Look folks, I don't want to become an economics blogger! Stop sending me economics questions. I hate to disappoint my readers and not answer their questions, but this economics stuff is almost terminally dull to me.
The mortgage posts have gotten an insane amount of traffic, which has in turn brought in a huge number of questions. Most of them are about details of the whole mortgage situation - and honestly, I can't answer those. I don't know the details, only the basics, and I can't explain what I don't know.
On the other hand, a lot of people have used my down-to-earth explanation of the mortgages as
a springboard to ask for a similar explanation of another issue that's been getting a lot of attention in America - insurance. Why is health insurance such a big problem?
I'm going to focus specifically on the insurance part. There are plenty of things wrong with the
American medical care system. But I'm going to focus specifically on how insurance works, and
how simple min/max calculations led to the current situation.
Once again, it pays to look at things from a historical point of view - that is, to look at how the insurance system developed in an informal sinse - because like the mortgage fiasco, insurance starts out with a simple, sensible idea, which gets turned into a giant disaster when financial speculation gets involved. I'm going to explain using some examples with made-up numbers. The real numbers are, obviously, quite different, but the made-up numbers are good enough to illustrate.
The original idea behind health insurance is very simple. An average person pays some relatively small amount of money every year for medical care. Let's say that, on average, each person pays $500 for doctors visits and medicine each year. But for one person in a thousand, something awful happens, and they end up with medical bills of $100,000, which they can't afford to pay.
The idea of insurance is that a thousand people get together, and each pay $600 per year into a pool. Then instead of paying their medical bills by themselves, they use money from the pool. So everyone pays a little more than they really expect to need, but if an emergency happens, they'll be able to pay for it.
So now you've got a thousand people creating a pool of $600,000 to pay their medical bills. That's a lot of money! If you invest that money really carefully, then you can make it grow. So instead of everyone needing to pay an extra $100 every year, they only need to pay an extra $50 each year. And everyone is happy.</p.
The problem is, you need to have someone to figure out how to invest the money. So, you hire an investment person to take care of the money, and you pay him a salary. You've got some overhead now - the money needs to cover peoples medical costs, and the cost of the investment guy. So you put him on commission - he earns a cut of however much he makes by investing the money for you. If he loses money, he doesn't get paid, and if he makes money, you're guaranteed that the pool gets to keep most of it. On a very rough level, this is what a non-profit insurance company does. They take money from people, invest it, and use it to pay the people's medical bills. Their employees are paid from a cut of however much money gets made from the investments. The organization as a whole doesn't make anything. So now, you've got people putting in $550 dollars per year, of which about $525 is really going to
the insurance pool, and the extra $25 is paying an investment guy.
Now, here's where the trouble starts. You've got investment people taking care of the money. You've got lots and lots of people putting money in to get covered. It's very complicated. So now you need to have accountants and people like that to take care of paying the bills. You hire people to do that. So now you're looking at a pool of
50,000 people instead of 1000 people. They're each paying in $550; only $500
of that is really going into the medical care fund. $25 is being paid to the investment guy, and another $25 is going to pay for the costs of managing everything.
Here's the first problem. You've created a layer of bureaucracy, who get paid for doing stuff - so it's in their interest to create stuff to do. Bureaucracy starts to develop. Paperwork starts to multiply - because they can charge more if they need to handle two pieces of paper than if they need one. So the overhead increases. This is the start of the pain, but it can't go too far: if they create too much overhead, you can just hire someone else. So there's a subtle balance, where they're trying to maximize the amount of paying work for themselves, while not getting to the point where you'll fire them. So you tend to see the bureacratic costs increase. So you wind up paying $575 for the insurance, and $50 of it is going to bureaucratic costs.
By now, it's become a huge hassle, and you're spending a lot of money on the paper pushers, and on the investment commissions, and so on. And some clever guy comes along, and offers to take care of it for you. He'll take care of all of the bureaucracy. He'll hire the investment people. He'll hire the paper-pushers. Sounds great, right? Only, what's in it for him? Well, he tells you, if he saves any money, then he'll take a cut of it. In fact, he'll guarantee that he'll save you money. In fact, he'll set it up so that you only pay him $400 per year per person. If he can make the investments work out so that there's anything left over after paying the bills, he gets to keep it. If not, then he'll cover the shortfall. Sounds like a great deal!
So how does your new insurance guy make money? Two ways. One is by choosing investments that make money. But there's a major limit there: he can't take too many chances. He's going to be left holding the bucket if his investments don't pan out. Now he's got a lot of money to invest, which means that he's got lots of great stuff available to him. But he's got to play it safe, so he's not going to be investing in
anything risky that might have a huge payoff. The other way that he can make more
money is by making sure that there's more money left over - by paying less for the
medical care of the insurance customers. This is the crux of the problem. You've now got a situation where the insurance guy takes your money,
pays the bills, and keeps what's left over. His primary interest is in making money for himself. He makes money by not paying medical bills. It is in his interest to find excuses to not pay bills - or at least to pay as few bills as possible without losing customers. So he's going to want to try to make sure that his customers are, as much as possible, people who don't need much medical care; and when they do, he's going to try to find excuses to cover as little as possible. Every time one of his customers goes to the doctor, the insurance company is losing money.
That's how things pretty much work now. You've got a lot of people interested in finding ways to make you pay as much as possible for paper pushing, and a lot of people interested in finding excuses to not cover your medical care.
The way that the system developed is perfectly logical. It makes sense. And the actions of the insurers make sense from their point of view. They are, after all, businesses. Their primary obligation, legally, is towards their shareholders, who want them to maximize profits - which means that they're primary obligation is to deny medical care whenever possible.
In my opinion, all of this ultimately means that "for-profit" medical insurance is a formula for disaster. There is a fundamental conflict in a for-profit medical insurance company, which I don't think can really be fixed. The insurance company is a middleman, who isn't really necessary to the system, but who introduces a set of interests that are fundamentally opposed to the original goals of the system. (It's a lot like what's happened in mortgages. When the person who issued a loan was the person responsible for losses in the loans, they were responsible for making sure that the loan was safe. When they became middlemen, their main interest became selling loans, not making loans, and the safety of the loan was someone elses problem. The middleman, by introducing a new goal into the system changes the whole balance.)
The usual objection to this whole line of reasoning comes from libertarians, who insist that the invisible hand of the market should make this all work out. After all, if an insurance company doesn't pay the medical bills of its subscribers, then people will simply take their premiums, and go to someone who will. So while the companies will want to cut expenditures, they won't want to cut any necessary care, because that will cause them to lose business.
As usual with arguments about the invisible hand of the market, it's a load of rubbish. In this case, there's a simple reason why. The whole market based argument assumes that the people choosing and purchasing insurance are the same as the people consuming insurance services. They're not. Insurance companies mainly provide insurance through peoples employers. In fact, as it currently
stands, unless you're buying insurance as part of a large group, it's almost impossible to get insurance for a remotely reasonable cost. So it's the employers who choose the insurance. The employees, who are the consumers of the insurance services, have very little (if any) choice.
For example, at my former employer, when I started working there, I had terrific insurance. Over the course of the 11 years that I was there, my insurance changed in some way nearly every single year. And in every case, the changes were not to my benefit. But I had no real choice: they provided me
with three options, which ranged from bad to worse. The "invisible hand of the market" had no opportunity to work on my behalf: my employer wanted to minimize their costs for providing me with insurance; the insurance company wanted to maximize their profits. Keeping me just healthy enough to work was all my employer really wanted - the fact that the insurance provided me with rotten care didn't matter to them. (Naturally, the upper management of the company, the people who make the decisions about how much to pay and what plan to purchase for the employees, are not on the same plans as the lowly peons. So the decision makers are totally disconnected from the effects of the decisions.) My only choice would be to go and buy insurance privately; but the system is set up to discourage that. Buying insurance privately would have cost me more than four times what the policy
(both my contribution and the companies contribution) cost at work.
Is there a solution to all this? Sure. Get the middleman out of the picture. Unfortunately, the current politics of America make that pretty close to impossible. The insurance companies are so powerful and have so much to lose that it's likely impossible to get anything past the congress. In the current election cycle, every proposal for insurance reform is built on having the middlemen involved.