Insurance. Insurance is one of the issues at the center of the recent healthcare reform debate. There's a lot of angst over the perceived socialization of healthcare, but what we're really talking about is the socialization of healthcare insurance. Let's examine that.
I was once told that the purpose of insurance is to spread risk among a group of individuals so that each individual would have reduced his own personal risk by taking on a small part of the risk of his peers. If for instance there was no such thing as insurance as we know it today, if my house burned down I would suffer an economic loss equal to the economic cost of my house. But let's say that I have a neighbor whose house has about the same economic value as mine, and his house burns down. I'm out nothing, and he will suffer a total loss. What if, however, before anyone's house burns down, we agree that if either of our houses burns down, we will each pay half the cost of a new house? Our risk of a loss will double, but our potential loss has been reduced by half, so that if it does happen, we won't be so completely economically destroyed.
Now, instead of one neighbor, what if there are ten thousand of us neighbors who want to get in on the deal. Suddenly our risk of an loss has skyrocketed. We'll almost certainly experience a loss in a given year, but on the other hand our loss with each house that burns down has been reduced to one ten-thousandth of what it was when we bore the loss alone, and it becomes a manageable amount.
When there are so many members of the pool, ten thousand in the above example, things get complicated enough that it becomes impossible for the members of the pool to manage it alone. Especially when you consider that all houses are not the same. The group has to bring in outside help. They have to hire a manager. When outside help is brought in, the group of course gives up some extra money over the amount of the total losses to pay for the management.
Because it would be so complicated to get a bill to pay your share of each loss as it occurs, and because losses have reached the point of certainty with so many members in the pool, it makes more sense to just make regular payments into the money pool so that you don't get a bill every time a house burns down, as well as a bill for the cost of the manager. Of course, if you have a more expensive house it makes sense that you have to pay more into the pool than if you have a cheap house. Also, suppose one of your neighbors only uses candles to light his house. All the time there are candles burning in every room of his house after nightfall. It's more likely that his house will burn down than yours, because you use light bulbs, so your risk is lower and you should have to pay less. The manager has to evaluate the level of risk of each home in the pool and assign a payment amount to that homeowner that correlates to that level of risk. We end up getting an equation that looks like this:
Payment into the Pool = (Cost to Replace House X Chance of a Loss) + (Cost of Management/Number of Members in the Pool)
If for instance over a period of a year your house has a 2% chance of burning down and it costs 100,000 to replace, your yearly payment to the pool should be $2,000 plus your share of the cost of the management.
It seems obvious that everyone's total cost of the plan when you add that equation up for every member of the pool should be equal to the total loss for the year plus the cost of management. In our pool of ten thousand, again simplifying things and saying that every member owns a $100,000 house and has a 2% risk, and the cost of management is $200,000, the total would be (10,000 X 100,000 X .02) + 200,000 = $20, 200,000, or $2020, which is what we got above.
If only everyone's house cost the same and their risk was the same it would be so easy to figure out how much we're paying the manager. Unfortunately this is not the case. Everyone has a different level of risk, calculated by something the manager invented called actuarial tables, and everyone's house costs a different amount to replace. That's a lot of complicated mathematics, and it allows something very insidious to happen. Here it is: the total cost to the entire group from each individual who joins in the pool may no longer match the total amount of loss experienced by the group.
In our example above our pool should experience a loss of exactly $20,000,000 over the year. But, because it isn't so simple to figure out, the management might mis-project our total loss to be $30,000,000 instead of $20,000,000. What happens to the extra $10,000,000 collected in payments? Well, we hired the guy, so obviously he can't just keep it. He has to hold it over for next year, and our payments to stay in the pool will be a lot less, right? Oh, wait a minute. Somewhere along the way, we told the manager that anything left over at the end of the year he could keep as a bonus, because he was doing such a good job. As a matter of fact we trust him so much that we don't even make him show us how accurate his projections have been, we just pay the amount he tells us that we owe.
One day, our manager comes to us with a special deal. He's rich enough now that instead of us worrying about paying our shared losses, he'll just cover those losses out his pocket, and he'll charge us the same as he did before. Instead of being connected by a business arrangement with all of our neighbors and paying him to manage the arrangement, we'll all just be customers. That way he can cover every aspect for each member of the pool's needs without worrying precisely how it will affect the other members. Only his bottom line is at risk. No worries for us, because everything works exactly the same as it did before, and now we're not a member of anything. We're just covering our risk by paying him to do it for us.
Now we see the root problem. What happens now when he projects our total loss for everyone at $40,000,000 instead of $20,000,000? How about $50,000,000? Suddenly our rates are going up and up and up, but we can't just fire him and get a new manager, because we're just customers now. Now the size of the pool has grown into the millions and no one can keep track of their real risk, or the total loss of the pool, because suddenly that's private information he closely guards. What's more, all of his buddies operate the same way he does, and increase their rates step for step with him, so going somewhere else to cover your risk doesn't even help. What do you do? Do you quit the system and take a chance on a total loss? Where did it all go wrong?
It's easy to point out where things went wrong in our above example. First, we let our manager start keeping everything left over in our pool, so that his pay depends on what he tells us is our own level of risk by his estimation and not necessarily reality. Second, we let him make that deal with us where instead of him working for us as a group, we're merely customers whose only recourse is to leave the pool, and not fire him if he's doing a bad job. But we had to do those two things. They are after all what makes our plan capitalism. If we don't do those two things, we must be socialists.
Suppose for a minute though, we weren't afraid of being socialists. Suppose also that we already have a group where we get to vote on things and pay people to manage things for us, and instead of continuing to pay this manager who we messed up and let overcharge us, we get this other group we're already a part of to hire a new manager? In this other group to which we all already belong we can refuse to relinquish control to profit-seeking behavior and not make the same mistakes we did before. We'll make sure the manager calculates our risk fairly without an eye toward making profits, and instead just makes sure that when we have a loss it's covered.
After all, those other managers aren't really providing a product. They're not in the home-building business. They're just managing our money for us, so that when it comes time to rebuild our burned down home we can get the money to do it. Any other competent manager could do the job as well, so why are we paying this crop of money managers so much to do so little?
In a large group of people, the people more likely to cling to the status quo are usually the same ones who can be successfully misled. What happens when those old managers lie to their customers and say that only they can really do the job of managing that money? Some of those people will believe them. Furthermore, remember that everyone is already part of our other group we were going to use to start over again and do things fairly. They get a vote on what we can and can't do with this group. The old managers are lying to them, telling them how not only is the status quo the best option, but if they allow us to leave and start over, the whole system will fail and no one's risk will be covered.
Okay, maybe I've taken the home owner's insurance metaphor for health insurance to an extreme, but it does help to simplify things. It should be obvious that insurance never should have become capitalized. Insurance by it's very nature is a socialist enterprise. We get together and we share our economic fortunes in our pool in order to cover our losses. What could be more socialist? Only after people started making money off it did it ever become capitalistic, and now the capitalists tell us that it has to stay that for it to work. Hogwash. You don't make any money from your insurance company. Only the owners of the insurance company do. You don't have any control over how it's managed. That control belongs to the board of directors, whose eye is only toward profits. So what do you get for all that extra money being siphoned off the top end? Nothing. It's no better managed than if we could do it ourselves, but instead of rates going down when losses are down, it's just profit for the owners. The natural way for it to work is that the insured are the owners. Profit should be shared among the group just as loss is shared. Control should belong to the group, not to a third party who adds nothing to the equation.
Next time someone tries to scare you by saying the public option amounts to socializing medicine in the United States, remember that what they're really afraid of is socializing health insurance, and it never should have been un-socialized in the first place.
