Let Insurance Be Insurance
On the separability of financial services and the knee-jerk impulse to combine them
Different financial products serve different functions, and sometimes consumers or politicians indulge a knee-jerk impulse to combine unrelated functions into a single product. In the best case scenario the result is a trivial enhancement in convenience, as when you can have a single insurer service both your home and your automobile. (These are still completely separate policies. The declarations pages are separate documents and the premiums are paid separately, and either can be cancelled while keeping the other.) In the worst case scenario, we completely demolish the functionality of the product.
Insurance is a financial product with a particular, narrowly circumscribed purpose. It is supposed to protect the consumer against large, bank-breaking expenses. If you own a home, it’s probably the most substantial investment you own. You’ve likely paid several years’ wages into it, so losing it would be a devastating life event. If a fire or windstorm were to completely destroy your home, you’d be made whole, minus the irreplaceable photos and home videos lost. If you own a car, that’s also a substantial investment. It’s far less substantial than a house in terms of “years of wages”, but it could still be a bank-breaking expense and leave you in a lurch if your car is totaled. More importantly, if you injure someone with your vehicle, you need to be able to cover their bills. Your auto policy will cover up to your policy limits on medical bills and property damage incurred. Getting sued for $100k (a typical auto liability limit for Bodily Injury) could be a life-altering event, certainly in a bad way.
Think of this function as pooling a small probability of a very bad outcome across thousands or millions of people. Out of a thousand home owners, one a year may have a house fire. Out of, say, ten thousand home owners, one might have a truly devastating house fire that results in a total loss. Insurance should be for this kind of expense, not the routine, expected expenses that are standard upkeep for a home. The average asphalt shingle roof will need to be replaced every ten to twenty years, at the expense of, say, $20k. Since this is predictable, a typical insurance customer should be self-insuring for this. (If you have just replaced your roof, and a storm destroys the new one, then sure. Insurance is totally meant for this kind of unexpected expense. But responsible homeowners should be budgeting and self-insuring for the expected costs of homeownership.)
There are other financial products with very different functions. Annuities, for example, take a lump sum of money and turn it into a payment stream. Say, a monthly payout that lasts until you die. Based on interest rates and actuarial life tables, insurance companies can calculate the cost of an annuity with a given payout, given the age, gender, and other policyholder characteristics.
Investment accounts grant you ownership of stocks and bonds. These allow you to store your money in a way that expose it to some downside risk and (on expectation) a large upside risk. There are different gradations of risk, depending on the mix of stocks and bonds. Someone who wants to minimize investment risk can store money in a bank account or as cash. Anyone who wants their wealth to grow and earn them passive income can avail themselves of these services. They’re available to anyone who says, “I have excess cash that I don’t need now, I want to convert it to more wealth that I can use later in my life.” The flip side of this is a loan. If you have expenses now, but won’t have the income to pay them until later, you can borrow money and pay interest on it.
Some financial products are really pre-payment or pre-commitment. My dentist offers a service plan, where we can pay an upfront fee and get certain services for free and others at a discount. That might be a negative expected value proposition from their point of view, but it locks in customers. (Or who knows, maybe the cost of the service plan is high enough and utilization low enough that the dentist makes a killing on it.) There are a lot of low-value service plans on consumer appliances. It’s low-grade insurance for small expense repairs and replacements. These are generally a terrible deal for the consumer and should be avoided. They are not really “insurance”, since the stakes are not bank-breaking. It’s more like pre-paying for the eventual replacement. You’re better off pocketing the money and saving it for when you’ll eventually need it. Most so-called health “insurance” is not really insurance. It’s this kind of pre-payment, but with slightly larger expenses.
Then there are things like lotteries and games. A small chance of a big payout, but negative expectation overall. These are to be avoided, unless you really enjoy them. They almost certainly should not be combined with insurance products. It’s a lark, a few dollars for a chance to dream big, to amuse oneself with thoughts of how to spend millions of dollars. That’s fine, it’s no major harm to indulge with these once in a while. But a serious, financially literate person can get through life without bothering with them.
There are also subsidies and transfers, whereby one party benefits at the expense of everyone else. These aren’t really financial products per se. It would be more accurate to say these are unintentionally built in to some financial products and done intentionally or unintentionally by government programs. They are features of certain financial products, but obviously you can’t simply purchase a subsidy to favors yourself. A fairly priced financial product would always make this a wash. (“You want a net present value of $100 in benefits? That will be…well…$100 please.”) I mention this category because pundits and policy wonks foolishly insist on building subsidies into financial products (via regulation or tax credits, for example) without thinking about what they’re meant to accomplish or pausing to consider whether it’s a good idea.
What I wanted to gripe about is the weird impulse to combine unrelated services into a single product. Whole-life insurance is an example of a product that shouldn’t exist. It is strictly better to get a less expensive term life policy and pocket the savings, putting it into an investment account. This may be apocryphal, but the origin story I heard for whole life is that some customers felt disappointed when their term policies timed out. They wanted something in return for all those premiums they paid over the years. Insurers came up with whole life so these dissatisfied customers could “earn equity” and not feel like they’re left holding an empty bag when the term is up. I don’t know, nor do I care, if this story is correct. It’s emblematic of the stupid financial decisions that people make all the time. It’s a perfect example of the kind of irrational consumer sentiment that manifests in regulations and ruins our insurance markets. Life insurance is supposed to serve a particular function. If you die young, it should cover your family’s expenses, since they’ve unexpectedly lost a primary earner. A 30-year term policy, purchased in your 20s or 30s, should be all you need for your entire life. The premiums you pay on that policy (which are usually cheap if you buy your policy young) strictly cover the cost of the risk transfer. (Essentially this is the probability that you will die, times the face value of the policy, integrated over the lifetime of the policy, applying discounting for time.) If you ask more of your life insurance policy, what you are really doing is trying to package term life insurance with some other financial product. (I know there are some tax advantages to whole life policies, but I see these as a mistake, an unintended arbitrage opportunity accidentally created by tax law. There is no valid reason for government policy to favor these instruments.)
Recently I saw a vacuous comment on Facebook. Someone suggested that auto insurance customers should get back a portion of their premiums if they don’t have an accident in a given year. My mind instantly flooded with several thoughts. 1) The impulse to say such a thing is stupid, strike it out of your head. 2) There are several ways this is already happening. 3) Taken to the extreme, this destroys insurance. This entire post is a reflection on 1), so I’ll say something about 2) and 3). On 2), I want to shake this person by the lapels and say, “Dude, you’re already getting this!” Every insurer surcharges for prior accidents, because the risk of a future accident is higher if you’ve already had one. (The insurer is not trying to recoup their costs from that past claim by surcharging you. This is another common consumer belief, but the math simply doesn’t work.) You effectively get a discount if you don’t have an accident for several years. It’s not the same as getting a cash payout for not having a claim, but it’s a premium discount for not having claims. There is also a version of this at the macro level, if the company that insures you makes more profit than planned. If you insure with a mutual (such as State Farm), when the insurer has a good year they will pay dividends to their customers. On point 3), note what happens if we extrapolate this concept to the logical limit. Each insured is refunded their full premium when they don’t have an accident, and each insured who does have an accident pays the full value of their claim. This completely undoes insurance. The original poster must have realized this, because the wording didn’t insist on a full premium refund. But still, they should have paused to reflect for a bit longer. If the logical bookends are “pure risk transfer with no premium refunds” and “complete annihilation of the insurance function”, why did they think a compromise was in order given the raw insanity of the latter extreme? A reasonable person would have deleted the post and learned something valuable through introspection.
Insurers basically come up with a fair premium for each risk, reflecting the accident risks of the driver (based on age, gender, martial status, credit history, and driving history), the vehicle (size and expense to repair) and location (some zipcodes are more accident-prone than others). Out of, say, one hundred people exactly like you, 95 won’t have a claim, but four will have small claims and one will have a big claim, which eats up all the premiums. You’re not being ripped off if you pay your premiums and don’t get any money back. That’s exactly how pure insurance is supposed to work. The recipe for coming up with these premiums already has your past accidents baked into it. The Facebook comment was appealing to an extremely superficial concept of “fairness” that makes no sense upon the slightest inspection. They wanted to pollute the pure risk transfer function of auto insurance with some weird kind of lottery. I wanted to say, shut up and let insurance be insurance. Clearly if you expand basic insurance policies to make them issue premium refunds, you have to increase premiums to cover the cost of this added “benefit”. If a customer decides they want to pay higher premiums to indulge their weird ideas about fairness, whatever, more power to them. But please leave me out of it.
I have another anecdote about unreasonable “fairness” sentiments applied to auto insurance. A woman was complaining that she’d been in a minor accident and hit a highway guard rail. Her insurer covered the damage she did to the guardrail, but not the damage to her car. She said this in a snippy way, as if the insurer sided with the state against her, as if they “cared” more about the third party than they did about their own policyholder. Actually, the policy was functioning exactly the way it was supposed to. Liability coverage is required by law. As a minimally responsible driver, she held a policy and was covered. She had bought a stripped-down policy without first-party physical damage coverage, the kind that covers her automobile when she is at fault. She had declined the option to purchase coverage for such an event. If she was truly dissatisfied by the outcome, then this is a case of poor consumer education. It may have been entirely bluster on her part, but the tone in which she told the story suggests that these “fairness” ideas infect many consumers. (Note: it may or may not be wise to cover your auto for physical damage. If your vehicle is old and depreciated enough, it’s smarter to simply self-insure. The purchase of an auto every decade or so is the kind of predictable expense that you don’t need to insure for.)
Health insurance is not really insurance. The misguided consumer sentiments and the resulting regulations have warped it into a monstrosity of weird pre-payments and subsidies. Consumers would never buy such policies in a free marketplace, where insurers are free to offer reasonable coverage terms and customers shop for desirable policies, disciplined by the reasonability of the premiums. Policyholders are often not aware of what is covered. They almost certainly have less financial stability than they would if they had a simple catastrophic care plan. For one, the very high premiums are a major household expense. Such a large drain on their household incomes makes them less able to save for big medical expenses. For another thing, they are often stuck with unpredictably large bills for care that they quite reasonably thought was covered. (It’s often very basic “standard of care” medicine, which is either denied or slow-walked by the insurance bureaucracy.) How did we get to this?
I’m going to start by blaming the voting public for having ridiculous ideas. If I were to nominate one toxic idea as the most destructive to our healthcare industry, it’s the notion that we should get all of our medicine free of charge. Politicians and public intellectuals invented this concepts out of whole cloth. (“Free at the point of service” is a founding “principle” of the National Health Service.) It’s not really derivable from anything, it’s not the natural extension of some other widely accepted moral principle, and it leads to horrible consequences. Most of what’s wrong with American healthcare can be blamed on the excessive use of third-party payments for what should be routine household expenses, expenses that ought to be paid out of pocket and with transparent prices.
We have extremely nice grocery stores and restaurants, notably better in terms of quality and selection even compared to when I was young, because these operate on a more-or-less free market. (They are astronomically better than what’s available in the communist dystopias of the mid 20th century.) Where there are programs that help the poor to acquire food, they are cash-equivalent assistance programs (as in food stamps). The customer is still the customer, s/he still has a motive to shop for a good price and economize on usage. The housing market is inefficient due to bad zoning laws, but in most places it works reasonably well. You can purchase a home with your money, and private businesses and developers build homes and rental units. Nobody insists that food and housing should be run by the government, or that these products should be free at the point of service because they are “essential”. (Well, almost nobody.) Assistance to the needy is done through a voucher system, where they have the incentive to economize and price-shop. Contrast this with healthcare, where the patient is not the customer. Behold what happens when you place an industry under near total control of the government, removing prices and market mechanisms.
What’s a better system? If we lived in Ancapistan, a libertarian utopia of free markets, what would health insurance look like? It would have much cheaper premiums, cover far fewer things (pure catastrophic coverage would be common), and require the consumer to do much more out-of-pocket spending. So if insurance covers less while the patient pays more out of pocket, isn’t this simply taking away with the left hand and giving back with the right? No, not at all. With healthcare consumers spending out of pocket, prices would be much more transparent. Patients would shop, including shopping in nearby cities (or perhaps out of state or country) to get a better deal. Prices would be dramatically lower, and providers would find ways to cut waste and do more with less. People would save and budget for expected lifetime expenses, such as regular office visits, childbirth, a hip replacement, or the occasional broken bone. But they would still be covered for something truly unexpected and budget-breaking. If someone requires a long hospital stay due to illness or an accident, there would be coverage for that. Supposing someone runs into poor health early in life, and they start needing the requisite levels of healthcare in their 40s or 50s instead of their 70s and 80s, a typical plan would cover this. I suspect there would be clearly defined coverage triggers, in contrast to currently existing plans. A diagnosis for, say, Stage 3 stomach cancer would trigger a cash payout that covers the average cost of care (or perhaps the 75th or 90th percentile of the cost of care…enough to ensure a standard level of care anyway). Such unambiguous triggers and cash payouts would keep administrative costs low. There would be minimal haggling over appropriate treatments or over which providers are in-network. Patients could take their cash payout to whatever provider they like. There would likely still be insurance plans that operate similar to the ones that exist today, plans that promise to pay for whatever level of care is deemed necessary. These would be more expensive and have more overhead costs (the haggling over standards of care, annoying phone calls to ensure treatments are effective and necessary, and so on), but there would still be a market for it. But most plans would cut out the small, routine expenses that can be planned for.
Why do I expect insurance would operate this way? And to be readily available and cheap? Because there are working examples of it. I pay just north of $50 a month for a term life policy with a six-figure face value. Now, this has an unambiguous coverage trigger (my death) and an exactly specified payout. Using life insurance as a starting point, you can make some assumptions and adjustments to get a reasonable back-of-the-envelope cost for real health insurance. A significant medical misadventure has a higher probability than all-cause mortality (say the likelihood of significant injury or illness is ~10x the odds of dying) and a smaller average payout (say five figures or low six-figures). It’s not unreasonable to think you could get pretty good catastrophic coverage for 2x or 3x the cost of a life policy. Compare that to ~$500 to $1,000 per month for the average health policy for a single person, and this is much higher for a family. Another back-of-the-envelope estimate can be gleamed from your auto policy. You can generally get Bodily Injury limits of $300k per incident (typically also limited to $100k per injured driver) for well under $50/month. These claims have a frequency of about 1% per year, with an average claims cost in the $10k to $20k ballpark. There is significant room here to make the coverage more generous without remotely approaching the absurd costs of existing healthcare policies. We are plainly making health “insurance” vastly more expensive by 1) loading small expenses into them and 2) having unclear coverage triggers, basically “whenever I want to use healthcare for whatever reason.”
With the customer paying out of pocket for most expenses, prices would be lower. In the existing system, hospitals don’t have listed prices and don’t really know what to charge. Instead of simply publishing prices and charging the listed price, they enter into an agonizing contest of brinkmanship with the patient and their insurance provider. Hospitals and other providers are willing to dramatically change prices based on the customer’s willingness and ability to pay. They have high fixed costs due to maintaining their buildings and paying their staff. (Hospitals seem to be under constant construction. I don’t know if this is just useless bloat or if those new wings and machines are actually providing meaningful health returns for the community. But they certainly add to fixed costs, which someone needs to pay for.) Businesses with high fixed costs can, and often must, engage in “price discrimination”, in which they present different customers with different prices. They can afford to do a procedure at a lower price for an indigent patient, while they charge full freight to the rich professional. In some cases it may even be profitable to do the procedure at the lower price, or to do it for free and get a tax write-off. But this requires having some whales to pay for the large fixed costs. When insurance gets involved, the hospital can slap the patient with an enormous bill, hoping the insurer will simply pay it. The insurer can deny the claim, or threaten to deny it, or offer to pay only a portion of it, sticking the patient with an enormous bill. The hospital can then decide whether to go to collection or forgive part of the bill. Healthcare providers are probing the ability and willingness of various parties to pay after services are rendered. It’s a dishonorable form of price discrimination. This is a toxic game of hot potato, and there is no need for it. Patients should be selecting health providers in an open market with transparent prices, mostly known ahead of time. (Marty Makary has made a hobby of suing hospitals that spring unreasonable bills on their patients. He told Russ Roberts that he wins 100% of those cases, likening these hospital practices to a lawn service slapping you with a $10k bill. So there is some hope, even under the current system. But it would be much better to change the culture such that people expect to pay most of their medical bills out of pocket.)
Why such a strong opposition to paying out of pocket? If mature adults are expected to budget for other large expenses, why should healthcare be any different? The consumer sentiment that “I should get free healthcare” is really skin deep and indefensible. They don’t have a well articulated philosophical or economic argument. If you asked them, they’d give a moralistic slogan like “I pay my insurance premiums, so they should take care of me” or “I paid my Medicare taxes” or “Healthcare is a basic right” or even a cynical “I want free stuff.” Which is all just question-begging. Exactly what coverage is implied by the insurance premiums? You’re obviously not entitled to unlimited care, just the standard of care and amount of coverage that was reasonably assumed by the insurer when calculating the premiums. And so what if you declare healthcare to be a basic human right? That just means we should select a system that maximizes your ability to get quality care when you need it. Which is more likely under the system I’m proposing than one where everything is covered and everything is “free at the point of care.”
A typical consumer might have a vivid memory of a large medical bill, their own or a family member’s. They are using the intuition that “But for insurance, I would pay for this out of pocket and it would be a devastating loss. Or I would have to go without care and suffer illness, perhaps death.” They generally aren’t thinking through the logic of how third party payments make these quoted prices much higher, or how direct out-of-pocket payments and consumer shopping would bring them down. I’ll provide a couple of well-known examples of exactly this point. The Surgery Center of Oklahoma offers transparent prices, which are much lower than the amounts billed by traditional hospitals offering the same procedures. And there are healthcare markets where out-of-pocket is the norm, such as Lasik and plastic surgery, or veterinary care for that matter. These markets are not characterized by the same exploding costs as the rest of healthcare.
Fans of all-inclusive coverage might say something about how insurance makes care more “affordable.” This is only true in an extremely limited sense and is not true in the way the speaker intends it. Take an average person who experiences routine healthcare expenses over the course of their lifetime. (So let’s stipulate no big, catastrophic healthcare costs, but the expected number of illnesses, trips to the ER, and surgeries over a lifetime.) Clearly this person, assuming we could identify them and rule out catastrophes ahead of time, doesn’t need insurance. Insurance does not make routine care less expensive, it does the opposite. It has the effect of obfuscating prices (described above), and on top of that you have to pay the administrative costs of insurance. It’s not really insurance, it’s just pre-paying for healthcare. Which means you pay for someone to hold onto your money for you. This is an extra layer of administration, paying actuaries and claims adjusters, keeping the lights on in the office buildings, and so on. A typical “loss ratio”, the proportion of premiums paid out as claims, is in the ballpark of ~60% for auto and homeowners. The Affordable Care Act stipulates an 85% loss ratio for health insurers. It’s an insane rule, but even this assumes a 15% overhead that can’t be done away with. So why do this for routine care? If you take a bunch of average people facing average healthcare costs, you’re obviously not making their expenses “more affordable” by pooling those costs. Or to put it another way, this average healthcare consumer can save back their insurance premiums, foregoing the policy, and simply spend the money when it’s needed. Lifetime healthcare costs = Lifetime healthcare costs. Prepayment doesn’t change this formula. Young people, who needn’t pay the huge Medicare taxes and insurance premiums, could be better equipped to save and finance their eventual costs. Let’s stop indulging this knee-jerk notion that we should get medical care for free. (Where the hell do these “should”s come from anyway?) Nothing is really free. “Free” at the point of care simply means extracting those dollars at some other time.
Policy wonks might make an argument here about consumer irrationality, specifically myopia (sometimes called “hyperbolic discounting”, a failure to anticipate even an easily predictable future). Normal people will “wait and see” rather than treat an illness. They forego necessary care. This can lead to higher costs later when a small problem isn’t treated in time. The bill is a barrier to care, which can simply be removed with mandatory insurance or universal healthcare paid for by the government. I have a few things to say about this kind of response. The first is that we clearly over-consume medicine. Voluntary limiting of one’s consumption, based on the patient bearing more of the cost, leads to cutting unnecessary medicine with no apparent effects on health outcomes. This is a straightforward result of the various health insurance experiments (see Robin Hanson’s breakdown here, also here). At the population level, when you give people a lot of free coverage, they consume more healthcare without making themselves measurably healthier. Healthcare policy wonks know about these results, but they play dumb, or they downplay the implications, or they cherry pick observational studies that contradict these RCT results. But this is the straightforward reading of the totality of the literature, so that’s my starting point. If we force people to pre-pay for healthcare (through taxes or insurance premiums), we shouldn’t expect them to be healthier due to the resulting increase in consumption. Another response I would give is that they’re appealing to consumer stupidity. You, consumer, are too dumb to make rational choices. You’re going to skimp on a necessary medication. You’ll leave a minor infection untreated until you go septic. My argument in this post is that you can save back those Medicare taxes and insurance premiums and spend the money when you actually need to. The policy wonks think you are too myopic and too stupid to manage your savings. If we allow for stripped down catastrophic insurance policies, you’ll probably spend the extra cash on stereo systems, the latest iPhone, and lottery tickets. These wonks understand my point about money being fungible. If you corner them, they’ll admit as much, but then appeal to consumer irrationality to justify their preferred scheme. I just wish they’d be more honest and upfront about where they stand and how much contempt they have for the consumer. (Sometimes they admit as much.) If we could change the culture, if we could strike out this ridiculous notion that we’re owed free healthcare, then consumer behavior would be far more rational. Consumers could see healthcare as being just one of many large lifetime expenses to plan for. Let’s all stop fueling these wrongheaded consumer sentiments with moralistic demagoguery.*
Policy wonks often wish to subsidize some groups at the expense of others. There is usually not a well-founded or thought-through reason for doing so. Even when there is, they really should do all subsidies on budget via direct taxes and transfers without polluting insurance markets. Governments have the power to tax and to distribute funds. Private entities are far more limited in this respect. Insurance should transfer risk, full stop. The premium charged to a particular customer should reflect the expected cost of covering them, as determined by standard actuarial methods. We shouldn’t be trying to achieve social justice objectives with insurance mandates or laws against risk pricing.
In P&C insurance (as in personal lines home and auto or commercial insurance) when an identifiable group is getting undercharged, we refer to that as a “subsidy”. It is quite correctly seen as an error to be remedied. Supposing we’re undercharging young people for their very high risk of having an automobile accident (or people with poor credit or multiple accidents or low policy limits), they’re getting a good deal, which is necessarily at the expense of all other customers. If this kind of mispricing is allowed to persist, it can lead to instability. We end up attracting too many young people, since we’re a good deal for them. At the same time, our price for them is inadequate to cover the risk, so we suffer outsized losses. This so-called adverse selection problem can spiral out of control unless the mispricing is fixed.
In the realm of health insurance, we deliberately flatten rates with misguided regulations. (Also true in P&C, but far less so.) An example of rate-flattening is Obamacare’s 3:1 maximum ratio for age rating. The ratio in health expenses between the youngest and oldest insurance customer is much larger than 3:1. I don’t know who pulled the number 3 out of thin air and imbued it with magical “fairness” properties, but they were not well grounded in actuarial science or moral philosophy. They just made that shit up. This is what we’re dealing with, this is why we can’t have nice things. When a proposal to replace Obamacare recommended loosening this 3:1 to a 5:1, some half-wits started referring to this risk differential as an age tax. It would be nice if young people were allowed to purchase cheap insurance, cheap not because it’s stripped-down coverage but because it is accurately risk-rated to reflect their age! Young folks are new entrants to the labor market, earning entry-level wages. Some damn fools, wielding the language of social justice, have managed to create a subsidy from the young and poor to the old and rich. I’ll be a broken record here and repeat the point that these are predictable life cycle patterns. The standard lifecycle is that you start your career relatively healthy and poor, and as you age your health deteriorates as your income and wealth rise. Young people would be better equipped to plan for their future if they weren’t burdened with subsidizing the health expenses of old folks. They should be able to buy a cheap risk-rated policy. They could then plow the savings into a health savings account or their general savings in order to plan for old age. If you’re old and infirm, your condition was entirely predictable, and you (unlike a freshly minted graduate entering the workforce) have had multiple decades to plan for it. It is just shameful beyond belief that retirees and near-retirees would be effectively demanding a subsidy from their kids’ and grandkids’ generations. The technocrats and politicians who crafted this rule should be admonished for their despicable behavior. They exploited the high voter turnout of senior citizens to get legislation passed, just so they could declare a moral victory and claim to have “done something”. We need to instill this ethic of planning for our predictable lifetime expenses, insuring only for the unpredictable ones, and not insisting on other people paying our bills for us. If we’re talking about the truly indigent, that’s a different story. It’s fine if there is support for them, but don’t do so by screwing up insurance markets. If the voting public is so inclined, there should be government programs that specifically address poverty with cash or in-kind benefits. If they are not so inclined, then the technocrats and social engineers have no business foisting such programs on us indirectly via insurance regulations. We have the right to expect transparency from our government, to not be undermined by technocrats with a different agenda. This is impossible when they sneak in subsidies off-budget with thousand-page legislation and millions of pages of regulations.
What about pre-existing conditions? I almost never hear a sane analysis of this problem. It’s always knee-jerk. “Here’s a sick person without coverage and with insufficient funds. Aren’t we all obligated to help him?” A truly risk-rated policy would be unaffordable for this person, since we already know they will have enormous medical bills in the future. I’ll start by saying the obvious: insurance doesn’t “solve” this problem. Suppose an uninsured person comes down with a cancer that’s curable, but very expensive to treat. The dice have already been cast, and the hit has already been taken. This person has declined to pay into the risk pool, but then expects a payout from it. As a group, these ill and uninsured individuals have created a shortfall by not paying into the big fund that’s necessary to cover the total cost of claims. Forcing other policyholders of a specific company (the one assigned to service the person with a pre-existing condition) doesn’t fix the shortfall. In the world of auto insurance, there are residual market mechanisms for this kind of problem. These are risk pools for extremely risky drivers who have trouble finding traditional insurance coverage at an acceptable price. These are a legitimate function of government in the sense that they solve a real problem. We all want the driver with a DUI and two vehicular attempted homicides to carry insurance, since they are likely to cause an accident (assuming they still have a driver’s license). Better to cover them than not to for the liability they present to other drivers. Generally there is a state-run pool, with insurers sharing equally in the losses and premiums based on market share. Or (less equitably) the state assigns a maximum premium, and they force an insurer to service the policy and simply eat any losses. Another option is that the government directly runs an insurance program, collecting premiums and paying losses. Such a “company” can run losses as large as the taxpayers will tolerate. If the government wants to have such a residual market, ensuring access for all and paying for uncovered losses, that’s perfectly fine. That’s almost certainly the right way to handle insurance losses that have already been incurred but which haven’t been funded. Society as a whole should share in that burden, through general taxes and transfer payments allocated specifically for this purpose. (Once again, assuming the voting public is so inclined). But it makes little sense to conscript a small group (say, the policyholders and shareholders of a particular insurance company or group plan) and saddle them with an unfunded burden.
There is another analogy to auto insurance here. If I injure you with my car on August 21st at 3:02 P.M., the policy I had at the time of the accident will pay for your medical bills, up to the limits of my policy limits. (If my limits are inadequate, whatever auto policy you held at the time of the accident can step in, assuming you have underinsured motorist coverage…which you should have if you’re financially responsible. The same principle applies, the policy you had at the time of the accident covers you for your associated medical bills. If you switch insurers, that is still true.) If you need a series of expensive surgeries lasting for the next ten years, my insurer is on the hook for those future claim costs. If I switch my auto insurer, I am not carrying around that liability like an albatross around my neck. I will pay a higher premium for the next few years, because such accidents are usually surchargeable. But this is in the ballpark of a ~50% premium increase, usually time-limited to three years. My next insurer doesn’t have to cover the cost of previous accidents. This is why health insurance is completely insane. We are attempting to insure liabilities after the die has been cast. It would be completely ridiculous to expect Insurer #2 to simply take onboard an already-incurred six-figure liability just for adopting me as a customer. But they are perfectly happy to write me for the correct price to cover future liabilities. Health insurance ought to work the same way. The coverage trigger should be something relatively unambiguous, like “a diagnosis for diabetes” or “a diagnosis for stage 3 cancer.” Prior to the diagnosis, this not-yet-pre-existing condition meets a classic criterion for insurability: it is fortuitous from the point of view of the insured. Supposing this person acquires insurance through a new employer after the cancer is a known quantity, they are effectively saddling their employer’s small group plan with an unfunded five- or six-figure liability. This effectively comes out of the pockets of the cancer patient’s new co-workers, given that they will see premium increases based on the group’s experience rating. This might seem more humane than denying the cancer patient coverage, but I insist it’s a wrong-headed approach. If governments are going to be in the business of making third parties responsible for unfunded liabilities, it should require all citizens to share in the burden equally through a general fund and general taxation.
I’m presenting a vision of how insurance could and almost certainly should work in an ideal world. Insure against catastrophes with risk-rated policies, self-insure and save to finance expected, routine expenses. It would take some work to get from here to there. This doesn’t really work for people who are already old and retired. They have been depleted by paying their high Medicare taxes and non-risk-rated insurance premiums over their lifetimes. They were counting on having those taxes and premium payments fund their health expenses in old age. That doesn’t mean we should be stuck with the current system forever. Someone who is currently in their 30s or 40s, with decades between now and retirement, could certainly afford to plan for their healthcare costs in old age. We could unwind the current system over the course of 20 or 30 years. Maybe we could call it 40 years to soften the landing further. But it doesn’t make sense to keep doing the irrational forever just because some people are checkmated by the existing system. I’ve been harping on the irrational consumer/voter sentiment that “I deserve free healthcare” for this entire post. We also need to ditch this irrational notion that Medicare reforms are an untouchable third rail of politics. We should be able to propose a reform that explicitly grandfathers existing retirees while promising to unwind our awful system over the course of half a century. If senior citizens react by locking arms and saying “Don’t touch my Medicare!”, we need to be able to say, “Sorry, grandpa, you don’t understand what’s being proposed. And you shouldn’t be able to dictate what policy looks like after you’re gone. And you certainly shouldn’t be part of a political coalition that conspires to steal from your grandchildren.” It is unfair of them to so utterly dictate the destiny of future generations, refusing to entertain even gradual course corrections. There are some push-button, tear-it-all-down libertarians, but I’m not one of them. I wouldn’t press the button that says “Immediately dismantle all government programs,” because this would cast some people to the wolves. There are some beneficiaries of government largess that I have zero sympathy for, but it seems wrong to suddenly dismantle old age entitlements that retirees are completely reliant on. But I think it’s fine to tell someone who was planning to retire in ten years that “Sorry, you’ll have to work another two to five years.” Young workers with longer timelines can absorb bigger shocks, and most of them would actually be far better off if we started making these changes now. I would push that button immediately, the one allowing a 22-year-old labor market entrant to buy a cheap risk-rated catastrophic care health policy. Fine, tax him to fund the expenses of current retirees, indigent patients, and residual market mechanisms for “pre-existing conditions.” But for crying out loud, start now!
Just let insurance be insurance! Stop forcing a straightforward insurance policy to be packaged with an annuity, or a subsidy, or a savings account, or a pre-payment service plan. I don’t resent anyone who wants such a policy, if a private insurer is willing to sell it to them. Waste your money on service plans and whole life policies if you like, or buy a policy from the “no risk pricing” auto club (which will almost certainly spiral out due to adverse selection, but have fun while it lasts). I don’t care, best wishes to you, seriously. Just don’t compel me to be part of your irrational system.
*I am not contradicting myself, btw. People have all kinds of wrong-headed ideas, and obviously I’m harping on them in this post. These ideas are often rendered harmless when the consumer faces the costs of their own actions. Government programs tend to insulate people from their irrational beliefs, and we get bad policy because of it. Consumers can “want” free healthcare, in the very limited sense that they declare as much, or when faced with a bill they might “wish” the bill was zero. But almost no one would buy an insurance policy providing unlimited, first-dollar coverage in an open market of competing policy terms and premiums.