At last we get to the core of the health care reform issue. Almost all of the attention is being placed on the insurance industry and the reforms of that industry that are supposedly needed to fix our health care problems. I’ll be doing a little number crunching today as well as taking a look at the workings of the insurance industry to find some answers. Are the insurance companies really the bad guy…or just a scapegoat?
H.R. 3200 will also reform the practices of health insurance companies so that they will no longer be able to engage in discriminatory practices like refusing to sell or renew policies due to an individual’s health status, or exclude coverage of treatments for pre-existing health conditions. The legislation also protects consumers by prohibiting lifetime and annual limits on benefits, and limits the ability of insurance companies to charge higher rates due to health status, gender, or other factors. Under the America’s Affordable Health Choices Act premiums can vary based only on age, geography and family size, and a new essential benefit package will serve as the basic benefit package for coverage in the health exchange. The basic package will include preventive services with no cost-sharing, mental health services, oral health and vision for children, and caps the amount of money a person or family spends on covered services in a year.
Let’s start by looking at how insurance works. It seems like it should be basic enough that people would already understand it, but that is obviously not the case, given the ridiculous and sorely misdirected attempts by our lawmakers to reform all the wrong things.
At its core, an insurance company does one thing. It offsets a portion of their customers’ financial risk for a premium. That premium will include the amount they are likely to have to pay out, the administrative overhead to maintain their business, and some profit (if they’ve calculated correctly). It is a pretty simple concept. You contract to pay the insurance company a certain amount of money to offset a certain amount of risk. The higher the risk involved, the more money it costs you to insure against it.
Let’s look at a simplified example to clarify things (we’ll omit administrative overhead and profit to keep it as simple as possible).
- An insurance company has a policy to protect against the cost of cancer treatment.
- They know, statistically, that cancer costs $1000 to treat and that 10% of people will be diagnosed with cancer.
- They have a pool of 10 customers with this particular policy.
Given these statistics, they know they have a 10% risk per customer in the pool of paying out $1000. In this simplified case that means they are guaranteed to pay out $1000 to cover their pool of 10 customers. Without administrative costs or profit, they would have to charge each customer $100 to break even.
Now let’s look at what happens when a bureaucrat decides to “reform” insurance by disallowing the “discriminatory practices” of raising the rates of higher risk customers without allowing a commensurate rise in premium.
- We still have a policy for the treatment of cancer.
- The costs stays the same at $1000 for treatment…but now you have a pool of customers with a 20% chance of being diagnosed with cancer.
- You still have a pool of 10 customers.
Based on our previous calculations, we should now be charging this pool of customers $200 per policy to break even. (20% chance of diagnosis * 10 customers * cost to treat of $1000 = $2000 to be divided between the 10 customers) Unfortunately, our bureaucrat has decided that it’s not fair to charge people any more than $150 for a policy. Basic math will show you this isn’t sustainable and the company will take a $50 loss per customer.
There isn’t any way to cheat these numbers. If you don’t allow the insurance company to recoup what it pays out with what it receives it will go out of business with certainty. I can already hear the complaints…”But the insurance companies are making huge, obscene profits! If they were just better human beings and didn’t insist on profits, our health expenses would drop dramatically!”
Aside from the fact that it’s ridiculous to think that some company should take on that much risk without a profit motive, let’s look at some numbers and see what these “obscene” profits really look like. (Numbers taken from 2008 SEC 10-K filings.)
- 2008 net earnings: $3 billion
- 73 million customers
- Net earnings per customer = $41
- 2008 Net Income: $2.49 billion
- 35 million customers
- Net income per customer = $71
- 2008 net income: $1.38 billion
- 36.5 million customers
- Net income per customer = $38
- 2008 net income: $647 million
- 11.5 million customers
- Net income per customer = $56
Well, that seems to tell a pretty important story for just a quick look at the SEC filings and a calculation or two. These are 4 of the biggest health insurance providers in our country making anywhere from $38 – $71 per customer in profits for one year. That doesn’t seem unreasonable to me. It certainly isn’t enough profit that these companies have a lot of wiggle room. Sadly, what that means is that when our beloved bureaucrats take away these companies’ ability to control risk they won’t be able to do it without increasing premiums. The profits just aren’t deep enough to absorb that kind of legislation.
The most important point to take home from this is that the insurance companies are not the source of our health care problems and therefore nearly every part of the health care reform is horribly misdirected.