The House hearings on rescission – the retroactive cancellation of individual health insurance policies – were over a month ago, but after its initial run through Daily Kos it seems to have waited a bit before popping up on Baseline and Slate. James Kwak at Baseline described the practice as rare, affecting only 0.5% of the population. The faint light bulb above my head began to flicker: could that be true…that’s not rare – that is amazingly common.
It is. In fact, from Don Hamm’s (CEO of Assurant) prepared testimony, with the company logo nicely on the front of it in the original:
Rescission is rare. It affects less than one-half of one percent of people we cover. Yet, it is one of many protections supporting the affordability and viability of individual health insurance in the United States under our current system.
What tangled webs we weave…
To understand why 0.5% of the people Assurant covers is a lot of people – a jarring, terrifying, probably criminal lot – you need to understand a little bit of math. You need to understand just enough math to understand what Don and his legal team are not telling you. You need to understand conditional probability. And the folks at Assurant are counting on the fact that you don’t.
A typical job interview question for aspiring finance folks is the Monty Hall Question. As typically phrased, you go on a game show and are asked to pick one of three doors. Behind two of the doors are goats. Behind one is a shiny new car. You pick a door. The host ceremoniously opens a door that you did not pick, and behind it is a goat. He turns to you while the audience giggles at the goat. Do you want to change your pick?
As I have pointed out on the Idea Locker comments, this typical phrasing is a bit unfair. If you haven’t seen the show, you might think the choice of what door the host opened was random, unrelated to the door you picked. Since there is no correlation, you don’t see why you should change your pick. If someone asked you to call the third of three coin tosses in a row, you wouldn’t change your pick if the first two were heads, would you?
But the nuance of the game is that the door is not random. The door that is opened will always meet two conditions:
- It is not the door you picked originally (or else what would be the point of carrying on)
- It is not the door with the car (that would certainly bring things to a close)
You had a 1/3 chance of being right in your initial pick. That means there was a 2/3 chance the car was behind “not your pick”. Well, if you change your pick now, you cover the entire “not your pick” set – you have seen one of the two doors, know that it’s empty, and now have the payoff from the other. You should change your pick.
Here’s the health care nuance (2005 HHS report based on 2002 data):
Half of the insured population uses virtually no health care at all. The 80th percentile uses only $3,000 (2002 dollars, adjust a bit up for today). You have to hit the 95th percentile to get anywhere interesting, and even there you have only $11,487 in costs. It’s the 99th percentile, the people with over $35,000 of medical costs, who represent fully 22% of the entire nation’s medical costs. These people have chronic, expensive conditions. They are, to use a technical term, sick.
An individual adult insurance plan is roughly $7,000 (varies dramatically by age and somewhat by sex and location).
It should be fairly clear that the people who do not file insurance claims do not face rescission. The insurance companies will happily deposit their checks. Indeed, even for someone in the 95th percentile, it doesn’t make a lot of sense for the insurance company to take the nuclear option of blowing up the policy. $11,487 in claims is less than two years’ premium; less than one if the individual has family coverage in the $12,000 price range. But that top one percent, the folks responsible for more than $35,000 of costs – sometimes far, far more – well there, ladies and gentlemen, is where the money comes in. Once an insurance company knows that Sally has breast cancer, it has already seen the goat; it knows it wants nothing to do with Sally.
If the top 5% is the absolute largest population for whom rescission would make sense, the probability of having your policy cancelled given that you have filed a claim is fully 10% (0.5% rescission/5.0% of the population). If you take the LA Times estimate that $300mm was saved by abrogating 20,000 policies in California ($15,000/policy), you are somewhere in the 15% zone, depending on the convexity of the top section of population. If, as I suspect, rescission is targeted toward the truly bankrupting cases – the top 1%, the folks with over $35,000 of annual claims who could never be profitable for the carrier – then the probability of having your policy torn up given a massively expensive condition is pushing 50%. One in two. You have three times better odds playing Russian Roulette.
People lie on their insurance forms, of course, and that is a serious problem. But let’s not forget that the very nature of the forms is designed to create inaccuracies, and it doesn’t matter in the slightest how minor the error may be once the company comes looking to get out of its policy. Back to Don Hamm:
I mentioned a story in my comment on the Baseline article, and it’s a favorite of mine, so I’ll repeat it here: Years ago I was walking a casino floor with a casino executive. It was an incredibly detailed tour, and we got to talking about pretty much everything that came to mind about crowds and gaming. Now, a clever observer might notice that even the tolerant people of Nevada will not allow alcohol in vending machines – wouldn’t want the little ones to be able to get a Bud Light without a human being verifying their ID. But there we were in the middle of acres of blinking lights, with absolutely no one making sure that underage kids weren’t walking up to a slot machine. Indeed, they don’t card for the table games.
The executive told me you are free to play if you are underage, you just aren’t free to win. You can sit down and pump your money into the slots, and if you look presentable you can drop some chips on blackjack or craps. However, if you should happen to start winning, the pit boss or security team will come over and check your ID. The house edge is 100%.
Conditional probability is tough for the human brain. We tend to think of things as either completely correlated (once the market tanked, McCain had to lose) or completely uncorrelated (coin tosses). To a certain extent, we make the calculations in everyday speech: when someone says that pancreatic cancer is exceptionally lethal, he doesn’t mean that it is likely to kill an enormous number of people; he means it will kill an enormous percentage of the people who contract pancreatic cancer. Get a bit more tangential and even very smart people with Nobel Prizes miss things; one of the reasons Long Term Capital Management melted down was that once they started sustaining heavy losses, people bet against LTCM’s other holdings – LTCM itself was the correlation. Low frequency, high severity events are also difficult for us to process – look at how much we invest fighting air piracy versus the sacrifices we are unwilling to make on drunk driving or domestic firearm violence.
Put them together and the guys with the actuaries working for them have a nearly insurmountable advantage. I tend to think of traditional banking and traditional insurance as mirror images: when you take out a mortgage, you get a lump sum and make a series of payments; when you get life insurance, you make a series of payments and get a lump sum. Health insurance is somewhat similar to life insurance, except the payout happens sometime during the payment stream instead of at the end.
When a person intentionally defaults on consumer credit, he is called a “ruthless defaulter” and the system, to the extent that it operates with any sort of efficiency, is designed to try to flush him out of the credit market in the future. Society can tolerate taking the risk of inadvertent defaults – the people who through some sort of misfortune are unable to make good their promised payments. The folks who do it on purpose…do it enough and the FBI might step in.
The insurance industry has a bit of a historical difference, in that pretty much everything in health insurance is similar to a liar loan. I tell the company if I have been sick, just like stating an income on a mortgage application. For a host of administrative and medical privacy reasons, the insurance industry has not historically wanted a comprehensive inventory of medical records before taking a client. Few people could probably deliver such a record even with the best of intentions. There is a problem with liar loans, and it was well described by Tanta (Calculated Risk’s late writing partner) here:
Well, with Number 1 [a liar loan that has gone bad], it’s “clearly” the borrower’s fault. He or she lied, and we can pursue a deficiency judgment or other measures with a clear conscience, because we were defrauded here. We can show the examiners and auditors how it’s just not our fault. The big bonus, if it’s a brokered or correspondent loan, is that we can put it back to someone else, even if we actually made the underwriting determination. No rep and warranty relief from fraud, you know.
It is in the health insurer’s interest to have application fraud, not only because it saves time and expense on the front end, but also because it lets them get out of any policy that isn’t going well for them. If the health insurer had to verify the information – if, in essence the insurance company had to behave as an accredited investor with adequate expertise to make a decision without reliance – it wouldn’t have the opportunity to bail out. It would catch more genuine liars, but many of these liars would have turned out to be healthy, profitable customers, and what the carrier really wants is a population devoid of expensive claims, not devoid of liars.
Years ago, the shameful business was the tobacco industry. There was a certain roguish charm to them; they had great ads and were fun outgoing people, and of course they made a product that if used as directed would kill you.
Say this for the tobacco folks: they printed the dangers right there on the pack. Few people who took up smoking after World War II did so with ignorance of the health consequences. Society wants tobacco, it might as well be produced in clean factories and wrapped in cellophane as opposed to sold on street corners. I hope we legalize marijuana and let Altria and RJR make joints and put the Mexican cartels out of business.
No, the health insurance companies sneak around. They have nice facades, they speak in the bureaucratic language of statistics few understand, and they make the eminently reasonable argument that they just need to protect themselves. They promise great coverage, and when many years later it comes time to pay out and the petitioner is sick and unable to function, sorry, wish we could do better, but there was an error and rules are rules. We’re keeping the premiums. It’s actually far more like this guy:
Bernie Madoff made people promises, and people believed them, because was it really possible that the former chairman of the NASD was running a scam? Come on. But he was, and his reputation was no more a shield to the defrauded than the huge balance sheets of the health insurance companies mean an individual claimant is going to get covered. The minute he began transferring money from one account to another and then raising external capital to try to square the numbers, he knew exactly where this was going. The insurance companies know too; they just know well enough to avoid outrunning the law.
I don’t know if this case is going to be the lever the Democrats need to get meaningful healthcare reform. The Democrats don’t even seem to be able to line up on the same side, which is probably a necessary precursor to getting something passed. The Taunter Drug Plan for lower prescription drug costs doesn’t seem to have taken the Internet by storm, so I give this post low odds of breaking through. But I will make this simple point in the hope some speechwriter pressed for a deadline picks it up: if a bank manager went to half of his highest net worth clients and said “sorry, you misspelled your address when you opened your account, I’m confiscating your balance,” he would be lucky to get himself assigned to minimum security.