Understanding Risk and Insurance: A Progressive’s Guide To National Health Insurance

I wrote this piece for one of those endless numbers of progressive websites – Figure they may not publish it so I thought I would put it here,

Introduction

Progressives invoke lofty social goals to support a national health insurance program. They want to correct disparities in access to care, cover the uninsured, promote health and well being, and they cede arguments about waste and inefficiency to mainstream and conservative adversaries.

This is incorrect as well as inappropriate. The real reason for a national health insurance program is that it is the most mathematically efficient way to manage health care service costs.

Risk

Risk is uncertainty. None of us know whether our health costs will be $0 or $1,000,000 next year. We do not know whether we will live or die, be injured, or ill next year. If we knew, there would be no risk related to our future health care costs. Risk exists because we do not know how much we need to pay for health care next year.

Risk Management Through Insurance

Very few people can afford to set aside sufficient funds to cover their future health care costs. Not knowing our future costs means we should all set aside large amounts to cover even modest costs, such as $50,000 or $100,000.

But, insurance reduces these costs. By joining together we can pay modest premiums, say $3-4,000 per person rather than $50,000, $100,000, or more because an efficient insurer can charge a little more than the average cost to provide insurance. This fact is based on the Central Limit Theorem, the workhorse from statistics and probability theory. The CLT is why insurance works for health, general liability and homeowners and private passenger automobile insurance.

The larger the insurance company, the closer to the average its loss ratio will be, the more stable its operating results, and the more efficiently it turns dollars into health services.

This is what everyone knows!

How To Destroy An Efficient Insurance System

Our current health care finance system is not efficient. There are two major reasons. Most people either believe, or are unwilling to challenge, the idea that more competition in insurance markets, meaning many more small insurers, will operate more efficiently than a single large insurer, or a small number of very large insurers. Wrong.

But that is the smaller problem. We have far too many small, very inefficient insurers, but we create even more inefficiency by transferring health insurance risks to health care providers. I call these insurance risk transfers “Professional Caregiver Insurance Risk.”

There are many insurance risk transferring health care finance mechanisms: Capitation, episode based care, Diagnosis Related Groups payment schemes, The Medicare/Medicaid managed care programs and Prospective Payment Systems, and many other profit/risk sharing agreements between third party payers and health care providers.

Professional Caregiver Insurance Risk

When health care providers accept insurance risks the insurance risks do not disappear into the aether. Risk assuming health care providers become even smaller, less efficient insurers than the insurers transferring the risks! The Central Limit Theorem works both ways. If large insurers are more efficient risk managers than small insurers, the corollary is: Small insurers are less efficient than large insurers.

Serving as their patient’s undisclosed health insurers is an obvious ethical conflict. But it is far worse. The annual operating results of inefficient insurers are very different than the annual operating results of efficient insurers. We can compare operating results by portfolio size. All we need to do is make some assumptions about a large, fairly efficient insurer.

A Paradigm Insurer

Suppose a Paradigm Insurer (PI) insures 1,000,000 people each year. Because it is an insurer its future operating results are uncertain. The measure of this uncertainty, the variation in its loss ratios from year to year, when insuring policyholders from the same population is measured by its standard error.

We assume that PI’s average loss ratio is $0.75 per premium dollar, and it has non-health related expenses of $0.15 per dollar of premium. We assume the year to year variation in its loss ratio, its “standard error” is $0.05 per dollar of premium.

There are two remaining components of insurer’s premiums. We assume PI charges a profit margin of $0.05 per dollar of premium and a Risk Premium, a charge for its risk management services, of $0.05 per dollar of premium.

Without belaboring the statistics, PI has an even chance (Probability 0.5000) of earning profits of at least 10% at loss ratios less than 0.7500, probability 0.8413 of profits of at least 5% at loss ratios less than 0.8000, and PI’s probability is 0.9772 of profits of at least 0% at loss ratios less than 0.8500. PI has a modest probability (0.0013) of losing 5% or more for the year and virtually no chance of losses greater than 10%.

The Flaw In Transferring Risks To Health Care Providers

All insurers selecting policyholders from the same population, have the same probability (0.5000) of profits of 10% or more. This is not true for other outcomes. While PI’s standard error is 0.0500, the standard error for an insurer insuring 100 times as many people would be 0.0050 and this larger insurer’s probability of earning profits higher than 9% is 0.9772.

But insurers 1/100th as large as PI, have standard errors 0.5000 and probabilities of losses greater than 0% 0.4207. This is what efficiency means in insurance. Large insurers are less likely to incur high losses, more likely to earn modest profits, are less likely to become insolvent, and can offer higher benefits to their policyholders than smaller, less efficient insurers.

Progressives need to focus on educating the public about how insurance works to shift the terms of the debate and claim the high moral and financial ground that a national health insurer is the most efficient insurer possible, not cede this ground to moderates and conservatives.

Thomas Cox PhD, RN, MSW, MS is a statistician, registered nurse, certified social worker, chartered property casualty underwriter, and licensed health care risk manager and author of “Standard Errors: Our failing health care (finance) systems and how to fix them”.

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2 Responses to “Understanding Risk and Insurance: A Progressive’s Guide To National Health Insurance”

  1. free ipad 2 Says:

    Terrific review! This is truly the type of post that should be shared around the web. Shame on the Bing for not ranking this article higher!

  2. hotshot bald cop Says:

    Excellent thoughts

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