What do I think is wrong with insurance? Actually, nothing in principle, if we could get the insurance system to work the way it is supposed to. It is the practice of insurance, the way it actually works, that is problematic. Frightfully problematic.
As everyone knows, in principle, insurance is a smart way to protect one’s self from possible losses that would be extremely difficult to cope with otherwise. Most people would be economically ruined for life if they lost their uninsured house to a fire while still owing $100,000 to their mortgage lender. Luckily, the actuaries who work for insurance companies can calculate the odds of a house being destroyed and charge homeowners enough for insurance so that the company will take in a sufficient amount of money to pay for houses that actually do burn down and still have money left over for the company’s operating expenses (salaries, office maintenance) and profit-making investments.
So what it wrong with this system? There are several. The major problem, as I see it, is that the relationship between the providers of insurance and the buyers of insurance is more antagonistic than most business relationships because the companies are merely redistributing money rather than providing a true product or service. In order for one home owner to receive money for the loss of a house, many other home owners need to pay thousands of dollars in insurance premiums and receive no money in return from the insurance company in their entire lifetimes. For one person to experience a financial benefit, countless others must experience a financial loss. True, there are other industries, such as the gambling industry, where many must lose money in order for one person to win money. Many people have compared insurance to gambling, although there are differences. One difference is that in gambling an individual theoretically has a chance win more money than he or she gambles. With insurance, at best you only receive a replacement at roughly the same value as the property you lost.
That is, unless you can defraud the insurance company. Many individuals are not satisfied with buying “peace of mind” with their insurance premiums. They want to receive more money back from insurance than what they put in. They look at the insurance industry as some kind of magic machine into which can insert a quarter and receive a dollar back. That’s the way it is with so many people--they like to get something for nothing. It is the same mentality that drives gambling, frivolous lawsuits, and ordinary theft. A lot of people are willing to risk the criminal consequences of filing false claims to get the big, free money. The insurance industry estimates the size of insurance fraud to be about 10-15 percent of the premium dollar (http://www.insurancelocal.com/insurancefraud.htm). To minimize losses from fraud, insurance companies must scrutinize claims very closely. Overly strict claim evaluation can result in the denial of benefits for meritorious claims. As a result, some people who have been paying insurance premiums for years fail to receive legitimate compensation for a loss while others receive money illegally.
But it is not just insurance customers who commit fraud. Insurance companies also commit fraud (http://www.pnpa.com/distribution/denenberg/column197.htm). Despite their fiduciary responsibilities as state-licensed companies and agents, insurance companies and those who work for them do sometimes intentionally fail to provide fair and efficient claims consideration in order to make more money. Does anyone really believe those television commercials that try to convince you that insurance agents are motivated primarily by a deep desire to help their clients? Phooey. Insurance companies are businesses whose primary goal is to make money--as much money as possible. What we have then is a natural arms race between the companies and the consumers. The insurance companies want to get ahead by taking in as much money as possible and paying out as little money as possible. The consumers want to get ahead by paying in as little as possible for premiums and taking out claims that are as large as possible. Lying and cheating on both sides is bound to occur and all the regulation in the world is not going to stop it.
Some might think that this antagonistic relationship is the same as the tension between a company that wants to sell a genuine product at the highest profit possible and a consumer who wants the product at the lowest possible price. It isn’t. Granted, business fraud occurs. Granted, some companies sell shoddy merchandise at inflated prices. But there is a fundamental difference between insurance companies and companies that sell bona fide products and provide services. The difference is that consumers actually receive a product or service every single time they make a purchase, not a promise for reimbursement for a future loss (if the loss occurs). Consumers can therefore choose to purchase from a company with a money-back guarantee. For companies that provide such a money-back guarantee, the possibility of a return helps to keep them honest. They are more likely to provide a product or service with sufficiently high quality so they do not have to lose the sale to a refund.
Of course, many retail companies have learned the insurance industry’s trick of making money by simply collecting more than they pay back by providing a “service contract” on products they sell. Using the same actuarial methods employed by the insurance industry, they charge a little more money for the contract than the cost of repair or replacement times the probability of an item failing within the period covered by the contract. Because these contracts for extended warranties are developed by the best available actuary science, the odds are that a product you purchase will not fail during the warranty period. At least it is unlikely to fail in a way that is covered by the contract. The profit margin on service contracts is general two to four times as high as the profit margin for the actual product itself. The high profitability of services contracts indicates that they are not good bets for a consumer ( http://www.oag.state.md.us/Press/2001/110201.htm ). So the fundamental problem of insurance has now spread widely into the retail industry.
I see the inherently antagonistic relationship between insurance companies and consumers is the “core problem” with insurance, but there is more. Imagine a retail organization that could somehow force every single person within the selling area to buy their product. What an amazing amount of money they could make! However, retailers cannot force people to buy their product. With insurance, on the other hand, we find that certain kinds of insurance are mandatory. It is against the law to own and operate a car without insurance. If your mortgage is greater than a certain percentage of the value of your house, so is Private Mortgage Insurance (PMI). Despite the fact that I was a tenured full professor, meaning I have a guaranteed job for life, and that I had never missed a mortgage payment in ten years of home ownership, my mortgage company socked me with a several hundred dollar per year PMI in case I defaulted on the loan. I wasted thousands of my hard-earned dollars over the course of several years until my house appreciated in value relative to what I owed. Medical doctors and hospitals, of course, demand proof of insurance before they will see you. Maybe I can’t blame them. Doctors have no choice but to pay outrageously high premiums for malpractice insurance, made necessary by the let-me-get-something-for-nothing mentality of those filing frivolous lawsuits.
Aside from the fundamental unfairness of mandatory insurance, when purchases becomes mandatory rather than voluntary, costs are likely to become inflated. I can charge you more if I know that you have no choice but to buy what I am selling. Furthermore, when something is covered by mandated insurance, costs of repair and replacement become inflated. People charge more because it is covered by insurance. How many people who have suffered fender bender auto accidents haven’t noticed overpriced estimates from body shops when the work is covered by insurance? Look at the cost of health care before the federal government got into the medical insurance business compared to the cost of health care today. Taking into account inflation, the cost of one of my son’s routine trips to the doctor is about twice what my parents paid when I was seen by a pediatrician. People used to be able to pay cash for normal medical care. Thanks to insurance, we cannot afford to pay the cost of normal medical care without the insurance. Mandatory health insurance, meant to help people with the cost of health care, has actually increased the cost of health care.
I already mentioned how the possibility of making fraudulent insurance claims can bring out the worst tendencies in people who think they can get something for nothing. But this kind of problem is not limited to liars and cheats. The mere availability of insurance encourages the mentality of expecting someone else to pay for your expenses. People want everyone else to share in the cost of their own particular medical needs. Consider when doctors began prescribing Viagra to treat erectile dysfunction and insurance companies began covering this drug. Whenever a new medical procedure or prescription begins to be covered by insurance, premiums must go up for everyone, or else the insurance company will lose money. So, in order for men with erectile dysfunction to receive coverage for their problem, all men without this problem and all women must pay higher premiums. Not surprisingly, many women have said that covering Viagra but not women’s contraceptives constitutes unfair sexual discrimination. Including contraceptives would raise premiums by $1 to $5 per person (http://www.acluofnorthcarolina.org/cgi-bin/cgiwrap/acluofnc/goto.pl?edconequ), which would make the contraceptives less expensive for the women who use them at the expense of others who don’t. If insurance covers women’s contraceptives, men may demand coverage for condoms. Beach bums may demand coverage for sun screen. The possibilities are endless.
Because insurance is an inherently rob-Peter-to-pay-Paul system, everyone wants to be Paul so Peter will pay for their unique expenses. But everybody can’t be Paul. Some people must lose in order for others to win, so medical insurance creates a continuous arms race amongst all policy holders. If you think that it is not so bad because everybody gets something, which balances everything out, then you are saying that insurance for all of these things isn’t necessary, and we would be better off not paying the extra money for premiums. But we have little choice; mandatory insurance has helped to increase medical costs to the point that too many people cannot afford health care without it. The arms races inherent in mandatory insurance programs have made these programs self-perpetuating.
Some people think that the problem of insurance could be lessened if it were administered by the government. The reasoning here is that the greed of private insurance companies--even with government regulation--makes insurance more expensive. I can understand this concern when I gaze at the palatial buildings constructed by insurance companies. The world’s first skyscraper, the Home Insurance Building, was built in 1885. The 100-storey John Hancock Center took 5 million man hours between 1966 and 1969 to construct at a cost of $100 million dollars. John Hancock Mutual Life Insurance Company sold the building in 1997 to Shorenstein Company for $220 million. In an even bigger deal, John Hancock sold its 62-storey Financial Services Building and two other buildings in Boston to Beacon Capital for $910 million. If the primary purpose of insurance is to protect people from loss, is it really necessary to build these kinds of temples on the backs of policy holders? Would a not-for-profit government insurance program provide a better, lower-cost alternative?
The track record of government programs gives us little optimism for providing a better deal than private insurance companies. The problem with any government program is lack of accountability for revenues and expenditures breeds inefficiency in cost control. Because private companies need to worry about making a profit, they pay close attention to minimizing their costs and avoiding waste. Whereas the government can count on a steady inflow of money through taxes that citizens have no choice but to pay, a profitable company has to earn every dollar through successful selling. Money is therefore more precious to private companies. A successful company must manage and invest its income wisely, avoiding waste and inefficiency. The government, with its virtually limitless supply of tax income, is not as accountable to the bottom line as a private company. Government programs are therefore inherently more wasteful, inefficient, and costly than private sector programs.
Unfortunately, people seem to forget that “free government programs” are never free. Taxpayers pay for them. Yet people continue to think that they can get more back from the government than what they pay in. It’s the old magic money machine mentality again. I want to be able to insert a quarter and get back a dollar. The desire to have someone else pay for one’s medical expenses has reached epic proportions in the call for government-sponsored, universal health insurance. For some reason, people seem to think that if the government to provide health insurance for everyone, then medical care will be free. They seem to forget that their taxes pay for this “free” medical care. They don’t consider how the government’s lack of financial accountability leads to inefficient and wasteful management, which naturally leads to debt, which must eventually be paid off (with interest) by taxpayer money. I can understand how someone living in poverty who pays no taxes would support such a program. They would gain at someone else’s expense. But why middle-class citizens would buy the idea of mandated, government-sponsored insurance is beyond me. They will lose rather than gain financially by this program. Anyone who feels sorry for the poor would be better off contributing directly to the poor rather than having their contributions wasted and diluted by the government.
I wish we had a better alternative to the current insurance programs that exist. The basic idea of insurance is reasonable. I would endorse an insurance program where all contributions were voluntary and the cost of contributions did not exceed what was necessary to pay for day-to-day management of the program and for meritorious claims. I don’t know how we could ever get there. Those with power--insurance companies with money and governments who make the laws--are in control of the show. Without some kind of revolution (peaceful, I would hope!) the rest of us will remain just cogs in the machine, just bricks in the wall.