History of Healthcare: is health insurance sustainable?

This is a series on the history of health care, exploring how and why health care costs in the US have risen beyond the levels a free market would normally bear.

The term “insurance” has become so distorted over the last century, it wouldn't be a bad idea to revisit its definition. Insurance is “risk management” that you can buy. If you purchase an insurance policy that covers accidental injury, you are then guaranteed compensation (money back) from the insurance company if you do, in fact, get injured.

By purchasing this policy, you are managing your risk of injury -- a risk we all face.

Every human being is theoretically at risk, for example, of breaking an arm. For most of us, the risk is low and won't actually materialize. But for someone who likes to skateboard, the risk is higher. And if a skateboarder dude wants to manage his injury risk with an insurance policy, he will pay more for that policy than a book-worm librarian will pay, who doesn't engage in risky sports.

This is fair.

I can't stress this enough, especially these days when people have economically ridiculous beliefs like we should all pay the same (or nothing) for insurance and be covered equally. Our needs aren't equal and our risk factors aren't equal, so forcing equality in a complex system like that will create huge distortions and imbalances, making our attempts to manage risk unsustainable. Remember that word.

The first attempt to insure health in the US was a form of accident insurance introduced in 1850 by the Franklin Health Assurance Company of Massachusetts. Their policies didn't cover illness, only accidental injury, and more specifically, only injuries sustained by crewmembers on trains and ships. These were very narrow parameters, and it was smart to keep narrow parameters in such an early experimentation with health insurance.

Why were narrow parameters so smart?

Because insurance is all about probabilities: how likely is it that your customers will get hurt? Having narrow parameters (including where such injuries could take place) makes it easier to determine the likelihood of injury. Narrow parameters give an insurance company more information about the risk factors at play, and when dealing with probabilities, information is key.

There are two types of probability analysis: class and case. Class probability is used for events (like injuries) that take place within larger homogeneous classes (like ship crewmembers). When dealing with classes, an insurance company can have knowledge of the behavior of the entire class of ship crewmembers, but it won't have (or need) any knowledge of the behavior of individuals in that class.

Using class probability information, Franklin Health Assurance could calculate the premiums for accident insurance. While they couldn't know which specific crewmember might be injured, they could know the frequency of injuries from similar groups in the past and could then estimate the probability of injury for this entire new class of crewmembers.

Case probability looks at events (like contracting a rare disease) that can't be “classified.” These are events we don't know very much about, like which factors might cause the disease. Without knowing what those factors are, we can't make predictions about who is more likely to contract it. This would make insuring against this disease difficult, and determining fair insurance premiums based on probability would be almost impossible.

Franklin Health Assurance Company was able to take advantage of the knowledge provided by class probability analysis. They charged premiums to the crewmembers and paid out compensation to those who were injured. By doing this, the company provided a valuable benefit to society.

But if you think I'm some sort of cheerleader for insurance companies, you're very much mistaken. I'm a cheerleader for the product of insurance. This type of policy was a game changer for people in the middle 1800s. A simple injury at work could devastate a family; insurance compensation helped to level the playing field for injury victims.

And although insurance is a great idea, many people are offended by the “obscene” profit it gives insurance companies. In a competitive, voluntary economy, I'm not opposed to the concept of profit, but I can agree that insurance companies have a pretty bad track record of neglecting, mistreating, and defrauding their customers, all in an attempt to keep more money than they should.

In response to these problems, lots of health insurance reforms have been bandied about. Many people think a better system could involve something closer to “organized sharing.” Why not just come together as a community to pool our resources and give money to those who have the greatest need? And if people won't go along with the plan voluntarily, we could get the government involved to force them to share. Right?

Well, we're forgetting that “organized sharing” is exactly what insurance is. The market (ie, the people) already found a way to manage risk by pooling the resources of a community to help those with the greatest need because of an injury.

And unlike charity or government-enforced sharing, a healthy, competitive insurance industry is sustainable. That's because it benefits everyone involved; operating correctly, that is, with healthy competition and no government interference that distorts the market. The industry benefits the insurance company with a profit; they're paid for organizing it all for us. The industry benefits the non-injured with peace of mind from potential coverage. And the industry benefits the injured by compensating their losses. These benefits keep people participating, and only with willing participation is the system sustainable.

Insurance can be a workable, sustainable, win-win transaction. But if it's such a beautiful thing, why is insurance so corrupt, fraudulent, expensive, and unsustainable today? One reason is because these companies are no longer managing our risk for us; they're in an entirely different business now. There are other reasons, too, that we'll be exploring in future posts covering many different ways the insurance industry has gone wrong.

(Don't miss the first post in the series, Medical cartels an early response to natural medicine.)

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