Insurance Companies Are Not Agents of Socialism

Yet people are baffled and outraged when insurance companies don't act as agents of socialism. Now, I understand were the confusion comes from. Insurance companies aggregate cost over a population. However, this is not the same thing as socialism where all pay an equal share regardless of what they receive. In socialism, everyone pays an equal amount into a pool in order to have access to a resource that may be consumed more or less than by others. The difference is that insurance companies provide a "product" and they charge customers based on the amount of "product" obtained. I will return shortly to what that product is, but first consider the following.

When some one buys a car, the price they pay is determined by the "amount" of the product they are obtaining. Someone who buys a fully option Mercedes is going to pay more than someone buying a stripped down Honda. This makes perfect sense. The Mercedes costs more to produce than the Honda and the buyer is getting a product with more value than the Honda. It is readily understandable that it doesn't make sense for the two buyers to pay the same price.

So the product that insurance companies are selling is relief of financial liability. Ok, but what does that mean? Financial liability is fundamentally the dollar value of a potential financial obligation times the probability of that liability coming to pass. Considering cars again, if someone having a Mercedes has an accident it likely will cost more to repair than someone with a Honda having and accident simply because it typically costs more to repair Mecedes than Hondas. If both drivers have accidents that total their cars, the resulting financial obligation is greater for the Mercedes than the Honda. The insurance company incurs a greater financial loss for the Mercedes than the Honda and the Mercedes owner receives greater value from the insurance company upon replacement than the Honda owner. In this way, the Mercedes owner receives a higher value product in purchasing insurance than does the Honda owner, and therefore, the policy for the Mercedes costs commensurately more than for the Honda. Also, if you have two Honda owners and one driver is twice as likely to total their car than the other, that driver represents twice the financial liability of the other. That person is twice as likely to require reimbursement for the value of the car. This person is receiving twice the product value from the insurance company and will therefore be charged commensurately higher premiums.

Thus, the value of the insurance product received, as well as the "cost" of providing that product is a function (product) of both the magnitude of a potential obligation and the probability of incurring that obligation. Mathematically, "expected value"/"expected return" is PxV, where P is the probability of the event and V is the value of the event. Essentially, insurance against event V would be priced at PxV (not counting overhead and profit). The greater the magnitude of the liability, the greater the value/cost of the insurance product. The greater the probability of incurring a particular liability, the greater the value/cost of the insurance product. (By value/cost I mean value to the purchaser of the insurance and the effective cost to the insurer in providing the insurance.) So, if event V has a 100% probability of happening, insurance against that event would simply be the the cost of that event. This is why, not surprisingly, we don't expect our auto insurance provider to pay for oil changes. We know we're going to have to have the oil changed, so an insurer would simply add the cost of the oil change to the premium. Yet surprisingly, we expect our health insurance provider to pay for regular checkups and exams. Along the same lines, most people understand that if you've had an accident and then buy auto insurance, it would be absurd to expect the insurer to pay for the accident you've already had. And if they did, they would simply bill you for the full cost of repair, and again, what would be the point in that? And yet for some reason, people expect health insurance companies to pay for the "accident" you've already had, aka "preexisting conditions". Once you already have a medical condition, buying new insurance is no longer insurance, because that's not how insurance works (it's no longer a probability, it's a fact), it's called "financing". That is unless it's being financed with other peoples' money in which case it would be socialism, but still not "insurance" because the people who are financing it are being ripped off because they are paying for a product that they are not receiving. It would be socialism because the person with pre-existing conditions is receiving 1xV but only paying for PxV, while everyone else is receiving a product of value PxV but paying PxV+Cf, where Cf is the (fractional) cost of financing the person with pre-existing conditions who is not paying full price for the value they are receiving. If every just waits until having pre-existing conditions to purchase insurance, who then is paying "Cf"? The result being that the insurer is forced to simply bill each person full price for their treatment and what would be the point of that?

The math governing insurance is virtually identical to that of casinos operating slot machines. A casino operator expects any given slot machine to earn for the casino, on average and in aggregate, Nx(C-PxV) where N is the number of times played, C is the cost to play, P is the probability (fractional, not percentage) of a payout and V is the value of the potential payout. Two things are readily apparent. One is that no sane operator is going to set the cost to play at less that the "expected value" payout as this would simply be a money loser to the casino operator. The second is that some machines will payout and some won't, and in aggregate, this cost to the casino will be NxPxV against the revenue of NxC. The math for insurance companies is the same except that slot machines are individual insurance policies, C is the insurance premium, V is a particular financial liability, P is the probability of realizing that liability, and one play is the term of the insurance policy. (N would thus be policy renewals) So similarly, insurance companies will set the premium C accordingly.

No casino operator in his right mind would put a machine on the floor such that C-PxV is a negative number as this is simply a money loser and the customer is receiving greater value than the cost to play. Alternately, the operator would then have to set C higher on other machines to make up the loss, in which case those players are being ripped off in that they are receiving less value than they are paying for and are subsidizing those who play the machine that pays excessively. This would be the socialist version of a casino and people would simply choose to play the machine that pays excessively and not play the machines used to subsidize this. Obviously, with no one playing the "ripoff" machines, there is nothing with which to subsidize the machine with excessive payouts and this cannot continue indefinitely. This makes perfect sense, yet people are surprised when health insurance companies refuse to provide insurance to people with pre-existing conditions or refuse to renew policies of those with "excessive" claims: preexisting conditions puts P at 100% and serious illness increases V. With a probability of 100% of requiring treatment for an illness, the insurer would simply set the premium C at the cost to treat the illness, 1xV, and what would be the point of that? Except that what is being expected of insurers is exactly that of implementing the "socialist casino."

I am not saying what is right or ethical or anything like that. What I am saying is that expecting insurance companies to act as agents of socialism, and being surprised and outraged when they don't, is simply irrational and unrealistic in view of the business models and economics principles, and fundamentally the math involved. Socialism is mathematically and economically a loser as a business model so it should not be surprising when entities in the business of insurance don't act as agents of socialism. It is unreasonable to get outraged at a lion for acting like a lion when that is the role it plays in the environment. Lions play an important role in the environment and expecting it to be somehow different is to ignore the principles governing the environment. Similarly it is unreasonable to get outraged at insurance companies for acting like an insurance business and not like socialists when insurance is the product they provide to the economy. Insurance companies provide a vital product to the economy and expecting it to be somehow different is to ignore economic, business, and mathematical principles.