Thursday, September 10, 2009

The Socialized Medicine Pricing Scheme

Regarding Socialized Medicine vs. Private Sector Medicine: a debate has arisen regarding “pricing premium” within the Socialized Medicine Scheme.

In the Socialized Medicine camp is the position that older insured’s should not pay more than two times what a younger insured pays. Please see the USA Today report below regarding the 2 to 1 pricing scheme.

“Pricing” in the field of Insurance is based on a series of different items depending upon the risk insured. For example, in Life Insurance the components of pricing are Mortality/Morbidity, Expense, and Interest. Mortality/Morbidity is the risk. Expenses are the cost of maintaining and operating the insurance company. Interest is how much money the insurer can earn on premium flow and reserves.

“Risk” must be underwritten. That is, what is the characteristics of the risk that makes the risk more or less prone to loss. Take auto insurance as an example. A person with a clear driving record for 20 years is different than the recent DUI offender.

You can create millions of risk scenarios. Try this: price those million risks into an understandable underwriting and price pattern. Good luck! But its not luck. Its Actuary Science. Further, Private Insurers have hard data for risk comparison spanning + 100 years. All that data is poured over by the best mathematicians you can find, known as Actuaries.

Human health generally deteriorates over time. That is to say, an increase in risk occurs with age. How many 30 year old people take 3 prescriptions per day? How many 80 year old people take 3 prescription drugs per day? How many 30 year old people have had a hip replacement? How many 80 year old people have had a hip replacement?

If an insurer offered health insurance to 30 year old people based on the risk of 80 year old people, they would have no takers. If an insurer offered health insurance to 80 year old people based on the risk of 30 year old people, they could not take enough applications.

The basic problem with an arbitrary price arrangement, not based on risk, is that you end up under charging certain risks and over charging other risks. The undercharged risks swarm to the under priced insurance. The overcharged risks refuse to buy the insurance. The collection of insured’s becomes risk adverse to the insurer as the risk translates into losses (claims) that can not be supported by the premiums collected, based on the arbitrary price arrangement.

Hence the price charged for the risk must match the risk. It is an Axiom within insurance theory and practice.

The idea of charging younger people more money for a health insurance risk, and older people less money for a health insurance risk becomes a mis-matching of risk and price. Charging older people no more than two times younger people is a mis-matching of risk and price.

When you mis-match risk and price, you have violated an Axiom of Insurance. You have also asked for unintended consequences. Likely cascading unintended consequences as you have distorted demand and supply at the point of price. Artificially distorting price is always a bad idea in the field of Insurance as well as Economics.

If you set up an arbitrary price arrangement, not based on risk, one will notice that the Socialized Medicine Scheme “forces” the overcharged segment to buy insurance (forced participation). The forced-overcharged-segment then subsidizes the under charged segment. The risk of the entire group is constant, premium is sufficient, but one group merely becomes the fall guy for premium.

Generally, the over charged group will find ways to opt-out or merely fail to participate (fail to pay premium).

One will notice Socialized Medicine Schemes generally include a “fine” for not buying insurance. This “fine” requires the Socialized Medicine Scheme to have access to the participants financial and tax records (starting to sound familiar?). The access to financial and tax records of participants is necessary to levy fines.

The following is the Insurance experience of such overcharged plans : regardless of forced participation or fines, the system will break down as the overcharged segment will fail to pay premiums in such numbers that enforcement becomes extremely difficult. The undercharged segment, on the other hand, will increase in number.

The cost of Fine Enforcement drives costs/expenses that are then a drain to the Socialized Medicine Scheme. The missing premiums and subsequent missing fines then causes the plan's income to be lower than claims paid. In other words, you have a combined ratio (claims and expenses) that exceeds income.

The excess loss (claims) over premium collected must be paid by some entity (likely tax payers).

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