Perverted Insurance

Now that we've gone through a rigourous treatment of how insurance works, let's look at how "health care coverage" works, and how this is different from insurance, even though the terms are sometimes used interchangeably.

Many people expect that for a monthly or annual fee, some organization will pay all of their medical bills for them, much as a traditional insurance plan would in the event of a catastrophe. The more procedures covered, the better the plan, and typically more expensive. Organizations that provide this service are called Health Maintenance Organizations, or HMO's.

Like insurance, the costs of providing this care are spread among a large population. Unlike insurance, the actual cost of doing this is much easier to calculate, because there is very little risk or uncertainty involved.

Why is that? Well, most people typically will visit the doctor or hospital, and most over a lifetime will incur significant medical expenses. The total cost to the HMO of paying for all of these people is simply calculated as follows:

Number of members * average cost of medical bills + overhead = total cost

Of course, overhead is significant and will likely include some profit for the HMO. The total price per person for these services is the total cost divided by the number of people. Obviously there is some variation in price based on coverage, prior conditions, etc.

Let's look at the total cost of paying for medical service directly:

Number of patients * average cost of medical bills = total cost

This total cost is the same total cost as before minus the overhead from the HMO. Simply by existing and having customers, the HMO is increasing the cost of medical care to society overall by having overhead. They are the quintessential middle-man.

In fairness, the HMO is going to have some value for those interested in mitigating the financial risk of an expensive procedure. However, any of those people who are able to afford routine care on their own will be better off purchasing insurance for catastrophes they can't afford and paying for the routine care on their own, thereby eliminating all overhead for the routine care and saving money.

Also, for the unhealthy people who use a lot of care and have high bills, the HMO may be a good deal. But for just as many people, it's a bad deal because they are sharing the cost of everyone's routine procedures. Because of overhead, there are more of those people than there are people who benefit.

In other words, due to the overhead, it is a mathematical certainty that a system with HMOs will cost more overall than a system without.

Is that difficult to believe? Let's take a moment to consider what would happen if you didn't pay for groceries directly, but instead had a grocery plan that paid for them for you. Your total grocery bill would no longer be just the price of the groceries, but also whatever your grocery plan charged for the service of paying your bill.

We don't do this, because it doesn't make any sense to have another middleman paying for your food when you're perfectly capable of doing it on your own. Such a system would increase the price of groceries for everyone.

Let's assume now that in order to purchase catastrophic health insurance, you also had to purchase this grocery plan. Seems ridiculous and wasteful, no? But that's exactly what we're doing when we pay for a health plan that covers routine care.