Insurance Needs Big Numbers 
By Walter Sorochan, Emeritus Professor, San Diego State University

Posted January 01, 2011 Updated September 25, 2014  Disclaimer

What is insurance? Insurance is providing protection to someone who is at future risk of catastrophic illness, disease, injury or death or loss of property. Should they get sick or have an accident, then their insurance coverage or premium would provide money or compensation to allow them to regain their previous state of being. This being able to regain their former state is referred to as indemnity.

Cost: Cost of an insurance policy is determined by comparing numerous actuarial factors like age, frequency of disease, injury, accident, length or age of the policy, factors increasing risk, etc., in the general population and then calculating the probability of such a happening. The greater the number of persons in the population pool, the less the cost of the premium. This is the key: the size of the population pool lowers the cost of the risk.

For example: The cost of requiring medical care for a person with cancer is difficult to estimate. But depending on the kind of cancer, the expenses of medical treatment, for example, can be well over $ 100,000 over a period of just one to two months. The expenses are for cancer specialists, therapy and hospital care. This expense of $ 100,000 is an amount that most persons do not have available as immediate cash!

longevity So how does health insurance help out? If the cancer patient in our example was covered by an health insurance policy, then the insurer, private or government, would pay for the incurred expenses. The patient would probably pay a small co-payment for each visit to the doctor or hospital. The insurer [ insurance company ] would absorb most if not all the expenses of cancer therapy.

In order for cancer therapy insurance to work, the patient, while in a healthy state, would have had to get the health care insurance policy before getting sick or being diagnosed with cancer. The healthy person would pay a small premium each month or year for the high cost health insurance coverage. Depending on the age, risk and other health-environmental risk factors, the insurance experts or actuarians would calculate the amount of the premium. The calculation of risk of getting cancer is spread over to all the other persons in the population pool.

The concept of insurance is that the losses of a few are made good by contribution from many. It is based on the law of large numbers. The risk of one or a few are shared by the many. And the more persons sharing the risk, in turn, results in lowering the cost of the risk to the few at risk. For example, the premium cost for 100,000 persons in the insurance pool [ coverage of those sharing the risk ], say $ 500 a month. is much higher than for one million persons, probably $ 200 a month, in the pool. And the insurance cost of $ 29 a month for a pool of 100 million persons is dramatically lower than for either the 100,000 or 1 million persons in the population pool. The cost of risk, spread to the population pool database, determines the cost of the premium policy or insuring the risk.

Most private insurance companies, like Blue Shied or Blue Cross, have a small number of persons in the risk pool and hence, the premium costs tend to be extremely high, as compared to Kaiser Permanente with a much larger population pool. Although there may be many small and medium sized private insurance companies competing for persons to insure, their population pool is much smaller than a national single payer population pool for a country.

The main concept of insurance --- that of spreading risk --- is the basis of all insurance. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium, and can be thought of a guaranteed small loss to prevent a large, possibly devastating loss. An insurer is a company selling the insurance. The insurance rate is a factor used to determine the amount, called the premium, to be charged for a certain amount of insurance coverage. Insurance or assurance, is a device for indemnifying or guaranteeing an individual against loss. The risk of loss is spread to a multi-aged population pool over a long period of time. The bigger the risk pool the lesser the cost of insuring a risk.

Now you should be able to understand why the cost of health care in a single payer insurance provider like the countries of Sweden, England, Canada and France cost less than the health care in United States. These countries have single provider coverage for health care referred to as universal health care.

Insurance is available for all aspects of life. You are probably most familiar with auto and home-fire insurance. Since most persons drive a car and are mandated by law to have state automobile insurance, let us look at how auto insurance works.  Your insurance carrier provides you with auto coverage based on various risks:

dot your driving record
dot your age
dot physical condition & age of your car
dot living/driving in dangerous environmental area
dot size [ number persons ] of your carrier pool
dot amount & kind of liability coverage
Here is a rough example of how your insurer determines your risk and the amount of your auto premium:
dot the older your car, the less redeemable value it has, the less you pay
dot the more speeding & parking tickets you have, the more you pay
dot the more stolen vehicles in your area, the more you pay
dot the more miles you drive, the more you pay
dot if you are between 15 and 25 years of age, the more you pay
dot size of all your liability risk
Now let us look at the risks for health insurance:
ageing BeltHeight dot the older you get [ probability of dying ], the more you pay
dot work in hazardous environment, you pay more
dot have genetic predisposition to disease, you pay more
dot are obese, you pay more
dot smoke cigarettes, you pay more
dot don't exercise, you pay more
dot have high cholesterol level, you pay more
dot have diabetes, you pay more
dot have cancer, you pay more
dot have cardiovascular disorders, you pay more
dot have autoimmune disorders, you pay more
dot have allergies, you pay more
dot visit the doctor a lot, you pay more
dot have less than high school education, you pay more
dot eat high fat diet, you pay more
dot drink alcoholic beverages, you pay more
dot more severe disability, you pay more

Here is an example of incentives to encourage losing weight and not smoking by employers

Although there are many risks in determining the cost of your insurance premium, the bottom line is the size of your database pool. You want the “LARGE numbers coverage.” The more persons covered in your pool, the smaller will be your premium costs and visa versa.

Spins on Available health Care

Unfortunately, the information provided by health care providers is not always forthcoming nor correct. Many insurance sellers, disguise information in their commercial advertising web-sites, by masking to portend to give accurate information.   Instead, they often distort the information by spinning the information on their web-sites. Another example, in MSN Money section, October 30, 2008, the information provided minimizes or omits mentioning the concept of "BIG NUMBERS!" as one of the best ways of getting affordable health care insurance coveage.

Another article in Kipling magazine: Shopping for guide to " Get cheaper medical coverage " provides some very good comparison health care premium costs but avoids giving readers the real savings picture; that of "BIG NUMBERS!" But the information about how different providers offer insurance deals is very good. This article is worth reading! An example:

"Each insurance company has its own rules about who it will cover. Depending on your medical condition, one insurer may reject you, another may add a 50% surcharge to your premium, and a third may cover you at standard rates. "Some companies reject as few as 5% of their applicants, and others may reject 15% or 20%," says Russ Childers, a health-insurance broker in Americus, Ga."

 Here is a good explanation of insurance and how it works: 

hightower_cartoon Insurance (including health) is all about spreading risks. Insurance, whether health, life, or disability, is used to take your individual risks and spread over a large number of people and a longer period of time.

A recent statistic estimated that 50% of health care costs are preventable or the result of lifestyle choices. Lung Cancer and Diabetes are two of the mostly costly illnesses to treat and a large percentage are due to smoking and the epidemic of obesity.

Government sponsored or Single Payer health care would be better. There are pro's and con's to every system. Ultimately, the only thing that will reduce health and medical expenses is if people collectively take better care of themselves.

Other good health insurance links: 
health insurance & Obamacare information
Obamacare Fixes Runaway Insurance Companies
Cost effective medical care system solution for United States 

Your feedback is most appreciated: E-mail to: Author Walter Sorochan

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References:

Actuarial Period Life Table 2004 Life table

Beattie, Andrew, The History of Insurance,  History Insurance

Cigarette Smoking Mortality: smoking mortality

Disability Insurance Payment Table, Disability table

Fulmer Melinda, " Get paid to lose weight," MSN Money, October 30, 2008. reduce costs

Health insurance spins Spin on Health options

Szalavitz Mala, et al.,"How to evaluate health risks,"Stats, George Mason Univerity. evaluateing risk

Social Security Disability History, Soc sec history

Thomasson, Melissa. "Health Insurance in the United States". EH.Net Encyclopedia, edited by Robert Whaples. April 18, 2003. Hea Ins USA

Zeckhauser Jack, Insurance, The Concise Encyclopedia of economics. insurance economics