Does The socialized medicine scheme, through mandated one-size-fits-all health care coverage, distort the
individuals ability to deploy risk management and consequently distort the pure risk transfer mechanism ? In this article we explore the following questions:
(1) are the
individuals decisions regarding risk avoidance, risk reduction, risk mitigation and risk retention being distorted by mandated coverage and the distortions leads to the immediate pure risk transfer aka purchase of insurance?
(2) does the socialized medicine scheme of mandate coverage reverse the proven process of insurance theory and practice and require the immediate transfer of risk (purchase of insurance) with risk management deployed after the fact via through tax disincentives ?
(2a) does the reversal of the proven process of insurance theory and practice lead to risk management becoming a cost item rather than a cost reduction item?
Defining Terms
(1) What is pure risk? A category of risk in which loss is the only possible outcome; there is no beneficial result. Pure risk is related to events that are beyond the risk-taker's control and, therefore, a person cannot consciously take on pure risk. (1)
(2) What is risk management? Risk management is the application of tools and procedures to contain risk within acceptable limits. (2)
(3) What is insurance? A promise of compensation for specific potential future losses in exchange for a periodic payment. (3)
Risk Management
Its well established within insurance theory and practice that one needs to review and employ risk management concepts and techniques before the consideration of the transfer of pure risk (insurance).
Risk management techniques reduce the need to transfer portions of pure risk. The less pure risk transferred means the lower the consideration paid (premium) for the transfer of risk. Hence risk management lowers costs.
Risk Avoidance
The first risk management technique one needs to explore is risk avoidance. This is simply avoiding the risk all together. For example, if you never want to sustain a football injury, then do not play football. However, risk avoidance has it limitations as not all risks can be avoided.
Risk Reduction
If the risk can't be avoided or you want to benefit from an endeavor that involves pure risk, then you need to go to the next step of risk reduction. That is, can one reduce the chances that pure risk might occur.
For example, risk reduction of operating and/or owning a motor vehicle includes taking drivers education, taking an advanced defensive driving course, reducing/combining trips to reduce miles driven, owning snow tires,etc.. Hence the pure risk of an auto accident can be reduced through safety.
Risk Mitigation
Risk mitigation is an exercise in risk management. Since the pure risk exists, and if the pure risk occurs, we need to mitigate the loss. Fire does occur. Owning a fire extinguisher, being trained in the proper use of a fire extinguisher, and placing the extinguisher in fire prone areas can mitigate the scope of the loss if fire occurs.
Risk Retention
Risk retention is the concept that if pure risk exists, and given the other risk management techniques have been deployed, then how much of the ensuing potential financial loss of the pure risk can you reasonably absorbed? This differs per individual. If the maximum potential loss is $100,000,000 can you retain $1000, $5000, or $10,000 of the risk? That is, given an
individuals financial situation, what portion of a loss can be financially absorbed before it becomes financially disabling?
Therefore, before one ever explores the transfer of a risk (aka the purchase of Insurance), one must go through the risk management process to access risk avoidance, risk reduction, risk mitigation, and risk Retention.
The Transfer of Risk
Only after you exercise the steps of risk management can you intelligently determine that a particular pure risk exists and how to financially treat the risk. That you can or can't avoid the risk, that you have determined how much you can reduce the risk, that you have determined how much you can mitigate the risk, and a determination has been made on the amount of pure risk that can be financially retained.
Once you have passed through the risk management steps, and determination has been made that X amount of pure risk needs transferred then at this point one must attempt to find a ready market to transfer the portion of the risk that one can not retain i.e. purchase insurance.
The Dynamics of Risk Management and The Transfer of Risk Regarding the Individual
Applying risk management and determining the need to transfer pure risk is going to yield many and varying results among differing individuals with differing circumstances. For example, John Q. Buffet can likely retain the majority of pure risks whereas on the other end of the pure risk curve Jane Q. Public needs to transfer the majority of pure risk. Between John's situation on one end of the spectrum and Jane's situation on the other end of the spectrum are an endless series or risk management and pure risk transfer scenarios.
Enter the Socialized Medicine Scheme
The socialized medicine scheme proposed in the US House of Representatives and Senate imposes a one size fits all risk management and transfer of pure risk scenario which minimizes the incentive for risk management. The known dynamics that exist within risk management and pure risk transfer among differing and varying
individuals are disregarded through the use of one-size-fits-all pure risk mandated coverage. The mandated coverage requires a relatively low set deductible and relatively low set out-of-pocket cost. The proposed plan also includes ancillary coverages such as relatively low doctor office co-pays and relatively low prescription card co-pays. The predetermined coverage with relatively low deductibles and co-pays causes little room for risk management. The predetermined mandated coverage design pigeon holes all risk management although its well known that individual risk management needs vary widely.
Consequently, the theory of risk management and pure risk transfer is violated by predetermined mandated coverage. The process of risk management immediately leading up to determination of the transfer of pure risk is minimized .
What are the Consequences of Minimizing the Risk Management step?
Inefficient Allocation of Resources
One very important consequence of minimizing the risk management step is the inefficient allocation of resources for individuals. For instance, why would John Q. Buffet want to allocate $10,000 per year for the transfer of pure risk when in fact he would rather retain the risk? The $10,000 is now transferred from other activities John Q. Buffet values to an activity John does not value. This becomes an inefficient allocation of resources for John Q. Buffet. The same inefficient transfer of resources cascades across the entire spectrum as the vast majority of individuals would have chosen deductible and plans different than the mandated plan and deductibles.
Incentives created to Minimize Risk Management Techniques
Another aspect of a one-size-fits-all approach which consequently minimizes the risk management step immediately prior the determination of pure risk transfer, is the effect on risk management techniques. When risk management becomes a minimized procedure so do the risk management techniques become minimized. Assume for a moment that John Q. Buffet wanted to retain the entire risk while Jim P. Public wanted a very high deductible major medical plan and retain a relatively large portion of the risk. John and Jim are now required to outlay resources they had allocated elsewhere in the past. This is an additional cost to John and Jim. John and Jim are now
incentizised to minimize rather than maximize risk management techniques they otherwise would have employed in the past.
The risk management techniques, that would have been paramount when retaining an entire pure risk or retaining a major portion of a pure risk, are now minimized by the relatively low deductible mandated coverage. John and Jim now have an incentive, through low deductible insurance, to minimize risk management techniques. That is, John and Jim don't deploy risk management techniques as they have in the past.
John and Jim rigorously deployed risk management in the past when they were retaining all or large amounts of pure risk. The retained risk is so low under mandated coverage that John and Jim have no incentive to rigorously deploy risk management. Lets say John always wanted to sky dive. However, as a risk management techniques John avoided sky diving. Why not sky dive now as the risk of injury is covered by insurance on a relatively low out of pocket dollar basis. It boils down to the following sarcastic comment you have surely heard in the past when a person is questioned about a risky endeavor: "...why not, I have insurance"!
Incentives Introduced to Recover Cost (to over utilize)
Another item creeps into the realm of pure risk when insurance is mandated and risk management is minimized: return on the dollar invest in insurance. The theory of insurance clearly points toward buying insurance for the catastrophe. When insurance is purchased for everyday items, consumers of insurance then have an incentive to maximize what they perceive as cost/benefit. In other words, if a consumer is forced to buy insurance with a low deductible, with plenty of benefits, but
at a perceived high cost, then the consumer will attempt to recover cost through utilization of benefit.
Attempts to Deploy Risk Management After the Fact via Tax Disincentives
In
the socialized medicine scheme an attempt is made to deploy risk management after the fact. As discussed above, the mandated coverage of the socialized medicine scheme creates an incentive to minimize risk management techniques. From the consumers point of view, all the risk management in the world will not reduce the cost of the relatively low out of pocket cost under mandated coverage.
Proponents of socialized medicine attempt to deploy risk management through a cost increase to mandated Insurance consumer. Rather than risk management being used as a cost reduction technique for the consumer of health-care, they use risk management as a cost increase item for consumers of health-care.
The proposed Soda Tax is an excellent example. Proponents of socialized medicine believe the consumption of soda leads to health problems. Hence to reduce consumption of soda they propose a tax. Hence risk management suddenly becomes a monetary increase in cost to the consumer rather than a monetary reduction in cost to the consumer.
Many proponents of socialized medicine also support taxes on fast food. That fast food leads to weight gain and hence is unhealthy. Enter the tax as a risk management technique to reduce fast food consumption. Once again we have a back door, after the fact, risk management method that increases cost to the consumer rather than decreasing costs through
traditional risk management.
Summary
Risk management has been distorted and minimized as a proven step in the determination of pure risk transfer through mandated coverage. Hence the method of deploying risk management after the fact becomes a cost increase rather than a cost decrease method.
(1)
http://www.investopedia.com/terms/p/purerisk.asp
(2)
http://msdn.microsoft.com/en-us/library/cc500392.aspx
(3) http://www.investorwords.com/2510/insurance.html
