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Do you know Mayhem?

He’s a new character played by Dean Winters in a recent run of pretty-damn-funny Allstate commercials.  Check this one out (< 30 seconds).

You see, before you (the driver) caught sight of the hot babe in the awesome pink headband you needed adequate property and casualty insurance to protect you from the distraction that caused you to drive into that light pole.  However, in the immediate moment after you drove into that light pole, you did not need insurance, because its cost would have been exactly equal to what you really need, which is a new car.  Insurance is valuable to you before you run into Mayhem when its price (the insurance premium) is considerably less than the consequences of Mayhem, or in this case, the cost of a new car.

The cost of insurance is much less than the cost of Mayhem because of pooled risk.  Lots of other easily distracted drivers bought car insurance too but most of them managed to veer away from the light pole at the last-minute, avoiding damage, thus providing you with a pool of funding to buy a replacement car after the accident.  Pooling the risk of low-probability high-cost events makes insurance a very valuable product for all purchasers in their effort to protect themselves against Mayhem.

In the health insurance market Mayhem represents the possibility we might get sick, which we know can be very costly.  Very good drivers can drive into light poles.  Similarly very healthy people can require health insurance to pay for unexpected costly medical procedures.  But either way, the fact that the costs are unexpected makes an event insurable at a price significantly less than the cost of the event.

Someone who is sick and is not insured does not need health insurance; they need to be provided with healthcare.  Including someone who is already sick in an insurance pool is the same as including you in an automobile insurance pool after you drove into the light pole.  The event is no longer unexpected, and so your individual premium, which is the cost of your new car, will be spread among the members of the insurance pool, the economic equivalent of your passing a hat around and collecting enough money to pay for your car – in this instance you are not being insured, you are being subsidized.

A type II diabetic with health insurance that covers the costs associated with diabetes is being both insured for the incidence of diseases other than diabetes and subsidized for the known costs associated with diabetes.

Continuing with our property and casualty analogy, consider flood insurance.  There is a much higher probability of Mayhem occurring at a property located on a riverfront than for a property located on a hilltop miles from the water, and, as such, it costs much more to purchase flood insurance for riverfront property.  I wonder, is this fair?  Would we all stand up for a homeowner’s right to live by the river and insist that the unit price for all property insurance be the same regardless of where the property is located?  If we did the cost to insure waterfront property would reduce and the cost to insure the hilltop property would increase, effectively subsidizing riverfront home ownership.  Now, is that fair?  If we were to subsidize anything shouldn’t we instead subsidize safe behavior, a la, living away from water and well above sea level?

A seemingly healthy person with an unhealthy lifestyle that receives health insurance at the same price as people with healthier lifestyles, as is typical in most Group Health insurance models, is being subsidized for the higher probability of Mayhem.

Insurance markets, left to their own devices, are awesome at pricing risk and incentivizing safe behavior (we all know your premium is going up after you file your auto insurance claim for driving into that light pole).  However they (insurance markets) don’t handle subsidization well at all.  If subsidization is going to be required, then it must be structured by forces outside of the insurance market.

The Group Model of health insurance, which is used in the market for corporate-based insurance, is one such structure.  If you work for a corporation and you are receiving a health insurance benefit from your company, you most likely pay the same per member cost as everyone else at your company.  This is done by pooling both the risks and the subsidies.

Clearly the pooling of subsidies creates fertile ground for Moral Hazard, a phenomenon discussed frequently here, but curiously left out of much of the discussion regarding the problems of health insurance, particularly when the subject is healthcare reform.  Healthcare reform claims to be insurance reform, but in fact insurance is insurance – if you have a pre-existing condition you cannot be insured for it because it is already there (your car has hit the light pole).  At the public policy level “healthcare insurance reform” as it is defined within PPACA, is the regulation of the portion of health insurance that represents subsidies and their funding.

All other things equal, an increase in the probability of Mayhem (more unhealthy people) and the expansion of subsidies into the insurance pool (the insuring of more sick people) will cause proportionate increases in health insurance premiums.  On this basis alone, the provisions of the health reform bill are unquestionably inflationary w/r/t insurance premiums.  Count on it.

As a greater portion of insurance premiums represent subsidy, the role of the health insurer has to change from one of underwriting risk, i.e., pricing the probability of Mayhem, to managing risk, i.e., working to reduce the cost of known conditions within the insurance/subsidy pool, the latter requiring a substantially different set of skills than the former.  This transformation of the health insurance industry was already under way prior to the passage of PPACA (our healthcare reform law), as corporations began requiring risk management programs from their insurance companies.  Without this transformation, healthcare inflation is destined to sustain at its current levels, probably for eternity, or at least until the increases in the prevalence of chronic illnesses and the probability of Mayhem achieve some steady state, which with the baby-boomers now reaching 65 years-old will not occur anytime soon.  Regardless of who “pays” for the insurance/subsidies the costs of healthcare are going up, up, up, until the system shifts toward a structure where patients, payers and providers are economically accountable for managing risk.