A few years ago, I went out to a sushi restaurant with a friend. Somehow, we got to talking about insurance. This led to my inventing a parable right on the spot, one for today we’ll call ‘The Invention of Soy Sauce Insurance’. I don’t remember much about the story except that I received pretty good feedback about the story. Despite my shaky memory, let’s give a brief retelling a try.
The parable starts with two idiots ('The Two Idiots') coming into a sushi restaurant. The Two Idiots realize that although it serves great food, the restaurant poses a significant risk – soy sauce. If spilled, soy sauce can ruin any article of clothing. They ask to speak to the owner about this problem. The owner takes a look at the situation and crunches some numbers. He determines that in the history of the restaurant, one out of twenty diners spill soy sauce onto their clothing – a 5% risk rate. He estimates that each ensuing ‘repair’ costs around $20 on average. He proposes a solution – what if he charged each person an extra dollar under an agreement that if they spilled soy sauce onto their clothing he would present them with a $20 payout? The Two Idiots look at each other, briefly think about the math, and agree with the owner. They each hand the good man a dollar and sit down for their meal.
The premise for this parable now established, we could spend the rest of this post inventing various hypothetical scenarios and working out the ramifications for this ‘soy sauce insurance’ system. In fact, I suspect that is exactly what happened on the night I first invented this parable. For today, however, I want to skip ahead. Instead of talking about how such a system might thrive, I want to talk about how such a system might end. I think the key is a big buzzword in the current discussion about health insurance – the preexisting condition.
Let’s suppose one day The Two Idiots expand their number and start bringing a third friend. Their friend the slob (‘Their Friend The Slob’) is in his own right an esteemed gentleman – the first few times, he pays the $1 Soy Sauce Insurance charge for both of his dining companions. However, Their Friend The Slob has one problem – he simply cannot keep his shirt clean. After a few consecutive weeks of $20 Soy Sauce Insurance payouts to this new guest, our good man the restaurant owner retreats to his spreadsheets and crunches the numbers again.
The next time The Two Idiots return for dinner with Their Friend The Slob in tow, the owner emerges from the backroom, greets the diners at their table, and informs them of a new insurance policy. The owner explains that although insurance is a great thing for everyone because it helps people bear huge and sudden costs in the event of an unpredictable emergency, even the noblest interventions require a sustainable source of funding. Therefore, the owner sighs as he makes a pointed glance at Their Friend The Slob, he has no choice but to adjust the premium based on each person’s risk of spilling soy sauce. This means that starting today, The Two Idiots will continue paying $1 each to reflect a 5% chance of cashing in on the $20 policy. Their Friend The Slob, however, will pay $4 to reflect what recent events have shown is a 20% chance of cashing in on the $20 policy.
This announcement leads to immediate protest. What an outrage! The Two Idiots demand the owner look at Their Friend The Slob. Look at his hands! Sure enough, Their Friend The Slob has fingers with an unusual feature – angles. It’s no wonder he can’t go five meals without spilling soy sauce! Eventually, they relent, and the trio pays the premiums as charged. The meal concludes (no spills) but the diners go home with a proverbial bad taste in their mouths.
The next day, The Two Idiots pool their limited brainpower. Isn’t the new Soy Sauce Insurance premium a form of discrimination? They take the issue to their local government office and eventually find a bureaucrat who agrees with their perspective. After several hours of admin, he mails a form letter to the sushi restaurant. The owner reads the letter and rolls his eyes – bureaucrats…
One week later, the diners return to the sushi restaurant. This time, Their Friend The Slob is not with them. The owner greets the pair at the door and presents them with a new Soy Sauce Insurance policy. The city office had been on this case, the owners explains, and he decided that to maintain fairness to all diners he will now charge a flat rate of $2 for insurance. The owner proudly explains that this new policy accounts for the rising rate of insurance payouts without discriminating against diners with preexisting conditions. It costs more, he points out, but it is fair and it is sustainable, and that’s what counts! He barely contains his glee as he seats the diners and returns to the backroom.
The Two Idiots are puzzled throughout the meal. They are initially too hungry to have any interest in thinking hard about insurance. However, as the meal progresses, they slowly work out the numbers. Their risk is still 5% - therefore, one out of twenty times they will receive $20 in compensation for a spill. However, they are now paying $2 instead of $1, so every twenty trips they are spending $40 to buy $20 worth of insurance. What a ripoff!
The pair settles their tab and emerges into the cool summer night. The walk helps The Two Idiots connect their outrage to action. What if, they suppose, we simply saved up our money so that we could cover an unexpected $20 expense? The Two Idiots chatter with excitement. Great idea! This means we don’t need that overpriced insurance!
The next week, they enter the restaurant with Their Friend The Slob and make a stunning announcement – we, The Two Idiots, do not require Soy Sauce Insurance. The owner is left stunned by this revelation. He eventually gathers his composure and slinks back to his spreadsheet. What are my options, he wonders, as he begins calculating the ramifications of The Two Idiots and their most recent decision...
What, indeed, are his options? There are simply far too many to list, a near endless amount, but let's consider a few of the simpler or more intuitive ones. The owner could support the insurance policy via the menu by marginally raising prices across the board, a move that essentially passes the cost of using a dangerous ingredient directly to the customer. Or, he could start badgering his local lawmakers, demanding that new regulations - which we'll call, I don't know, an individual mandate - force all diners to buy Soy Sauce Insurance whenever they enter a sushi restaurant. He also could partner with local businesses, perhaps encouraging them to offer soy sauce insurance as part of employee compensation, and therefore have the cost of the policy effectively subsidized by employers. He might introduce complexity to the current system by lowering premiums while adding concepts such as deductibles and out of pocket maximums, each detail carefully considered so that low-risk diners end up paying far less than high-risk diners without arousing public suspicion of discriminatory pricing.
I’m not going to explore these options in any more detail, however, because each of these ends up violating one of two key principles of an insurance system – it’s funded through equal premiums or funded by an accepted version of discriminatory pricing. These two principles form the basic foundation of any sustainable insurance system. In the example I’ve outlined above, I stopped at the moment Soy Sauce Insurance failed - when the restaurant owner lost the lowest risk customers after imposing equal premiums. However, this moment was partly brought about because he also faced a backlash when he adjusted premiums to reflect risk. These two events combined spelled doom for this particular insurance system's ability to pay for itself.
There is a third challenge here that I didn't even bother to include because it complicated the numbers - wages. How much should someone earn for administering an insurance policy? In fact, we also haven’t considered administrative cost. The restaurant owner in this parable is in a business sense running the system out of the goodness of his heart – and all he got in return was public scorn!
But let’s return to the question I posed earlier in case you disagree that the Soy Sauce Insurance example is doomed. What are the restaurant owner’s options? The only sustainable answer is to charge $4 to the slob. This is the fairest way to account for the pattern of revenue and cost to the system. The way the math is arranged, since the slob spills 20% of the time, one out of five times he cashes in for a net $16 cost to the system while in the other four out of five cases a spill-free meal means a $4 contribution to the system ($16 total). In this setup, the system breaks even over the long term. There are many insurance systems that remain sustainable because of this math. Flood insurance at the top of a hill, for example, costs less than it does for an equally valued property sitting on a low-lying riverbank.
The difference with health insurance and flood insurance is that we seem to have reached a certain agreement that charging people based on their risk of using health care is not allowed, a sentiment seemingly based on a widely held belief that most health needs fall largely beyond individual control. This brings me back to my earlier idea about how the parable applies to our current discussion about the healthcare system and the ongoing debate about preexisting conditions. The short version is that if I have certain preexisting conditions, I’m more likely to cash in on my premium next year than those who do not have these conditions. An insurance system allowed to fund itself would consider these probabilities and charge me a higher premium. However, this violates the aforementioned agreement that health insurance premiums should remain identical regardless of preexisting conditions.
This is why I believe the private health insurance system in this country is doomed. The end is a matter of when, not if, and although I concede that when might be a very long time from now, if we all keep our heads and remain in collective agreement that charging different premiums based on preexisting conditions is morally abhorrent, the game is effectively over for private insurers. As long as this aversion to charging for preexisting conditions remains widely held by the taxpaying public, there is no way for health insurance to directly maintain sustainable balance sheets. I’m very confident this sentiment will hold up over the long-term. Even President Trump, in what I consider the highlight of his term, declared his opposition to charging for preexisting conditions. If he’s against this, who is going to favor it?
What I see happening today in the context of private health insurance is a variety of death rattles indicating the imminent end of a doomed system. Most of these rattles are manifestations of that second option I presented above – denied a system directly funded by equal premiums, insurers are finding ways to hide discriminatory pricing practices beneath layers of bureaucratic complexity. There are so many examples of these indirect mechanisms in place to keep private insurance afloat that, again, I feel there is too much to list. These mechanisms include but are not limited to bills full of ridiculous line items (I've heard $8 for a box of tissues), an overly complex system of rebates (such as for having a gym membership) that help insurers maintain positive cash flow, and an endless stream of new spending categories that only the unhealthiest are sure max out (HSAs, copays, deductibles, and so on) and therefore leave them on the hook for a much larger annual outlay than the average policyholder. If you break these numbers down and consider total spending by a subscriber over the lifetime of a policy, you see that people with preexisting conditions are essentially guaranteed to pay more than those without such conditions. We already know that public opinion is firmly against such charges made ahead of time – once our collective thinking expands beyond considering solely premiums, the backlash will pressure insurers to shelve these practices.
Give credit to those private insurers, I suppose, for finding new ways to stay in business. Sooner or later, though, the public will turn against their indirect methods for charging those with preexisting conditions. One common solution I hear pretty regularly in this regard is to simply expand public insurance, perhaps mimicking single-payer systems in other countries, and I think there is plenty of logic to the idea. The easy argument is that the largest pool of policyholders gives the insurer the best chance to spread risk – since the entire American public is the largest possible pool for any American insurer, the government would be best positioned to directly fund a health insurance system through premiums without charging so much that healthy individuals would be encouraged to opt out.
The subtler argument is that the government is also much better positioned to implement discriminatory pricing for health care than any private enterprise. In short, a government can discriminate with their pricing without facing the same backlash that would befall a private organization doing the exact same thing. This discrimination can be easily hidden under the guise of 'discouraging' harmful behavior through taxation. Take the example of lung cancer – the government could support health care expenses for treating this disease by allocating tax dollars from cigarette sales instead of increasing premiums for smokers. The healthcare premium paid by a smoker would be the same as for a nonsmoker but if you consider the amount paid in cigarette taxes the smoker ends up paying more into the total system. A similar structure could work for skin cancer – beachgoers might pay an additional tax for parking by the sea while sunscreen could be made exempt from all sales taxes. This structure would charge people for actions rather than genetics, a form of discriminatory pricing that I believe the public supports for any freely made decision.
The problem I’m having as I articulate my lofty future is the most important question of all – tomorrow sounds great, but what can we do today? As always, when a big idea sounds nice in theory, I struggle to reframe it into a series of steps an individual can take to help us all collectively move closer to the ideal. I think the key just goes back to the basic idea about preexisting conditions – as long as we remain adamant that charging differently based on these conditions goes against what we stand for as a society, we continue to chip away at the overpriced and underperforming system of private health insurance in this country.
