Episode: 2325
Title: HPR2325: Insurance - How It Works
Source: https://hub.hackerpublicradio.org/ccdn.php?filename=/eps/hpr2325/hpr2325.mp3
Transcribed: 2025-10-19 01:20:22

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This in HPR episode 2,325 entitled Insurance How It Works.
It is hosted by a huker and in about 22 minutes long and carry a clean flag.
The summary is to begin discussing the policy we need to first explain how insurance works.
This episode of HPR is brought to you by An Anastos.com.
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Hello, this is Ahuka, welcoming you to Hacker Public Radio and another exciting episode.
I wanted to do something kind of a little bit different so I know I have not done as many programs as I was doing a few years ago and some of you may wonder why is that?
It was a combination of things but one of them was I was needed to kind of refocus my life.
There were some health issues that I had to deal with and I've mentioned one or two of them along the way
in some of the shows that I've done that I've handed references but I thought I'm going to end up discussing this and then as I started to look at discussing this we suddenly had all sorts of ruckus in the US over health care policy and I'm actually interested in stuff like that.
Then kind of a policy wonk so I wanted to maybe explain a little bit what's going on and how this stuff works for those of you who are not in the United States it might seem a little strange and so maybe this will just be your window into the weirdness of the United States and for those who are in the United States maybe this will just help you to think about what some of these issues are.
Now what I'm going to try and do is explain some basic principles in this particular program without getting into polemics because when you talk about public policy in the United States it very quickly degenerates but I think there's some basic principles here.
I was a professor of economics at one point I've also worked for a number of hospitals I've taught some stuff about health care economics so it's an interest of mine and what I'm going to do right now is I want to talk about this initial one just some basics about insurance.
Now how does an economist understand insurance and the thing you have to understand when you talk about health care policy is that in the United States we do things a certain way that probably seems a little strange to people in other countries who do things in a different way.
So I'm going to give you a broad generalization that is not 100% true but I think it's true enough to give you a sense of this and that is people in Europe I would say
tend to trust government and view corporations with a great deal of suspicion
and people in the United States tend to trust corporations and view the government with a great deal of suspicion and so that leads to very different outcomes and that's just something to bear in mind as you look at how this works but let's just start with some basic principles of insurance and some of the problems you have, okay?
Because a lot of the stuff I've read is just ignorant in news publications and stuff that I've read online and it just leads to a very bad policy discussion so let's start taking a look at this and so I'm going to quote the famous lesson from Ernestine Almer life is uncertain each dessert first.
What do we mean by uncertainty uncertainty and risk are the key concepts in developing an understanding of insurance.
Insurance is at its heart a pooled risk program which means that a group of people agree to share the costs of uncertain events in any given population there will be a certain number of adverse events that will have a negative effect.
But we cannot tell in advance to whom these events will occur when I buy a homeowners insurance policy I cannot tell in advance whether my home will have a fire or be destroyed by a tornado or any number of other adverse events my policy covers.
This is rather like gambling and that I am paying money to get a policy on the assumption I might need it while the company is selling the policy on the assumption I won't and therefore they will get to keep all those premiums I paid.
Now how can the company do this and make a profit?
Well they need to have very good estimates of how often they will need to pay policyholders and they use that information to set the level of premiums.
This requires some very careful statistical analysis from people called actuaries this is serious green ice shade stuff and very technical.
There is a joke about actuaries question how can you tell the difference between an actuary and a computer answer the computer has a personality.
That's kind of unfair I've actually known some actuaries and they were fine people one of the folks I was in graduate school at the University of Michigan Department of Economics ended up going into actuarial field.
But they are kind of similar to accounts about whom the same joke has been written.
Okay so how does a profit making company maximize its profits in this scenario it can charge higher premiums it can identify people more likely to file a claim and refuse to sell them a policy
or some combination of the two or reduce the number of things that it will cover say certain things are just not covered.
So what can stand in the way of either of these approaches well if there is effective competition in any market there is pressure against raising prices.
So one policy goal might be to increase competition and when possible that is frequently the best way to go but an alternative is government intervention in the marketplace to either limit prices or reduce the ability to refuse coverage.
Obamacare does both of these things to some degree as we will explore but that's for later.
Now there is a problem called moral hazard this is something economists are fond of investigating and from the very early days of insurance in the 17th century this problem of moral hazard was in fact recognized in its broadest form as applied to insurance it says that people might make decisions differently just because they have insurance.
They would in other words engage in riskier behavior if someone else bears the costs then they would if they had to bear them all.
Now we want to be careful here this is not the same thing as fraud if you burn down your house just to collect the insurance money that is a crime but that's not what we mean by moral hazard.
Instead think of someone who drives a little more aggressively knowing that any fender benders will be covered by the insurance company.
If you knew you would bear the whole cost you would probably be a little more careful.
Now to address this problem insurance companies typically include in their policies incentives to get the kind of behavior that reduces claims.
They can be either carrots or sticks though generally I found the carrots to be more common.
For instance my automobile policy sends me a good driver check every year because I have not made a claim.
That's nice it probably nudges me in the direction of being a more careful driver.
If I take a look at the size of that check versus the size of the checks I send every month to cover my you know it's a very small fraction of what I've paid them but you know it can't hurt.
And I assume if they're doing it and many insurance companies do things like that they probably have good data that says that it reduces the claims.
Now my health insurance premium is lower because I have demonstrated healthy behaviors that reduce the chances of large claims.
So I in fact had a long questionnaire I had to take something to my doctor and have it filled out that was looking at my weight and you know various blood measurements and all sorts of things.
That would say you know which level of premium I would be charged.
And in fact I scored very well because it's something I pay a lot of attention to.
Now when there are sticks involved it usually comes in the form of limiting coverage or even refusing it.
For instance if you are looking for a long term care policy but you are 65 years old have several major illnesses and a bad family history of illness you should not be as surprised if a company turns you down or quotes a premium you cannot afford.
That's just how insurance works.
Now what about the profit versus non-profit?
Now I'm going to say in general I don't think it matters all that much whether the insurance company is a for-profit company or a non-profit company and we have both in the United States in different areas.
Any organization that wants to remain functioning needs to cover all its costs.
Now an insurance doing that is referred to as being actuarially sound.
And it's simplest terms that means the organization has the funds to pay all reasonably anticipated or projected costs of claims.
Does adding a profit on top make a big difference?
Actually I don't think it does in general.
It will probably depend on the same factors of market competition and government regulation as to whether profit becomes excessive.
But even non-profit organizations face a challenge here.
For example in the United States there is a social insurance program called Social Security that is plainly an insurance program.
And periodically there are concerns about whether it is actuarially sound.
And when the topic turns to state and local retirement schemes in the United States there is a serious crisis because they are demonstrably unsound in many cases.
So I think pointing a profit is kind of a red herring.
And in the United States at least it is a legal principle that companies are entitled to fairly pursue a profit.
If government regulation places limits on this and there are examples, public utilities for instance, the law is clear that the company is entitled to a normal profit and it has grounds to sue the government to preserve this.
But even outside of legal structures as a practical matter is very hard to force private companies to lose money.
In the United States that would result in the company leaving the market.
In India it caused decades of abysmal economic performance because they prevented companies that were losing money from leaving the market.
One reason economics is often referred to as the dismal science is because it tends to tell you that your ideas won't work.
Now one of the features that we have here with insurance is conflicting interests.
Consumers and insurance companies have opposite interests in many ways.
Consumers are most desirous of having insurance if they face large risks and that is when companies are most likely to turn them down or quote premiums they cannot afford.
This is inherent in the nature of the system.
So how can this be reconciled?
There are only a few solutions given the strictures we have already examined.
For example, I'm ruling out forcing companies to lose money.
So I just said that doesn't tend to work very well.
So what do we do?
Now we can do nothing.
Some people will get insurance others won't.
If your daughter is born with the birth defect the company can cancel your policy. Too bad.
That is one way of resolving it.
Or do nothing but mandate that the emergency rooms need to treat people.
Now this has been an effect for some time and what it does is limited since emergency rooms only treat emergencies.
You won't get ongoing treatment for diabetes here.
But if you go into a diabetic coma they will stabilize you before putting you back on the street.
Costs are shifted onto the government and onto people with insurance policies in varying proportions.
Because guess what? Hospitals have to cover their costs as well.
I worked in the finance department of the University of Michigan health system.
And I can assure you of this.
All of those costs do get passed along to taxpayers and to private insurance companies.
It's built into the contracts.
So you're paying for it whether you know it or not.
Another example, government help for the worst off.
Similar to the do nothing policy.
But in this case the government steps in to make sure you still have coverage after your daughter is born with a birth defect.
That means the cost is shifted onto the taxpayers.
In the United States that's what they call high-risk pools.
The people with a high risk of a claim get put into a particular group and then the government essentially has to pay all or most of the premiums because people can't afford it.
Another approach, government regulated insurance markets with strict mandates.
Now that's the Obamacare approach.
Companies cannot for instance refuse you coverage.
And certain medical treatments must be covered in some cases free of charge to the consumer.
For example, certain preventive care things are mandated to be provided for free.
But the insurance is offered by private companies who do get to make a profit.
And if they cannot make a profit they can leave the system.
And then with the insurance care is provided by private organizations like doctors and hospitals.
Another possible solution.
Full government provision of health coverage but with private providers.
Well we have one example of that in the United States.
It's something called Medicare.
Well actually there's two because it's also Medicaid but they're...
I would call them two branches of the same thing essentially.
So with Medicare every American is eligible at age 65 to sign up.
Costs are covered through a combination of premiums paid.
Beginning when you reach age 65 and by tax payments collected through payroll taxes throughout your working life which are essentially prepaid insurance.
Finally, full government provision of all health care.
Now this is what is done as I understand it in Great Britain.
National health system and I think in some other European countries as well.
I'm not an expert on how health care is provided in every country and there are a lot of interesting variations on this.
But we know one solution is for the government to just say hey you know we're going to tax people and create a whole health care system and put it out there.
So we've got I think I've counted up six different options that I've presented here for what to do in terms of health policy.
And the thing about this is there are pluses and minuses to everything.
There's trade-offs to everything.
And one of the things that really bugs me is that people will just say well you know this option is completely bad.
Let's rule it out without ever saying and this is how we will deal with the consequences of that.
You know one of the things I've seen politicians say in the United States is hey why do we need to provide health insurance? We've got emergency rooms.
And as I said no that's not a solution.
Number one emergency rooms only do emergencies.
Number two it is the most expensive way to provide health care imaginable.
And number three all of that cost is going to be sent to the taxpayers and the policy holders anyway and no one ever says that.
So what I want to do is just kind of lay all of this out because what I find is that when you're dealing with health policy there are some hard truths.
Okay hard truth number one all health care has to be rationed and I know people hate that when I say that but it's true.
It has to be there you cannot provide absolutely unlimited on demand whatever you want you get because we don't have that kind of no one has that kind of money.
They ration in different ways. So in the United States the answer is well we'll ration by deciding who gets to have it and who doesn't.
In other countries they ration by well if this isn't terribly urgent we'll put you on a waiting list and get to you when we get to you.
Both are perfectly reasonable ways of doing what needs to be done.
So you know that's a problem we need to deal with.
You have to look at you know the moral hazard thing.
If you give people lots of health coverage you know but they're smoking and they're overweight and they're drinking too much and the sort of okay.
Do we really want to support that?
You know there's some issues here. So anyway I think this is enough for an introductory.
I've been nattering on long enough. So this is a hookah signing off and reminding everyone as I always do to support free software. Bye bye.
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