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Thursday, August 12, 2010

Defending the Wicked Part 7: The Insurance Company

Insurance companies are often very much hated, especially health insurance companies. They are accused of taking advantage of sick people for their own profits and that this is the reason why healthcare is so expensive. I am not going to defend the insurance company as it is, because there is no much that I see in them that I can defend. Insurance companies favor closing interstate competition to secure their profits, imposing regulations on themselves to make it more difficult for competing companies to enter the market, and other tricks that they use for their own gain. Because of this I cannot defend insurance companies for how they operate. But I will defend insurance companies from the accusation that they are the problem of what is wrong with the United States healthcare system.

Let us first understand something very important. Insurance companies cannot dictate prices. An insurance company cannot say, "I will make prices extraordinarily large to gain large profits for myself". The reason why insurance companies cannot do that is precisely why you cannot make your pizza shop really expensive if you were to open it up, say 10$ a slice. Because if you were to do that people will simply go to other pizza shops and you will go out of business. Competition is what prevents you from increasing prices. The same concept is also true with insurance companies. They cannot raise their prices because their competitors will economically hurt them. One should remember that there are few insurance companies with regulations that protect them from more competition. Thus, one can ask that perhaps these insurance companies agree unanimously to raise their prices, in other words, collusion. They would probably be able to get away with such a practice because they are protected from heavy competition. But this is also false about insurance companies because anti-trust regulators will go after them for such practices. Therefore, we have a situation of insurance companies competing against themselves (though limited competition) and not being able to collude. All this means is that no one insurance company or a group of insurance companies can decide to raise their prices simply because they want even more profits.

The above point is very important. Insurance companies are sometimes blamed for keeping prices too high, however, this cannot be true as explained. Insurance companies are not in a position to dictate either by itself or among themselves what the price of insurance has to be. The insurance companies, therefore, are entirely not responsible for high prices. So if the insurance companies are not responsible for high prices, then what is? It is the cost of healthcare itself that drives the insurance costs even higher. Think about it. The nature of insurance companies is to provide money for people who need them and are unable to pay for it themselves (well actually the nature of insurance companies is to scam people and make as much money for themselves, so I guess it would have been more accurate to write "the function of insurance companies" instead). Thus, if the price insurance companies have to pay goes up then the prices they charge their members must go up also. Otherwise insurance companies would be running at a loss. This means high healthcare costs cause high health insurance prices. To confuse this issue and to say that high health insurance prices cause high healthcare costs is to confuse the cause for the effect.

Once an insurance company knows what the prices are for health and the probabilities of people getting sick it now calculates the necessary prices it needs to charge its members. That number is determined by the laws of probability and health costs. If the price is very high it means one of two things. Either the probability of a person being sick are too high or that health costs are very high. Blaming an insurance company for charging their prices based on these mathematical calculations is like blaming a plane crash on gravity.

Another important issue that insurance companies got blasted for is denying people with pre-existing conditions. But I do not understand why an insurance company can be blamed for doing this. Remember an insurance company uses the numbers it has in front of it to calculate the prices that they charge, it cannot dictate their own prices. Therefore, if a person is unfavorable then an insurance company will not allow him to join the plan. Insurance is a risk against yourself, and like all risks it is a gamble. Insurance companies gamble with people, but they do not lose money in the long run because they create their plans around probabilistic calculations. If, however, insurance companies started to accept people with large risks, against their probabilistic calculations, then they will in the long run begin to lose a lot of money and possibly go bankrupt. The decision insurance companies do is the economically responsible decision. One cannot blame them if they are simply following the numbers here. Insurance companies should be able to extend their plans to high risk people but charge them more money for their pre-existing conditions. However, I think, though I am not sure about this so correct me if I am wrong, that charging higher prices for people with pre-existing conditions would be a form of price discrimination and is illegal, so the insurance company can either deny the person or allow him to join the pool but charge all other members higher prices. As a result the health insurance prices must go up.

The actions of an insurance company are therefore understandable. We would do the same if we were in their situation. No house/fire insurance company would be successful if it did not discriminate against burning buildings. If my building was on fire and I called a house insurance company to be insured as my house was burning down and they accepted then such a insurance company would be out of the market very quickly. Discrimination and price discrimination is necessary for insurance companies to be in the market. Furthermore, insurance companies cannot be blamed for doing so, they did not actually harm the person, they are just following the probabilistic calculations.

I have been saying this in my posts already before but I will say so again - stop looking for scapegoats. It is very common for people to find scapegoats. All over history people blamed some scapegoats. Insurance companies are just another example of a scapegoat in present times. The problem with scapegoating is that it is usually wrong. As in our case with insurance companies. And the problem with wrong answers is that they prevent us from searching for real answers. Once we turn an insurance company into a scapegoat we no longer have the same drive to understand why health costs are so high. In fact, from what I can tell, there is no scapegoat at all. It is not the Republicans, it is not the Democrats, and it is not the president. None of these people can turned into scapegoats and blamed for the problems. The problem is the system as a whole and how it operates. No person, no one, but the operation of bad economics and inefficient programs that when they come together create problems. So instead of trying to blame scapegoats how about we try to understand the reasons to why problems occur?


  1. The whole concept of insurance is a bit like a Ponzi scheme, not the fault of the insurance companies themselves. They rely on a steady influx of new healthy members to pay for the sick members.

    I prefer a socialized system in which people pay for their own health care costs on a sliding scale basis and governments pay the remainder.

    Governments should also do a serious study of which aspects of preventative are actually cost effective in preventing future costs (not all preventative health care actually is that), and cover those completely.

  2. Kisarita, there a lot of problems wrong with what you said.

    1) Insurance are not like Ponzi schemes. A Ponzi scheme is when the late investors recieve the money from the early investors. Mathematically Ponzi scheme are therefore not sustainable in the long run where the old investors run off with the money and the young investors are scammed. Insurance is not about who is a late or early invesstor, but who needs insurance at the moment. Which is why insurance is sustainable.

    2) I am sure you support Social Security. That is a government program that is exactly what a Ponzi scheme is. Of course, it is not illegal when they do it because they create their own double standards. If you are against Ponzi schemes (which I hope you are) then do you support Social Security?

    3) But what is the most ironic out of all the things you say is that you say "insurance is like a Ponzi scheme ... I support a socialized system". What does "government pays the remainder" even means? Where does it get the money from? It gets the money from the people - because governments never make a single dollar themselves. So you propose that people pay for their costs and the remaining costs are covered by other people's money. How is that not so different different from insurance except for the fact that everyone is now coerced into being part of the socialized system? Another double standard on your part.

  3. "Governments should also do a serious study of which aspects of preventative are actually cost effective in preventing future costs (not all preventative health care actually is that), and cover those completely.":

    Governments have never cared about what is cost effective and what is not - since it is not their money which they are using. Exactly when in US history has the government carefully managed the money? It never is effective and there is no reason to assume why there will be an exception to socialized medicine now. You can say that the government should carefully calculate these numbers, but you can say that all you want, it is never going to happen.

  4. Yet insurance companies are not blameless. They profit ruthlessly in our controlled, regulated society. Government drives up healthcare costs, making it difficult to get care without insurance, and the companies profit. Nixon bans wage increases, and companies respond by offering free insurance - and insurance companies profit.