enter the industry, make a profit, and survive, continuing to provide a service that people want and choose to pay for of their own free will.
By Sherry Jarrell
Learning from Dogs 