« Do we spend too much on health care? | Main | Was there a place to hide? »

September 16, 2009

How insurance operates

Health insurance has been a topic in the debate over health care. How exactly does insurance operate? Is it different from other businesses?

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Well, first of all, it is a business and it operates very importantly on the principal of uncertainty. And what people do with insurance is we all face some unknown risk. We know than someone in that risk pool is going to face a big cost, a big loss. So we all willingly put money into an insurance pool, and then whoever does have a loss gets the money. Let me give you an example. Let's say that one person in 10 will face a loss of $1,000 in the next year, but no one knows who it's going to be. So what people are motivated to do is everyone in that group will kick in perhaps $101, so that the losing person does get $1,000. And then maybe there's $10 left over for the insurance company to compensate them for their time and money. Now, what this illustrates is that the insurance company has to operate on the principle of uncertainty, not knowing who exactly is going to face that risk. If, for example, we say that an insurance company has to pay each of those 10 people $50 for an annual checkup, what’s that going to do the insurance premiums? Well, they're going to go up by $50 because the insurance company knows exactly that they're going to have to pay - $50 for each of those people. It also raises the issue of pre-existing conditions. If an insurance company knows that they're going to have to shell out a bunch of money for one person because they know that person's going to get sick, obviously that's why that person's premiums would be very high. That's an issue, of course, we could address outside, perhaps, of insurance."

Posted by Dave at September 16, 2009 08:04 AM