Health insurance: The smoke and mirrors industry

 Before we consider the issue of health insurance it is useful to examine the basis of insurance, generally, and how revenue is generated within that business model. The basic premise is that a group of individuals will pay premiums which will provide a reserve of funds which can be used to pay out claims to any member of the group for whatever has been insured. The model is relatively straightforward when it comes to car insurance, homeowner’s, and even life insurance.

In effect, the business model is a gambling enterprise where the insurer is gambling that only a minimal number of claims will ever need to be paid, whereas the insured is gambling that they will be filing claims that need to be paid. Consider the case of life insurance where premiums tend to be quite low when the individual is young because the insurance company is betting that you won’t die, while you’re betting that you will.

The latter position may seem counter-intuitive, but if you really believed you wouldn’t die, then there would be no incentive for you to obtain life insurance, so the point remains

One of the key factors that go into insurance is that most of the protected resources have finite limits on value (including life insurance), so there is a clear ability to calculate the odds and costs of a pay-out and the period of time over which such a risk extends. When this is coupled with a high number of insured individuals that may never file a claim, then the pattern is set so that revenue flows in from premiums and is offset by claim pay-outs.

It is easy to see that, it is in the insurance company’s best interest to minimize the real risk they are absorbing, hence the strict controls regarding individuals that have had car accidents for car insurance, or aging individuals regarding life insurance (and pre-existing health conditions).

Even so, we’ve seen how the insurance companies may have difficulties honoring their commitments when too many claims occur at the same time, such as with Hurricane Katrina. A curious consequence of such mega-catastrophes is the dependence on federal money to supplement insurance industry capacity.