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This is a universal topic since we are all humans and are all subject to eventual death, with some miserable periods in between. This is a burning question since so many countries either have some sort of national health coverage or are looking at getting it. It is also important for many companies who are trying to provide health care insurance (i.e. serving their customers). It is therefore only fair that we review health insurance in free and managed markets.

FREE MARKETS

The Theory

How health insurance operates in free markets has been elucidated many decades ago by Ludwig von Mises. We won’t bore you with detailed statistics, but some information to this regard is important and therefore we need to review some concepts.

The basic idea is quite simple. A company providing health insurance is providing this service for-profit. It they cannot make a profit, they won’t provide the service. Since this service is a future service that may or may not happen, it is critical to understand what is going to happen on average in the future. For that, enough information is required. Sometimes there is enough information and sometimes there isn’t. Mises called these statistics:

• Case Probabilities: we do not have enough information
• Class Probabilities: we do have enough information

How they operate and how are they are calculated is not relevant to this lesson. The general idea is that if a health problem falls within Case Probabilities (such dementia, Parkinson, Idiopathic pulmonary fibrosis and many others) it cannot be insured. On the other hand, if it falls within Class Probabilities (such as lung cancer, cardiopulmonary diseases, death) they can be insured.

This is, of course, the dry, theoretical view. Reality is somewhat different, but not by much.

Class Probabilities In Practice

Insurance Premiums, Costs, Profits and Loses

Insurance costs are directly related to the probability of getting a disease and the cost it will have to treat such a disease. The higher the chances, the higher the cost, the higher the premium. It is only fair.

It is illuminating to see how people and companies look at health insurance.

Warning: all the graphs in the website are oversimplifications of reality. They illustrate basic points but they are not faithful representations of reality. They are sufficiently good for educating but not for actual research. Still, they are there to make a point.

From a customer’s perspective, this is what they hope to achieve:

Fig 1

The Green Line symbolizes the premiums you are and will be paying. You expect your payments to go up as you age.

The Yellow Line symbolizes the money you expect to pay for health issues as you age, if you do not have insurance.

The Red Line symbolizes the money you expect your insurance company to pay for your health issues as you age.

The Blue Arrow symbolizes your expected savings.

The idea is quite simple. When you are young, your medical needs will be low, and therefore you expect to lose the insurance premium money. As you age, you expect that your premiums will be significantly lower than your needs and therefore the insurance company will lose money.

From the company’s perspective, this is what they hope to achieve:

Fig 2

The Green Line symbolizes all the premiums that all customers are paying. The company expects those premiums to rise as people age.

The Red Line symbolizes all the money the company is paying out as insurance to treat illnesses.

The Blue Arrows symbolize company’s expected profits.

As the red and green lines can be statistically determined, short of a massive unexpected event, the company cannot lose money. But it a customer gains money, how is it possible that the company do too?

From a realistic company’s perspective, this is what happens:

Fig 3

The Green Line symbolizes the premiums people are paying.

The Red Line symbolizes all the individual payments the company is making out as insurance to treat illnesses of different people.

The Blue Arrows symbolize customer’s loses.

In reality, the company has determined statistically that on average payments to different customers will be less than their premiums. Therefore, on average, they make a small profit from each customer. It is this profit that enable insurance companies to have occasional loses with a minority of customers.

Pre-existing conditions

Something similar happens with pre-existing conditions. Companies determine which pre-existing diseases they may or may not cover, based on statistics and costs. Each company makes their own calculations.

As long as there is sufficient information to develop a sound statistical model and therefore be able to forecast the future, pre-existing conditions are not a problem. However, it is up to each company to decide which pre-existing illnesses will be accepted and to which degree they will be covered. This is only reasonable since these conditions are pure loses. A company will only take on loses if there is a larger benefit. Benefits may include issues such as low cost treatments, infrequent medical requirements or marketing uses.

The graphs for a company willingly accepting pre-existing conditions are the same as for one not accepting them (Fig 1, 2 and 3).

There is yet another way in which companies operating in a free market accept pre-existing conditions almost without limitations. This is the same way in which they deal with exceedingly long life spans. They increase premiums to cover potential losses. This can be seen in the next Figure:

Fig 4

The Red Line symbolizes what the company expects to pay out for a customer with pre-existing conditions.

The Green Line symbolizes the premiums that customers with pre-existing conditions will have to pay.

As you can see, passed a certain point, the premiums are slightly higher than the loses. The company gets some profits in the beginning, some minor loses later on, and it breaks even after that. Why would a company be willing to provide a break-even service? Primarily marketing and competitiveness. It looks good in a newspaper or tv add to be able to say that they have no age limit or pre-existing condition limitations.

Many companies have such insurance policies, particularly when it comes to dental work. Also, these type of policies are quite common in developed worlds where there is a difference between private and public health care. It is always better to go into a private establishment than a public one. In order to do so, one needs insurance.

Some people point out that this kind of insurance equates to be self-insured (i.e. money in the bank). This is correct. However, some people prefer to have all money matters handled for them by a professional corporation than themselves, in the event of illnesses.

Note: please see the Glossary if you are unfamiliar with certain words.