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What IS Insurance?

Most people have insurance of one kind or another, for example I carry a hefty life insurance policy (from when I was in the army, I really should get rid of it now), car insurance, health insurance and insurance on my residence.

But what is insurance?

Insurance is simply a way to spread risk around. Take the following example:

A group of 1000 people are offered a chance to purchase health insurance.

500 accept and pay, say, 5,000$ for a year of total coverage.(this is group A)

The other 500 have to pay any health related costs out of pocket. (this is group B)

For group A there is a pot of 2.5 million dollars just sitting around.

For group B there is nothing.

Over the next year 10 people in each group have to go to the hospital and, oddly enough they each end up with a bill for 25,000$.

The 10 people in group A pay nothing.

The 10 in group B are in big trouble.

The people that are the best off are those in group B that never got sick or injured. Followed by the people in group A that got sick and only paid 1/5 of the cost of their care through their premium. Followed by the people in group A that never got sick and are out 5,000$ and they are followed by the 10 group B people who are on the hook for 25,000$.

The total cost to the insurer was 250,000$, and they pocket the rest of the cash to the tune of 2.25 million dollars. Now the profit margin is no where near that high but you get the idea.

Now assume that group A has a bunch of people who have high risk factors for health problems. Say 1/5 of group A or 100 people, get extremely ill due to factors they knew before, they have cancer for example, and their bills each come to the same 25,000$.

If you have been paying attention you’ll notice that there is no money left. Again these figures are not representative of much outside my scenario so bear with me, they are merely illustrative.

What to do? There are 2 big options.

Force group B to buy insurance.
or
Raise premiums.
(price controls are not an option because they have never worked, artificially low prices coupled with massively increased demand means bad things)

Now in the real world we are faced with much tighter profit margins, much more expensive care and a finite amount of resources. Simple supply and demand will tell you that you can’t increase access and reduce costs at the same time. More people using the services still likely means higher premiums, only for more people and also likely a reduction in quality.

Insurance is a gamble, you bet them you’re going to get sick, they bet you you won’t. Winner makes the profit, but you get security to soften the blow of ‘losing’.

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