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What Health Insurance Is and Isn’t

March 4, 2010 4 comments

I’m not going to use this blog to stump for any particular side of the health care debate, but I want to clear up a misconception that’s been bothering me since the debate began.

Many of the arguments made for reform include comments about insurance companies denying coverage to individuals with pre-existing conditions. This has been represented as a greedy and heartless practice by insurance companies to avoid having to pay claims. This argument is being made by many who (in my opinion) do not understand the basic concept of what insurance is.

Insurance is the management of risk. Each of us lives in risk of suffering harm or illness at any point in our lives; health insurance helps us manage that risk by allowing us to pay (comparatively) small amounts of money over our lifetimes with the promise that funds will be provided for our care should such harm or illness befall us. We enter into this agreement with an insurance company knowing full well that we may never need those funds — we may pay out our entire lives and never get back. On the other hand, we may end up needing far more than we ever pay in. Several people doing the same allow the risks of these outcomes to be spread out over a larger group so that no one person bears the entire burden.

Insurance is not a discount program. It is not a way to get medical services for less than their market value. The money for insurance coverage has to come from somewhere, and there has to be enough of it available to cover any needs that may arise.

A person with a pre-existing medical condition who has to see a doctor or have procedures performed regularly will draw out more than he or she puts in. They are not managing risk, but receiving discounted care. They are denied coverage because there is no chance that their premium payments will ever equal or exceed the benefits they receive, so there is no risk to manage.

To borrow an analogy from a popular (if misinformed) YouTube video, imagine that maintaining a fire department was not one of the normally responsibilities of government. Instead, imagine that you had to pay $6,000 each time a fire needed to be put out at your home. You may never need fire service during your lifetime, or you may need it several times.

To help manage the risk, you and 9 other people in your neighborhood decide to pool your resources. You research statistics on home fires and determine that it is likely that one of your homes will catch fire in any 10-year period1. To manage this risk, each of will pay $5 per month (10 people × $5 per month × 120 months = $6,000). Your expectation is that any one of you may need to draw out this money at any time in a 10-year period. You may go 10 years with no fires, or there may be 2 fires, but at least this way the risk (and the charge) are spread out among the 10 of you so no one bears the burden by themselves.

One day a neighbor comes to you who is not part of your pool. His house is on fire and he wants to pay his $5 to become part of your pool. There is no risk to spread out here; you know that if he enters the pool you will have to immediately pay out the $6,000 to cover his bill, for which he will pay only $5. He is under no obligation to continue in your pool after he receives his money. This is what it is like when someone who has a pre-existing condition is applying for health insurance. He is asking you to pay his costs — which is not insurance, it is a subsidy.

Now I’m not saying that we shouldn’t have ways for everyone to have affordable access to health care. I’m not defending any other practices that insurance companies may or may not engage in. I am simply saying let’s stop using coverage denials due to pre-existing conditions to demonize insurers. Insurance is not a subsidy or discount program, it is risk management. If there is not a chance that you may not need your benefits, then it defeats the entire purpose and function of insurance.

Now let’s get back to debating.


1. This is of course not a real statistic and is only being used for illustrative purposes.