Cost of Health Insurance

Posted by PITHOCRATES - May 27th, 2013

Economics 101

Making Health Insurance a Fringe Benefit removed Market Forces from the Equation

The reason why health insurance is so expensive is because it is not insurance anymore.  It’s more of a welfare program.  Where other people pay.  Whereas insurance mitigates financial risk.  People pay a small premium to insure against a large financial loss.  They may pay $250/year to insure something that may cost $25,000 to replace.  For something they may own for 10 years.  Because they would rather spend $250 each year (for a total of $2,500 over those 10 years) than have to replace it by paying another $25,000 should something happen.  Insurance reduces the amount of money you can lose.  In this case the greatest financial loss is reduced from $25,000 down to $2,500.  This is insurance.

Health insurance used to be like this.  When we paid for it ourselves.  But things changed when it became an employee benefit.  Where we no longer saw the true cost of that insurance.  This happened during World War II.  As FDR put in wage caps.  Why?  With all the men in the military and wartime production through the roof there was a shortage of labor.  And the last thing FDR wanted on top of the inflation they were causing by printing so much money to pay for the war was wage inflation.  Hence the wage caps.  But the problem with wage caps is that employers could not entice the best workers to come work for them by offering them higher wages.  So to entice the best workers to come work for them and get around FDR’s wage caps employers began offering fringe benefits.

This is the cause of all our health care woes today.  Making health insurance a fringe benefit.  For it removed market forces from the equation.  People receiving the benefit had no idea what the benefit cost.  And did not care.  Which wasn’t a problem at first.  But then the Sixties came around.  And women stopped having as many babies.  Causing the population to start getting older.  Worse (from the perspective of paying for health insurance), people were beginning to live longer.  So when a person retired from a company they lived a long retirement.  So companies who offered these generous fringe benefits began to suffer under the cost of them.  Between pensions and health care costs retirees were costing some companies more than their active workers.  Because they were living so long into retirement.  (Just as these long retirements are straining Social Security and Medicare).  And modern medicine just keeps pulling them back from the brink of death.  Prolonging this crushing financial burden.

Health Insurance is more Expensive than it once was because it now Pays for Routine Medical Expenses

Compounding this problem is how health insurance is no longer insurance.  Instead of a small premium insuring against a large financial loss people expect health insurance to pay for everything.  And get righteously indignant whenever they have to pay anything out of pocket.  From a prescription co-pay.  To a small co-pay at a doctor’s office.  This is not paying a small premium to insure against a large financial loss.  This is demanding a free ride.  If health insurance was actually insurance it would look something like this:

Health Insurance Cost - Insurance

This assumes a health group with 100 participants.  Of this 100 five people suffer a serious accident in one year.  Incurring a large and unexpected hospital expense of $6,000 each.  While three people suffer a serious illness that same year.  Incurring a large and unexpected hospital expense of $4,500 each.  The total for these large and unexpected costs is $43,500.  If we divide this over the 100 members of the group that comes to an annual health insurance premium of $435 each.  Or $36.25/month.  Or $8.37/week.  Which isn’t much.  If you were one of those suffering a serious accident you didn’t have your personal finances wiped out by an unexpected $6,000 hospital bill.  Instead you only paid a manageable and budgeted $435 each year.  In other words, spending $435 saved $5,565.  Not a bad deal.  This is insurance.  Because it only paid for the unexpected.  Not our routine health care expenses that we should pay out of pocket.  If we add these routine expenses into the health insurance formula we can see how they increase the cost of health insurance.

Health Insurance Cost - Welfare

Assume each person consume $750 in routine medical costs.  For office visits.  Allergy shots.  Vaccinations for the children.  Flu shots.  Seeing the doctor when you have a cold.  Annual checkups.  Physicals.  Cancer screening.  Prescriptions.  Etc.  Those things that can be reasonably expected each year.  When our health insurance policies pay for these routine medical expenses note the large increase in the annual insurance policy premium.  Going from $435 to $1,185.  An increase of 172%.  Everyone will pay $1,185.  Whether they consume $750 in medical costs or not.  Also, of the three things health insurance pays for (serious accidents, serious illnesses and routine medical) routine medical is the biggest of the three.  Explaining why health insurance is now so much more expensive than it needs to be.

It was the Pension and Health care Costs of Retirees that Bankrupted General Motors

This is why it is better to pay out of pocket for these routine costs.  Because if you’re really healthy one year and never see the doctor you will not consume $750 in medical costs.  So if you normally pay these out of pocket but don’t you would only spend $435 that year for real health insurance.  Not the $1,185 that pays for everything.  Whether you use it or not.  This is where market forces come in.  Instead of paying for a costly doctor’s visit when you have a cold you may just buy some over the counter cold medicine from the drugstore.  This is how we behave when we pay for stuff.  But when you introduce a third party it alters our behavior.

“Whether you use it or not.”  When people can get something more for no extra money they are going to take it.  Like going for seconds and thirds at an all-you-can-eat buffet.  It doesn’t cost anything more for the second and third plate.  In fact people will feel cheated if they don’t go for plates 2 and 3.  Because all-you-can-it is pretty expensive if you only eat one plate.  Because that one price pays for 2, 3, even 4 plates.  If you can eat that much.  It’s this mentality that causes people to go to the doctor when they have the sniffles.  So they can get ‘free’ antibiotics.  Because it doesn’t cost anything more.  Since their health insurance is already paying for it.

But it does cost more to those who are paying for it.  A lot more.  So much more that small business owners can’t afford to provide health insurance for their employees.  Because to do so would require that they greatly increase their selling price.  Which they can’t do and expect to stay in business.  Because the market sets the price.  Not them.  It’s up to them to figure out how to sell at a price the people will pay.  And if they raise it too high to pay for health insurance for their employees the people will stop buying from them.  Putting them out of business.  Even bigger businesses struggle with this.  For it was the pension and health care costs of retirees that bankrupted General Motors.  Which was one of those companies that started offering health insurance as a benefit during World War II.  Giving us all our health care woes today.

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