Sebelius’ Wrongheaded Definition of Insurance Has Real Costs for Young Adults

What is insurance? The dictionary would define it as “the equitable transfer of the risk of a loss, from one entity to another in exchange for payment. It is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss.”

I think most people understand the definition. Unfortunately, the Secretary of the Department of Health and Human Services, Kathleen Sebelius—the person you would hope would know the definition better than anyone—apparently doesn’t. The Associated Press reports:

“At a White House briefing Tuesday, Health and Human Services Secretary Kathleen Sebelius said some of what passes for health insurance today is so skimpy it can’t be compared to the comprehensive coverage available under the law. “Some of these folks have very high catastrophic plans that don’t pay for anything unless you get hit by a bus,” she said. “They’re really mortgage protection, not health insurance.”

The problem is that understanding is simply not true; in fact it’s exactly backwards. Health insurance companies make money by paying out fewer dollars than they take in through premiums. Individuals are relatively happy with that arrangement because they’re paying for peace of mind. There’s no fear of foreclosure, bankruptcy and homelessness because you were unlucky enough to be afflicted with, say, cancer. And, if you do have a serious injury or illness, insurance becomes that much more of a good deal.

But Sebelius doesn’t want health insurance to work like that, instead she wants it to be akin to grocery insurance, whereby an insurance company would pay for your groceries each month while you pay a premium, co-pay and fiddle with deductibles. As the brilliant Megan McArdle explains in The Daily Beast:

But notice that it’s the catastrophe which makes insurance a good deal.  You wouldn’t get much value from buying “grocery insurance”.  At best, you’d be paying an extra administrative fee to route your routine expenses through an insurer, rather than paying them directly.  At worst, you’ll end up with bills skyrocketing as all sorts of perverse incentives appear.  After all, if the insurer is paying all your grocery claims, why not load up on filet mignon instead of ground turkey?

But insurers try very hard never to sell insurance for less than the cost of your expected claims.  If you expect to buy $10,000 worth of groceries next year, it will not charge you less than that for a “grocery policy”.  And if we all drive up the costs of grocery insurance by consuming more, the insurer can do one of two things: raise everyone’s “insurance premiums” to cover a filet mignon budget, or create a list of “approved groceries” that it will cover, and start hassling anyone who tries to file an excessively expensive claim.

If that sounds eerily familiar it’s because it’s a pretty damning indictment of what is currently happening in our health care market. Unlike car insurance, which pays out when you get in a wreck, but doesn’t cover oil changes, tune-ups and putting gas in the tank (because that would be silly), health insurance has somehow come to cover everything. The result is that we’re not paying for true insurance, but instead are financing an incredible inefficient system whereby we funnel our health care dollars through a middle man insurance company. All the while we’re consuming more, and often unnecessary, health care services because the incentives are misaligned to force us to feel like we’re getting value for ever-rising insurance costs.

Secretary Sebelius’ misunderstanding is especially troubling for young adults, for whom it is not always a good financial decision to buy a Cadillac health plan with all the bells and whistles. What many young, healthy people need is a stripped down plan that protects them from a financial catastrophe while allowing them to keep more money in their pocket month-to-month. Unfortunately, Sebelius definition of insurance precludes that option.