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Pre-Existing Condition Exclusions Are Necessary

March 23rd, 2009

Another pair of lawmakers, this time in West Virginia, have introduced legislation that seeks to over-ride the laws of economics. Jay Rockefeller and Joe Courtney would like to “eliminate pre-existing condition exclusions from health insurance policies.”

The industry has some concerns about a practice, referred to in the industry as “bump and run”, the process by which an individual takes out a policy “with the intention of obtaining medical care within the first few months of coverage, then not paying premiums after medical procedures are paid for.” And rightly so. If insurance companies can’t deny coverage for pre-existing conditions, what incentive is there for anyone to purchase a policy, if they are healthy?

None.

Insurance, as a business model is not rocket science. In short, it requires that there be a large pool of insureds, about which we have reasonably accurate predictions with regards to the class probability of certain perils and risks which might befall some of them. Insurance “works” because people have varying tolerances for risk. Many people (most of whom won’t become ill or die during the term) pay a modest premium to protect themselves and their families financial well-being in case they become ill or die during the term. These premiums then pay for the costs incurred by the small number of people who actually do become ill.

By removing the incentive to buy insurance when one is healthy as a preventative/protective measure against an unlikely misfortune, this legislation all but guarantees moral hazard. No rational person would purchase insurance until they needed treatment, which would essentially be the opposite of adverse selection: the only people with “insurance” would be people in dire need of immediate medical treatment. No insurance company, anywhere, ever, could survive more than a few days under this sort of regime.

Au contraire!” say the legislators. In fact, they are so bold as to argue that this legislation would actually serve to make insurers more profitable! I can’t make this stuff up:

Both lawmakers said the change should not hurt the insurance industry, but increase the pot of customers, thereby bringing down the cost of premiums.

“Im confident this measure is something the market can deal with,” Courtney said. “This will expand the market, increasing customers.”

The market will in fact “expand”, but the pool of actual customers will be greatly reduced. Since exposure to risk under this scenario is increased, it follows that premiums would have to increase. In fact premiums would likely exceed affordability for all but the wealthiest.

Additionally, the cost of premiums is not determined by the size of the pool of policy holders – there is not really a volume discount or economies of scale at play here. The cost of premiums is largely determined by the exposure to risk. If exposure to risk increases, if economic loss is experienced more frequently, then premiums go up. If not, premiums remain unchanged or decrease.

Further statements from Courtney and Rockefeller indicate a profound ignorance of how insurance markets actually function.

Both lawmakers … said the insurance industry is set up to pool risk, not to avoid it, and should take on more policies and claims.

Indeed, the insurance industry is set up to pool risk. But “risk” implies some degree of uncertainty, and a person with a pre-existing condition is anything but an uncertainty. If you try to insure your car after it’s been hit by a semi truck (i.e., a “pre-existing condition”) the insurance company will rightly deny “coverage” to you. Why this fairly straightforward concept is so difficult to understand in a different context is beyond me.

“If we’re going to have universal health coverage, we’ve got to get these insurance companies under control,” Rockefeller said. “They are in business in order to pay for people who are sick.”

Wrong. Insurance companies are not in business to pay for people who are sick. They’re in business to pool and assume risk at a slight premium, and to pay for people who become sick, which is hardly an insignificant distinction. At least their motives are clear, though: this is simply one step in the process of back-dooring us into “universal” health coverage, which in practice has been a pretty abysmal failure, everywhere it’s been tried.

One thing is certain: the new bill proposed by Joe Courtney and Jay Rockefeller is ignorant beyond comprehension, both of what insurance is and of how it works. I have no idea whether these legislators are lying out of malice, of if they’re truly ignorant yet well-intentioned, but it doesn’t much matter: in either case, they’re absolutely and demonstrably unfit for the respsonsibilites to which they’ve arrogated themselves.

Comments

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  • Zach S. says on: March 23, 2009 at 10:33 pm

     

    It is not "insurance" if you pay for it only when you need it. That's call paying for your doctor's bill.

  • nothirdsolution says on: March 23, 2009 at 10:45 pm

     

    Precisely! Therein lies the problem…

  • Eric Ogunbase says on: March 23, 2009 at 11:21 pm

     

    David, I've sold insurance for the past 8 years. What will happen if this happens is that insurance companies won't deny the coverage. But those who have pre-existing conditions will be charged some astronomical rate that they won't be able to afford. Or, what they will do is issue the policy, and then scour the applicant's MIB (like a credit report, but contains your medical history) for any undisclosed condition. Once a claim is filed, they'll deny the coverage based on misrepresentation.

    But no one will think of these things. Just like it was a "right" for the American people to own a home. We see how well THAT turned out.

    But have no fear. This won't come close to passing. Insurance companies and banks run the country.

    • nothirdsolution says on: March 24, 2009 at 1:09 am

       

      But those who have pre-existing conditions will be charged some astronomical rate that they won't be able to afford. Or, what they will do is issue the policy, and then scour the applicant's MIB (like a credit report, but contains your medical history) for any undisclosed condition. Once a claim is filed, they'll deny the coverage based on misrepresentation.

      Exactly – thanks for putting it in perspective!

      I forgot all about "misrepresentation" from my Risk Management class a few years back… The alternative, is more government meddling: the State sets the maximum rates which can be charged for certain policies, as a result, everyone (pre-existing conditions or no) will essentially be charged a surcharge "pre-existing condition fee".

      No matter what ultimately happens, as you've explained above, the lawmakers are not able to circumvent the law of scarcity, to satisfy limitless wants/needs.

  • Dale says on: March 24, 2009 at 5:11 pm

     

    Nothirdsolution doesn't understand the economics of adverse selection very well. The legislators may, I'm not sure.

    Try reading this http://tinyurl.com/czz7q5

    or this http://tinyurl.com/czz7q5

  • Dale says on: March 24, 2009 at 5:13 pm

     

    Sorry second URL should have been
    http://tinyurl.com/da5z7y

  • nothirdsolution says on: March 24, 2009 at 5:55 pm

     

    I'm not paying $35 to read a paper. Sorry. The second one might be interesting though.

    There are numerous problems that compound the phenomenon of adverse selection, most of which are the fault of government meddling in the insurance market, or incentivizing certain behavior, etc. For example, ask yourself why most individuals in the U.S. don't have an individual policy? (Hint: tax laws)

    Another question worth asking is why the people who would allegedly suffer from A/S weren't in the first place (i.e., before the condition manifested) covered by a catastrophic injury/illness policy?

  • John says on: March 26, 2009 at 3:22 am

     

    David, excellent post. In my amateur understanding, every point you made was spot-on.

    What is the answer to this question, though: which tax laws prevent individuals from having their own health-insurance policies? Do those tax laws not apply to auto insurance and home insurance?

  • John says on: March 26, 2009 at 3:22 am

     

    David, excellent post. In my amateur understanding, every point you made was spot-on.

    What is the answer to this question, though: which tax laws prevent individuals from having their own health-insurance policies? Do those tax laws not apply to auto insurance and home insurance?

    • nothirdsolution says on: March 26, 2009 at 3:59 am

       

      the laws don't prevent individuals from taking out their own policies, they just make it relatively advantageous to take an employer-provided plan. If you get a group plan through work, your contribution comes from pre-tax dollars. Health insurance premiums, to my knowledge, are not tax deductible for individuals, but for corporations they are a deductible labor-related expense.

      Because most people end up with a group plan through their employer, which terminates with their employment, it's not a "term" policy and it's generally not portable or extendable beyond one's employment tenure.

      • Zach S says on: March 26, 2009 at 11:24 pm

         

        Healtcare premiums are tax deductible if you itemize and your medical expenses exceed 7.5% of your AGI. Most families do not meet this requirement as if you are making that much money, you most likely have employer provided health insurance…becauses its cheaper.

        • nothirdsolution says on: March 27, 2009 at 4:23 am

           

          the other complication is this: if you decline your employer-provided benefits, it's very unlikely that they'll increase your compensation accordingly. My health plan through work costs my employer something like $300/month plus the $70 that I pay out of pre-tax dollars. I could take that extra $300/month and buy a CDHP/High-Deductible plan to cover emergencies, but if I decline coverage, I don't get that money — the company keeps it!

          • Zach S. says on: March 27, 2009 at 1:25 pm

             

            Depends on the company. I've declined my insurance and I get $50 bucks a month. I know of some other companies that give you more, but in general, you are correct.

            I think you can reasonably make the assumption that most employers offer health insurance as an additional benefit for compensation. Whether you take advantage of it or not is up to you and should be no consequence to the company…although it would be nice if they compensated you for not taking advantage of the healthcare. It's the same as 401k matching, pension, etc. .

            In general, I would like to see the money in whole; however, I hardly think the company keeping the money from a program I voluntarily decided not to take advantage of makes the company "bad."

          • nothirdsolution says on: March 27, 2009 at 2:11 pm

             

            yeah, but that $50 is a pittance compared to the actual expense they'd incur if you took their health insurance.

            What I'm saying essentially is, if I decline my coverage through work, my paycheck increases by exactly $0. I'd have to buy my own insurance with after-tax dollars, and since I don't have any more of those, I'll be worse off. Therefore, I "accept" the employer plan, even though (all else being equal) I may be able to get better coverage or a better price, on my own. The caveat is important, because all else isn't equal.

            So, this policy I agree, no it doesn't make the companies "bad" per se, but the only reason they began doing it was because of price controls implemented during WWII which prevented them from increasing salary/wages.

            The problem is that, like student loans and the cost of college, most people are so insulated from the true cost of health insurance, and so far-removed from the actual evaluation/decision-making process that goes in to selecting coverages, etc., that the market is pretty heavily distorted in favor of group policies through work – which, is problematic for a number of reasons described above.

no third solution

Blogging about liberty, anarchy, economics and politics