Let's Put 'Insurance' Back in Health Insurance

Includes: AET, ANTM, HUM, IYH, UNH
by: The Market Flash

I guess healthcare reform is still open for suggestions. Well I have one: let’s put the 'insurance' back in health insurance. Insurance is a spontaneous and very social benefit of a free enterprise economy. To see how insurance works, picture an island with a town of a 1000 huts sitting next to a volcano. Every now and then the Earth God gets angry and sends down a fireball that destroys a few huts. Everyone in our hypothetical town can sit around and worry if they’re next, or they can set up an insurance fund. With the insurance fund, all the people on the island pay a small amount into the fund and then people whose huts are destroyed by the fireball get their huts replaced from the insurance fund.

A few things to note about our fireball insurance fund: First of all, most of the people on the island have to participate (pay in) for it to work. Secondly, the losses have to be small relative to the whole population. If half or all of the huts are wiped out, the insurance fund concept stops working.

I would argue that insurance, for the most part, works pretty well in the United States. I don’t see headlines screaming that auto insurance is causing people major financial loss. Home insurance seems to pay for a lot of the damage caused by hurricanes and tornadoes. And even though life insurance deals with matters of life and death, most people seem to be content with how life insurance works.

But when you talk about health insurance, the conversation becomes heated. I don’t know how it happened, but somehow heath insurance in the United States has morphed into “pay for all my medical expenses” instead of being an insurance mechanism. Some argue that the tax free status of employer paid health insurance has driven health insurance beyond its original insurance function.

It seems to be a given in most major media outlets and most politicians that forcing health insurance companies to accept all pre-existing conditions (I have serious heart condition and I’m applying to your company for health insurance) is a good idea. Perhaps if more people ran small health insurance companies they’d come to a different conclusion. A person, who has never paid you a dime, with a medical condition that’s known to require a half million dollars of treatment over the next two years shows up on your door and is willing to pay you $1,000 a month for health insurance. In my opinion this situation is not an easy one to resolve.

I think the problem with health insurance comes down to a definition of the insurance event. For most insurance, the event that requires a claim is well understood, and the claim can be paid, and item restored to its original condition, or the life insurance benefit paid, in a relatively short period of time. With matters of health, restoring the person to their original health may be impossible or may require treatment over a number of years. Some medical problems are associated with increased probabilities of the condition or related conditions recurring throughout the patient’s life.

So we should put the Insurance back in health insurance. If a person has a serious medical condition (the equivalent of the hut being destroyed in the example above) that requires care over a long period of time, that person’s insurance company should be required to put the present value of all the future costs to treat that condition for the rest of that persons life in an insurance bank. If you think this present value is hard to figure out, I assure you that actuarial statisticians have solved much more difficult problems. The insurance bank would only pay future medical expenses associated with the condition for the person who held the insurance. The people who are holding health insurance who develop a serious medical problem (people with serious heart conditions, or cancer) get all their future medical treatments paid for by the insurance company they are currently holding their policy with. This solves the problem of pre-existing conditions. The person is free to change insurance companies because the cost of their pre-existing condition is already paid for.

I don’t know how the decision makers at United Healthcare (NYSE:UNH), Humana (NYSE:HUM), WellPoint (WLP), or Aetna (NYSE:AET) would feel about this proposal. On the one hand it would require them to pay more in the short run if some of their customers develop serious illnesses. On the other hand I am showing more sympathy and understanding of the cost structures of the health insurance industry than I see in the media or by most politicians involved in the health care debate. I think a primary goal of healthcare reform is that the average person in the United States feels they will not be wiped out financially if certain health problems occur to them. Restoring the insurance aspect of health insurance is a major step towards meeting this goal.

If this suggestion imposes more costs on the health insurance industry than they were paying before, we have to be willing to discuss taking other costs off the table. Perhaps health insurance no longer pays for routine medical expenses like checkups or blood tests. I would be willing to say that health insurance should not pay for anything that’s not life threatening or could cause major injury. Health insurance businesses need to be able to maintain themselves as a going concern after we put the insurance aspect back in health insurance.

Medical progress has been incredible as of late. Diseases that were a death warrant 25 years ago are now curable and people go on to live healthy and productive lives. If the state of the world sometimes gives you the blues, think of the medical progress there has been in our lifetimes and it will cheer you up. Advances in the field of genetics are soon going to make custom treatments and drugs individualized to treat one person a reality. This may result in treatments that cost a million dollars that can save a life. It is not a failure of the health care system to have this million dollar option to cure a disease, when there were no cures before. True health insurance may be the way to allow people other than the very wealthy to benefit from these treatments.

Disclosure: The author holds a long position in UNH.

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