Arnold Kling

Economics of Health Insurance

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In this essay, I contend that what most people think of as health insurance is not technically insurance, but something else.


An equivalent plan for restaurant meals would be that instead of paying for your meal, you would pay an annual premium to "Blue Eats," which would in turn reimburse restaurants for their costs, plus a profit margin. Every individual member of "Blue Eats" would have an incentive to eat out a lot and order the most expensive items on the menu, because the cost is shared among all of the members of "Blue Eats."

For insurance to work, your expenses have to be unpredictable, so that you contribute to the insurance fund most of the time. With predictable expenses, you would always be drawing from the insurance fund and never contributing to it, so that insurance is not possible. The only way to pay for predictable medical expenses is out of savings.

Insurance is possible when there are unpredictable expenses, not when there are predictable expenses. Again, there are plenty of ways that our society can arrange for other people to pay for your predictable expenses, but those arrangements are "split the check" or "pass the buck." They are not insurance.


Read the whole thing. The essay attempts to clear up some very common misconceptions about health insurance.

For Discussion. How else one might explain the idea that for costs to be insurable, they must be unpredictable?


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TRACKBACKS (2 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/129
The author at Ashish's Niti in a related article titled This is not a real Health Insurance writes:
    Arnold Kling explains how the current scheme is not a real health insurance scheme but simply a "split the check" or "pass the buck" mechanism. [Tracked on September 28, 2004 9:52 AM]
The author at Catallarchy in a related article titled Blue Eats Restaraunt Insurance writes:
    Arnold Kling has a great piece over at TCS called You Call This Health Insurance? It argues that what we call health insurance is rarely insurance at all, instead its a split-the-buck program: What Blue Cross and Blue Shield pioneered was a "split... [Tracked on September 29, 2004 1:51 AM]
COMMENTS (14 to date)
Mats writes:

unpredictable - yes. but by whome...

Jason Ligon writes:

Thanks for making this distinction explicit. I have struggled for years to explain that insurance may be about 'spreading risk', but it isn't a risk once you can predict the bad event with accuracy.

Of course, the problem with 'real insurance' is that as a society, we won't allow the failure to save for predictable expenses to be a death sentence. A social program WILL be demanded to cover those costs, and once such a program is in place, the incentive to save plummets.

Is there any way to incent saving while maintaining a 'pass the buck' safety net? Should we make 'pass the buck' hospital beds ridiculously uncomfortable or something?

joe shropshire writes:

The key phrase that I remember being taught is "socializing risk." I guess you'd then have to go on to explain that if your risk is 1.0 (which for routine medical expenses it is), it ain't risk, it's certainty.

Ramji Balakrishnan writes:

I use the example of 100 skiers. Say that everyone knows and agrees that one skier will break his/her leg. If a broken leg is valued at $1,000, each person is willing to pay $10 to cover the risk. But, if we know which skier will break a leg, the market collapses...insurance is not feasible. I also use the example, with risk-averse skiers, to underscore that costless, public, and accurate information can destroy value.

I also make a distinction between high-deductible insurance (which truly is insurance) and insured from the start plans. My university has both and to the administration's surprise (!) all but the sickest people have been abandoning the co-pay from the start plan.

Bob writes:

I don't know about the skier example to demonstrate that "costless, public, and accurate information" can destroy value, a claim that we should generally be skeptical about. The skier who is certain to break a leg will stay home, to the benefit of all.

Jason Ligon writes:

"The skier who is certain to break a leg will stay home, to the benefit of all."

I don't think the problem is the information but in a result where all of the skiers are forced to pay hospital bills for the guy they knew would break his leg. It is a subsidy for reckless skiing, not an insurance policy against accidents.

Lawrance George Lux writes:
How else one might explain the idea that for costs to be insurable, they must be unpredictable?

Your point is correct, Arnold, but you defeat your own purpose. You would advocate normal, predicable medical costs be paid out of Savings, which they should be. You simply point out that all current plans to pay for medical costs lack the elements of Savings. There is no accurance of Capital, there is no assurance of payment, and there is no systematic withdrawal of funds. Insurers and Economists insist in lumping it all together without differentiation--which you somewhat describe.

There should be a Basic Care Insurance policy mandated by Government, specifically designed to be a Savings account forum. It should specifically exclude extraordinary costs--which you cite as unpredictable. All Employers should be mandated to supply such premium Savings, with necessary withdrawals from Employee income. Prevention of dictated Outsourcing would insist equivalent premium Savings come from Outsourcing income, thereby reducing American employee withdrawal costs for said Savings. Basic medical costs are covered with Employees actually bearing the cost, but with Employers innately concerned with controling health care maintenance costs in search of suppression of Wages. Part-time help can be covered by Individual coverage--with exclusion of family coverage. The segmentation of Employment can be forestalled by forced accounting of Employee hours per year--with insistence of so many months of coverage for the Indivdual to start from his use of the coverage for medical expenses.

What Economists fail to understand is We do not need health insurance, We need an adequate Savings account for medical expenses. lgl

spencer writes:

What you are also leaving out is preventitive medicine. My HMO wants me to have a physical every year -- what you call a predictable expense-- because it increases the odds that it will catch an illness early when it is much less expensive to treat. So, my HMO pays part of my annual physical costs because it will save the HMO money on unpredictable costs --maybe not for me, for for the HMO policy members as a whole.

You need to give a better definition of predictable and unpredictable expense.

Rob Sperry writes:

Thanks for pointing this out! It drives me crazy that the media focuses more on weather or not someone has insurance than if they actualy get health care.

spencer writes:

I also have major problems with your conclusion that the taxpayers of Prince George's County(PGC) are subsidizing Joan. The school system of PGC is a better than average school system. One reason it is a better than average school system is that it pays higher salaries to attract better teachers than weaker school systems. The salary also includes fringe benefits, and to make a difference in the dollar salary and the fringe benefit is misleading. Part of the pay PGC gives its better teachers is superior fringe benefits. So a better fringe benefit is not a subsidity, nor does it deprive the student of other resources that would otherwise be available. The expensive fringe benefit is simply part of the costs of attracting superior teachers.

Basically, I have to conclude that all of inference you make are wrong.

spencer writes:

Lawrence -- what is the difference between health insurance and fire insurance that we need fire insurance and do not need health insurance?

Insurance and savings are two completely different things. Savings is not a form of spreading risk.

Lawrance George Lux writes:

Spencwer,
We need health insurance as Individuals, but We do not need health insurance as an economic institution. We do need a Savings account system to pay for basic medical costs. Individuals can acquire additional health 'insurance' against unpredictable medical costs, based upon their evaluation of personal risk. The insistence on lumping the two together guarantees neither need is served. lgl

Kopp writes:

I was actually just reading up on the health care / economics issue today and came across this little paper which I thought did a pretty nice job explaining rising health care costs. I also linked that paper and a couple other articles (which I snagged from your nice blog here) on my site.

Fazal Majid writes:

Sometimes, insurance is required even when the risk is predictable. A small but still significant proportion of the population suffers from hereditary diseases that are almost inevitable once the gene carrier is born, e.g. Tay-Sachs disease, or sickle-cell anemia.

No private insurer will take on people who are afflicted with these diseases unless compelled by law. Even though these costs are predictable, and thus by your logic should be covered by the victims' personal income or savings, most people would agree it is not morally right for a society to condemn them to death by withholding treatment (Spartan style) or to a lifetime of poverty just because they were unlucky in the genetic lottery.

Your proposed mandatory insurance scheme would thus have to include in its premiums some allowance for the highly predictable socialized cost of hereditary diseases.

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