Insurance

Insurance policies give you the right to spend the insurance company’s money, and whenever someone else is paying you should buy the best.

Let’s say that you typically buy $30 worth of drinks when you go to your neighborhood bar. One night the bar has a $30 all-you-can-drink special. Will this special cause you to consume more or less alcohol?

After you get the special, each drink is free. The $30 purchase price represents a sunk cost that you should ignore because you have to pay it regardless of whether you have that next drink. Consequently, the special should intensify your intoxication.

Health insurance resembles an all-you-can-consume medical care special. You pay a fixed amount for insurance, but then pay little for the medical services you subsequently use. The problem for health insurance companies is that their insurance causes customers to spend too much on health care.

After your car gets stolen, it’s reasonably easy to calculate how much your insurance company should reimburse you for. What if, however, you buy health insurance and you get sick? How much of your health bills should the insurance company pay? If the insurance company agrees to pay for everything you could possibly call a medical expense, you will obviously have incentives to overspend. If the insurance company is paying, why not get that expensive massage chair to help your back or the ergonomic keyboard you need to alleviate carpal tunnel syndrome? When you have health insurance, you purchase medical care with other people’s money. Consequently, health insurance companies need to constantly monitor their customers’ medical expenditures.

The more price sensitive the demand for a service, the more health insurance companies need to monitor. A service is very price sensitive if a decrease in price causes consumers to buy much more of the service. Heart operations probably aren’t that price sensitive since a reduction in the price of bypass surgery is unlikely to induce you to get another heart operation. Consequently, insurance providers don’t have to worry that health insurance will cause customers to get unneeded bypass surgery. Of course, even if you must have a bypass operation, you don’t necessarily need to have it performed by the world’s top surgeon. If someone else is paying, however, why not get the best?

Consumers are in a strange game with insurance companies in which we want them to rigidly monitor everyone else’s expenditures but our own. The better job insurance companies do at keeping down everyone else’s costs, the less we have to pay. Of course, once we have paid our premium we want our insurance company to give us the best, and often most expensive, care.

Insurance companies are especially challenged at providing mental health coverage. There are, I imagine, objective ways to determine whether someone needs a heart bypass operation. It’s much more difficult to figure out whether someone needs psychotherapy. Furthermore, while almost no one would get a bypass operation just for fun, a lot of mentally healthy people would enjoy spending a few hundred hours talking to a friendly psychotherapist. Since it’s difficult for an insurance company to determine how much mental health care a customer needs, it’s tough for them to control mental health care costs by stopping fraud and abuse.