Why Insurance wastes money

Insurance is big business. It makes huge amounts of money. And it wastes money.

At $5.23 trillion[1]Gross premiums written by the insurance industry worldwide 2000 to 2020, if it were a country, the insurance industry would be the world’s third largest economy.

The arithmetic of how insurance works needs explaining.

Insurance is a form of socialism. People suffer from catastrophes, and the cost of those catastrophes is drawn from a shared pot of money that the insurance companies manage. We pay premiums to create the pot, and the insurance company invests the money. The return on the investments in large part makes up the profits of the insurance company. 

That’s the revenue side.

The costs are: the insurance claims and the administration costs.

Because Premiums = insurance claims + administration costs – we will always be losing on the deal. The premiums are always more than the claims.

So, why do we insure?

Two reasons. Most people are very bad at anticipating a catastrophic event, so will not, or cannot save up for it. They think it will never happen to them, until it does.

The other reason is that the vast majority of people don’t have the resources to cover a major catastrophic event – say one that destroys their home. 

So insurance spreads the cost, and if is does this efficiently, then everyone is better off. Or are we?

Firstly, many people don’t care, or don’t understand, that there are ways of reducing the chance of catastrophe. Look at the number of houses that are built on the shoreline, at risk of being destroyed as oceans rise. That increased risk should draw higher premiums, and when it does, the balance is restored. When people are insured, unless they pay higher premiums to compensate, they will naturally take more risk, and so the cost for everyone increases.

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People who drive recklessly should draw higher premiums than those who are careful. But when the premiums don’t reflect the risk, it’s a bad deal.

And that’s the problem with health insurance in Switzerland.

The law requires that everyone has health insurance, but also that the health insurers cannot make a profit on the basic health insurance. Sounds like a clever idea, but isn’t. 

The law also does not allow the insurers to set premiums according to the specific policyholder risk. People who smoke or lead an unhealthy lifestyle don’t draw a higher premium than those who mitigate the risk.

So, there is no incentive for the insurance companies to be more efficient, and to motivate policyholders to reduce the risk.

The health insurers provide extensive advice to their policyholders on how to reduce the risk, giving the appearance that they are making an effort.

If they really were trying, they would measure whether the policyholders were following that advice and would advocate to change the laws so that the premiums were adjusted accordingly.

There is another way of reducing health care costs, and with that the cost of the insurance.

In many countries, including Spain, the United States, and Britain, there are powerful measures that have been put in place to mandating the use of generic drugs in place of the significantly more expensive branded alternatives.

A generic drug by law must contain exactly the same chemical ingredients as the branded original. The drug companies, quite successfully convince consumers that their products are better, but in reality the only difference is the price.

The health insurance companies, if they cared about the cost of healthcare, would be advocating that the price of generics is what they will insure, with the difference between that and the branded price being paid by the policyholder. That would educate people fast, and bring about a dramatic drop in the price of healthcare.

Similarly, the FOPH, who have the primary responsibility of the high cost of health care in Switzerland should be pushing to have the laws amended. The question is why has it not happened.

The most logical explanation is that they simply don’t care.