The Death Spiral of health insurance
Eugen G Tarnow November 2 2015 12:50:15 PM
By Eugen Tarnow, Ph.D.Avalon Business Systems, Inc.
http://AvalonAnalytics.com
Ever heard of the "death spiral" of health insurance? Well, here it how it works.
Health insurance claims are dominated by the most expensive participants - see the blue line in Figure 1. The orange line shows the total collected for the various members if the revenue is 20% over cost.
Fig.1. Total cost of health plan members starting from the most costly (blue line).
The costliest 1% represent 40% of the total cost, the costliest 10% represent 80% of the cost.
Income (orange line) crosses the cost curve near the full membership.
When is the break-even point? This is better illustrated in Fig. 2. The cost function (blue line) crosses the revenue line (orange line) near full membership. If the revenues are 20% over cost, then the break-even point is at 83% of membership. If the revenues are X over cost then the break-even point is about 1-X.
Fig.2. Total cost of health plan members starting from the most costly (blue line) and the corresponding income (orange line).
If the revenue is 20% higher than the cost, then the break-even point is roughly at 83%.
If the revenue is 1+X of the cost then the break-even point is at 1/(1+X) which is roughly 1-X for small X.
Of course, the break-even point for the policy holders is much lower than that. As shown in Fig. 3, it is about 13%. Thus 87% of plan members lose money by being members. Since health insurance costs are so large, it is tempting to forgo it. If the 5% healthiest members leave the plan, the insurance company has to increase the price for the remaining members by 5%. If then the next healthiest 5% balk at the cost increase, the new price goes up another 5% and so forth. At the same time the plan members get sicker with time which also increases costs.
That is the "death spiral" of health insurance. It does not occur for other insurance types, presumably because the associated costs are so much smaller: insuring one's house is only about $500 per year while health insurance for a family is $20-$30,000 per year.
It would seem that one way to remove the death spiral would be to only insure against catastrophic costs. However, ObamaCare does not allow this for anyone but the poorest members and, presumably, health insurance companies would be shrinking without the gigantic premiums and health care providers would get many fewer customers if regular care would be paid by the patient instead of a third party.
Fig.3. Break-even point for members occurs at a low 13th percentile of the costliest members.
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