Wednesday, July 15, 2009

Risk and Health Insurance

With a new President, America has a new pledge to expand health insurance coverage to everyone. It is a complicated subject but all types of insurance are supposed to let people pay premiums into a risk pool that generates a reserve fund to pay losses. Insurance companies employ mathematicians to analyze actuarial data on mortality: accidents, sickness, disability, retirement and other risks. Actuarial data are necessary to construct probability tables that will determine the premium payments to charge that will generate cash reserves to pay future losses.

The risk pool has to be defined and the probability tables have to be calculated as random risk. Life insurance actuaries use data accumulated from many years to know the random risk that someone age 50 will die during their 51st year. They don’t know who will die but they know the probability, which lets them determine the premiums necessary to build an adequate reserve fund. Life insurance policies typically exclude death caused to soldiers in warfare because it is not random risk and prevents actuaries from building a reserve fund.

In home owners insurance, the premiums go to cover only those homes, and those risks, that occur in a random fashion. Insurance companies exclude flooding from homeowner’s policies because flooding is not random. The home in the valley or next to the stream always gets flooded while the home on the hill never gets flooded.

Risks and losses from flooding along rivers, flood plains or hurricane zones are high enough that excluded home owners acted through the political system to pressure Congress. To insure against the single peril, flooding, means defining a risk pool of homes and property with risk of flooding. With a risk pool of potential flood victims, premiums create a reserve fund to pay losses from random flooding to those in the risk pool. However, homeowners and property owners subject to flooding are widely scattered and geographically spread out in a way that has prevented private sector insurance companies from creating a large and random risk pool for flood victims.

The answer turns out to be a government sponsored National Flood Insurance Program(NFIP) administered through FEMA, the Federal Emergency Management Agency. On their website they explain that communities participate in the program by adopting and enforcing floodplain management ordinances to reduce flood damage in exchange for federally backed flood insurance available to homeowners, renters and business owners in these communities.

The NFIP identifies and maps the Nation's floodplains to provide the data needed for floodplain management programs and to actuarially rate new construction for flood insurance. In other words, Congress turned to the government for a solution to a problem that the private sector could not solve.

Similar problems with risk have plagued the health care system for many years. President Truman advocated and proposed national health insurance 60 years ago, which the American Medical Association opposed and defeated. During the Eisenhower administration the medical profession decided to build and expand the private health care insurance system as a way to reduce the pressure for national health insurance.

From the beginning of the expansion of private health insurance in the 1950’s, there were problems with random risk. Someone who already has heart disease or diabetes when they apply for insurance has a health problem, but they are not insurable in a private health plan because they are not a risk, they are a certainty. To use insurance jargon they have a pre-existing condition. In effect, their probability of loss is one and their premium would have to equal the cost of treatment to avoid draining a reserve fund.

In the early 1950’s insurance companies started marketing group policies in large numbers and defined a risk pool through the work place. People started buying health insurance and hence joining a risk pool through their employer.

One trouble with a health care risk pool that depends on jobs comes at retirement, when people lose their employer sponsored health insurance. Age and the likelihood of pre-existing conditions assure it will be difficult or impossible for retirees to re-enter a risk pool and buy insurance. Pressure to cover retirees increased when the United Auto Workers convinced the auto companies to cover retiree’s health care in the 1950’s. Pressure continued until the passage of Medicare health insurance for retirees in the Johnson Administration.

The second trouble with a health care risk pool that depends on jobs is that not everyone has one, or has one they can keep until age 65 when they become eligible for Medicare. Employers without health care amount to an exclusion from a health insurance risk pool. Layoffs and unemployment are not just loss of income, but removal from health insurance.

Before a layoff someone is in a risk pool they may have entered long ago when they were young and healthy. In the mean time they may have developed heart disease or some medical condition that is not a risk for a private insurance company, but a certainty or pre-existing condition, which cannot be covered when someone has to reapply for health insurance in mid-life.

In this way defining a risk pool for health care is a problem of timing. If everyone entered a common risk pool at birth and stayed in the same national risk pool until death then all Americans would share in the risks of all our injury and illness. The pre-existing condition for someone age fifty would be a random risk to share by all if the risk pool started after birth and continued to death.

Private health insurance companies do not have the ability to define a national risk pool. They have to process applications when they receive them, or go out and propose and sell group policies to employers. Other private insurance companies do the same thing and each of them has an incentive to assemble risk pools with the healthiest people they can find, and avoid the sick and all those with pre-existing conditions.

There is nothing in an economic system of private contracts and market competition that will move private health insurance to a national risk pool, or provide health care insurance that includes everyone. Private health insurance creates an expectation that cannot be served. Only the Federal government has the ability to maintain a national risk pool. Private health insurance cannot solve America’s health care failures, but will leave people without health insurance, exactly as it has been doing for more than 60 years.


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