Sunday, April 7, 2013

Obamacare: actuaries, insurance policies, maintenance policies and Kathleen Sebelius

“In a report that could prove a big political headache for the administration, the Society of Actuaries estimated Tuesday that insurers will have to pay out an average of 32 percent more for claims on individual health policies under the Affordable Care Act, a cost likely to be passed on to consumers.”

“Kristi Bohn, an actuary who worked on the study, acknowledged it did not attempt to estimate the effect of subsidies, insurer competition and other factors that could mitigate cost increases. She said the goal was to look at the underlying cost of medical care.

"Claims cost is the most important driver of health care premiums," she said.” (1)

Enter Kathleen Sebelius:

“At a White House briefing Tuesday, Health and Human Services Secretary Kathleen Sebelius said some of what passes for health insurance today is so skimpy it can't be compared to the comprehensive coverage available under the law. "Some of these folks have very high catastrophic plans that don't pay for anything unless you get hit by a bus," she said. "They're really mortgage protection, not health insurance."

She said this in response to a report from the American Society of Actuaries arguing that premiums are going to rise by 32% when Obamacare kicks in, as coverage gets more generous and more sick people join the insurance market. Sebelius's response is apparently that catastrophic insurance isn't really insurance at all--which is exactly backwards. Catastrophic coverage is "true insurance". Coverage of routine, predictable services is not insurance at all; it's a spectacularly inefficient prepayment plan.” (2)(3)(4)

What Sebelius is saying is that maintenance policies are insurance. This would mean the risk management matrix, insurance theory and actuaries are fallacious as maintenance policies are true insurance.

At this point many pundits show the absurdity of Sebelius's claim by pointing out the oft quoted case of “grocery insurance” or “gasoline insurance“. That is, if you “insured” the maintenance of grocery purchases or gasoline purchases your price for such coverage would be exactly the cost of your groceries or gasoline, plus an administration charge to handle the transactions. (5) (6)

The problems mentioned above regarding claim costs and hence rising premium price and the problem with maintenance policies can be summed up very easily: in the risk management matrix the most efficient use of insurance is for low frequency and high severity risks. All other deployments of insurance in the risk management matrix are inefficient allocations of insurance. (7) (8)


Given insurance theory and in particular the risk management matrix and knowing the most efficient deployment of insurance is for low frequency and high severity risks, then why does Sebelius advocate high cost maintenance insurance designs which drive up claim cost and hence premium? Sebelius’s argument finds its implicit assumption in categorical risk management. However, before one can discuss categorical risk management one must examine incremental risk management. All firms and all individuals deploy incremental risk management. That is, risk management is viewed in a cost/benefit fashion with certain risks retained as the cost outweighs the benefit. For example, the vast majority of households do not install sprinkler systems in their homes as the cost/benefit is ineffective given constraints but many households do find smoke/fire detectors cost/benefit effective.

Then who advocates categorical risk management such as Sebelius? Categorical risk management advocates take the position of unlimited benefit regardless of cost. Who in the world can disregard cost? Ah, enter Milton Friedman’s fourth category of spending. Those that advocate categorical risk management do so with other people’s money. (9) (10)

Hence we end this examination with the Health and Human Services Secretary, Kathleen Sebelius dismissing the Society of Actuaries by advocating the deployment of insurance in an inefficient fashion via categorical risk management with other people’s money. Political nitwitery is best served with dupery.



(1) Study estimates Obamacare could raise individual claim costs 32 percent, Washington Guardian, 03/27/2013 [update 03/28/2013].

(2) ibid

(3) Health and Human Services Secretary Doesn't Understand What Insurance Is, Megan McArdle, 03/27/2013, The Daily Beast.

(4) What is the purpose of insurance? Greg Mankiw’s blog, 03/28/2013.

(5) ibid

(6) Health and Human Services Secretary Doesn't Understand What Insurance Is, Megan McArdle, 03/27/2013, The Daily Beast.

(7) The Socialized Medicine Scheme: reverse risk management.

(8) ObamaCare: more on categorical risk management

(9) Milton Friedman’s Four Categories of Spending.


(10) Applied Economics, Thomas Sowell, pages 144 - 145









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