Playing the odds…

Is insurance gambling? It feels like we have “won” if we suffer a loss and it is covered. In point of fact, insurance is not gambling. In gambling you start in a position of low probability of a loss (money safe and secure in your wallet) but move to a high probability of loss (once you lay your money down the odds are very good you will lose it). You move from a “more-sure” to a “less-sure” state. With insurance, however, you move from a “less-sure” to a “more-sure” state. Without insurance you have a non-zero chance of a bad event occurring (less-sure state) that will result in a loss, but with insurance you have reduced that non-zero chance of a loss to zero – so you have moved from a less-sure position to a more-sure position.

Health insurance in its current form (laden down by numerous government mandates) is not insurance anymore but rather is simply prepaid consumption.

Likewise the insurance carrier is not gambling because they actuarially know for a given number of insured that they will experience losses of $x/year, so they simply set rates high enough to ensure all claims can be paid and they can still make money and thus build up a reserve for those years where the predictions are off. Insurance costs scale directly with the likelihood and magnitude of a covered loss. That’s why a several million dollar liability policy can be had for only a few hundred dollars per year but a health insurance policy costs several hundred dollars per month and pays only a fraction of what the liability policy would pay. Health insurance in its current form (laden down by numerous government mandates) is not insurance anymore but rather is simply prepaid consumption.

For an event to be insurable it must be statistically unlikely (e.g. theft, fire, being sued, etc). Health insurance covers events that are statistically guaranteed (routine exams, drugs, contraception, pregnancy, etc). Why are routine events 100% covered? Government mandates. For example, as we have all learned recently, Obamacare requires 100% contraception coverage. <sarcasm> Apparently women who desire contraception are unreasonably barred from obtaining this essential human right due to a burdensome $30/month cost barrier </sarcasm> and so it is mandated that all of society must subsidize this cost. This and many other mandates drive up cost. A catastrophic health policy would be relatively inexpensive. For example last year I investigated the cost of a non-group health plan for my family and discovered that simply removing pregnancy coverage cut the cost of the policy in half! But a group plan cannot remove this coverage and thus most pay for a coverage they can never use. As an employer I’m not even allowed to offer more than three health plans. Why? Government mandates.

Individualized prepaid consumption (saving) is an effective method to address intermittent but regular events. However aggregated and shared prepaid consumption is a terrible method. It has the effect of actually raising costs. In order to understand this, just imagine that we had “food insurance”. The premium would be equal to the total of all money spent on food in a given time frame divided by the population. For some the premium would be more than they would have spent on their own. In those cases there would be an increase in consumption (so as not to get short changed). That increase in consumption increases demand, and hence prices. Additionally, the “food insured” won’t be directly paying for any of their food thus they’ll have no inclination to restrict their intake (why buy ground beef when you can get grade A sirloin). This overall increase in demand will drive up prices. Insurable events can’t be “over consumed” because they rarely occur. Prepaid events can be over consumed because they occur regularly and thus there is ample opportunity. Just imagine what would happen to auto insurance costs if the government mandated that it had to cover the cost of oil changes, brake pads, and other routine maintenance.