The Mises Institute monthly, free with membership
Volume 14, Number 11
The Insurance Scam
The Senator has a painful announcement to make. His daughter
is mentally ill. This gives him special insight into a social
injustice: insurance companies are less willing to cover mental
illness than other forms. They place annual and lifetime limits
on the number of permitted psychiatric sessions, for example.
Moved by his pleas, the entire Senate agrees to stamp out bias
against mental illness with a new law. If firms offer mental
coverage, the law says, it must be identical to other forms of
coverage. Otherwise, the victims of mental illness will continue
to be "stigmatized."
It's no shock that the Senate has taken another step towards
socializing the medical sector. That's been the pattern for
nearly a century. What's appalling is that this socialization is
confused with authentic insurance, a viable market institution.
Here's how real insurance comes about.
Life is risky. The roof might fall in. You might get hit by a
car. Your own body might rebel, sending cancer cells on their
deadly metastatic journey.
In theory, an individual can manage risk by himself by
exercising extreme caution. He may stay home permanently while
paying someone to run errands, or set foot outside only after
exhaustive research on weather and traffic.
The trouble with most individualistic measures, though, is
that they are self-defeating--sitting in one's living room all
day (under a reinforced roof) is hardly conducive to good
health--or prohibitively expensive. Worse, the individual is lost
if his private preventive measures fail.
A better hedge is a risk pool, a group of individuals agreeing
to help each other in case disaster strikes one of their number.
Risk pools are common in everyday life, where high school
students take notes for friends who miss class, and office
workers share computers should one crash.
One obvious benefit of pooling risk is cost: letting someone
use your computer should his break down, in exchange for use of
his in case yours does, is cheaper than buying a backup system. A
greater benefit of risk pools is their access to resources to
offset the aftermath of disaster. If, despite every self-reliant
effort at safety, your house catches fire, you are minus a house.
Join a voluntary fire brigade, and your house may be saved.
But risk-pooling has its downside. There is of course each
member's contribution, the premium he must pay. It is a nuisance
to take exhaustive notes in chemistry class whenever a friend is
absent. There are the transaction costs of calculating the
resources each member must put in to balance expected gains. In
fact, even though on average everyone gets out exactly what he
puts in, the careful or lucky risk-pooler will put less into the
bargain than he gets out.
Enter the entrepreneur, offering to assume everyone's risk for
a price. He sells you coverage should some evil befall at a cost
exceeding your expected gain; after all, the insurer is not in it
for his health. (He's in it for yours.) In exchange, you save on
negotiating time, and, more important, you gain surer protection
against a wider range of catastrophes.
Spontaneous risk pools tend to be small, and limited in
purpose. The guys in the office will cover for you if you miss a
meeting, but they cannot put your kids through college if you
However, suppose an entrepreneur finds 100,000 people, each
willing to pay $100 for the assurance that his kids will be put
through college should he keel over in the next ten years. The
pool now contains $10 million, enough for plenty of tuition
bills. Enterprising insurers can merge payments to cover unique
risks: Lloyd's once insured Marlene Dietrich's legs.
The critical factor controlling an insurer's costs, hence the
price he asks for a policy, is the probability of disaster. He
can sell life insurance of $50,000 to 100,000 people at $100 a
head only if it is actuarially certain that fewer than 200
subscribers will die in the next 10 years. He will go bankrupt
should he underestimate the risk, leaving his remaining
subscribers exposed once again.
So it is in the interest of the subscribers and the insurer
that insurers protect only those unlikely to sicken,
die, or get into auto accidents, and charge more as the
likelihood of these mischances rises.
Consequently, it is in the interest of both insurer and
subscriber that insurers use all available information about
potential clients to maximize the accuracy of probability
estimates. Should family history be relevant to expected life
span, for instance, Smith's insurer (seconded by other
subscribers) will want to know his father's age at death.
Should ignoring this factor underestimate risk, Smith's
premiums will be too low. The insurer has made a potentially
expensive mistake. If the insurer makes too many mistakes, it
will be outcompeted by insurers who are better at assessing
Should ignoring this factor overestimate risk, Smith
should take his business elsewhere. If an insurer does this
often, it will lose business to other insurers. This pull and tug
of the competitive insurance marketplace pushes risk and premiums
to a proper level, so both insurers and those they cover benefit
Commercial insurance plans are as voluntary as informal risk
pools. Nobody makes anyone take out a policy. For the same
reason, the nosy questions asked by an insurance company do not
invade your privacy. You may decline to reveal your blood
pressure, or whether you are HIV-positive--just as the insurance
salesman may decline to sell you a policy.
This is why government regulation of insurance, and the
excuses for it, are nonsensical. The New York State legislature
passed a bill requiring insurers to pay for chiropractic
services. "Genetic discrimination," i.e. the use by health
insurance companies of the results of genetic tests, is illegal
in New Jersey.
Connecticut is considering a law that would forbid health
insurance companies from refusing to insure women who have
survived for five years after breast cancer. Many other states
forbid health insurers to turn anyone down on the basis of
HIV-positivity. In a sweeping approach, a new federal law bars
insurers from denying coverage to people on the basis of
In the Alice-in-Wonderland rhetoric of socialism, such
regulation is "a freedom-of-choice-in-health issue" (the New York
Chiropractic Counsel) that "protects against genetic
discrimination" (a New Jersey State Senator), fends off
"discrimination against people predisposed to breast cancer" (the
National Breast Cancer Coalition), and gets "rid of the terrible
stigma and discrimination based on mystique, mystery, and Dark
Age concepts" (Senator Pete Domenici). As one advocate of
insurance regulation sums up: "Genetics should not be used
But people can't be protected from "genetic discrimination,"
and genetic information cannot be "used against" anyone, because
the practices so tendentiously described do no harm. You do harm
only by making someone worse off, and an insurance company
refusing to cover a man genetically disposed to cancer or mental
illness, or offering coverage at an unusually high rate, leaves
him no worse off. He was uninsured before, and uninsured now.
Buying a policy at a higher rate betters his
condition, for he clearly prefers the cost-with-coverage package
to previous vulnerability. If the rate is too high, he can choose
not to pay the necessary premiums and hope that his total
out-of-pocket costs never add up to more than the total premiums.
Should insurers be forced to sell him a policy in ignorance of
his genetic make-up--a proxy for his likelihood of getting
sick--other policyholders will be forced to support his family if
he does contract terminal cancer. That tramples their right to
free association. This right includes association for
risk-sharing, under any terms the associates please. There is no
more right to insurance than there is to someone else's notes for
your 8:00am chemistry class if you are a genetic "night person."
When insurance companies and healthy policyholders are
considered at all, the issue is usually put as one of "balancing"
their interests against the "freedom" to have insurance. Yet not
only is the freedom of insurance companies to deal with whom they
please also at issue, this freedom is the more fundamental of the
In a market system, the Senator and his unfortunate daughter
have two choices: pay for treatment out-of-pocket, or pay the
premiums necessary for the unlimited medical attention she
desires. A remedy that involves government coercion is not
insurance but welfare.
Freedom to share risk limits no-one else's freedom to make
similar arrangements. Freedom to have protection at a
fixed cost necessarily excludes others from that same good.
Contrary to the endless propaganda of the welfare state, the
desirability of insurance coverage creates no right to it.
Michael Levin teaches Philosophy at City College of New York