BBO Discussion Forums: The Affordable Care Act Greek Chorus Line - BBO Discussion Forums

Insurance, in all forms, is a derivative contract. If you are buying the contract, you pay a premium for a put option to the seller. It is little different from buying a put on a stock. Stock options are normally standard contracts bought and sold on exchanges. They have an exercise price and an expiration date.

Insurance is the same, except that the contract is normally not bought and sold in an open market. The seller's business is to make money by analyzing the risk across a portfolio and pricing it to make money. (For the benefit of the one guy here who opposes profits, if the company is not profitable, then it is highly likely to be unable to perform on a claim - i.e. would default when a claim was made. If that happens, you have paid insurance premiums for nothing.) The buyer of the contract should take into account the credit-worthiness of the seller - ability to pay the exercise price, in the event the option is "in-the-money". As with the options with which you might be familiar, there is an expiration date, after which the company no longer has a liability, and your option has expired worthless.

You buy home-owners insurance. You pay premiums. The exercise price is your deductible. If you have $1000 deductible and an incident that cost $800, your option is out-of-the-money. Your put still has time-value, which is related to the likelihood that your damages would exceed $1000 by the expiration date.

Whatever the risk it is that you want to insure, it is an exercise in mathematics to the insurer to price it and legal judgment to determine whether the terms of the contract are sufficiently safe against fraudulent claims. If you want to insure against having to buy drugs, then you will be charged something in excess of the expected value of the drugs you will purchase (modified slightly by the ability to invest the premium in "risk-free" investments - there really is no such thing, but they get something suitably close.) If you don't buy the average amount, you will have paid out more money in premiums than you would have for the drugs.

Would it be smart to charge everyone the same amount, knowing that some will be riskier than others - yes, if you charge everybody an amount that covers the worst risk. So you assume that everybody has all the bad preconditions and none of the good ones. Why must you do this? Because only the worst risks will pay the premium.

So if you look at it that way, it should be VERY clear. Universal health insurance must cost more in the aggregate, than non-universal. Why? Because the self-insured population will not be paying a profit, and as a result will have lower health costs.

Does this mean that you should not buy insurance? No. If you are just out of school, with no accumulated savings, a catastrophic illness could be devastating. But it is also less likely if you are healthy and maintain a healthy lifestyle. So you might reasonably opt for a reasonably large deductible, if you have a good job. Likewise, as a hedge against loss of income, you might purchase disability insurance that would cover a percentage of your normal earnings if you are unable to work for some minimum time. Does it make sense to buy insurance to buy birth-control pills? Clearly not if a) you are going to buy them anyway, or b) they would not work - unless you were planning to sell them for more than they cost you - highly unlikely - if the premium is fairly priced.

I think I covered that option, there is not a free market in health care was one option.

FM75, on 2013-November-20, 17:11, said:

You are misinformed.

Insurance, in many forms, namely those that have an individual basis, could be viewed as a derivative contract. In other forms it is a cooperative shared liability.

Derivative contracts call for an accurate assessment of the risks on an individual level, leading to slicing and dicing. Cooperative shared liabilities call for an accurate assessment of the risk on a society level, without a need for slicing and dicing.

Social security, most pensions and medicare are only a few examples of insurances in the form of a shared liability.

Apart from being technically wrong, the statement that an insurance is a derivative contract is cynical. Because the fundamental idea of insurances is not about the trade in risks to make a profit. It is for sharing a liability in solidarity.

Cooperative solidarity is relatively un-American. This is rooted in the American ethos based on the ideas of the founding fathers: individual freedom (Americans might even wonder: Is there any other form of freedom?), free will and self-determination. The European ethos is based on the French revolution. That was also about liberty, but even more about equality and brotherhood. Slicing and dicing goes against the moral values of equality and brotherhood.

While cooperative solidarity maybe relatively un-American that does not mean that it doesn't exist.

Derivative contracts are agreements made for the purpose of financial gain/security. Cooperative solidarity doesn't have a purpose of financial gain: Its purpose is to do the right thing... together.

Rik

Trinidad, on 2013-November-20, 19:04, said:

There is no liability sharing. The liability is entirely on the insurer. The premium payers have an asset whose value declines until expiry, unless the option value is in the money - due to some sort of loss.

Purchasers of insurance are not ordinarily looking for a gain, only a limitation of loss. That said, there are some forms of insurance, for example as practiced by Lloyds where the liability is shared by other investors (reinsurers seeking a profit) or resold to manage exposure.

Everything that I said was accurate, some of which you even repeated. All options are inherently derivatives. The value of a derivative is based upon a contract with an expiry, and a stochastic distribution of events governed by the contract.

Looking at it other ways, will only mislead you into difficult and wrong conclusions.

Cthulhu D, on 2013-November-20, 06:39, said:

So either there's some other motive, or the screwing is down to sheer incompetence.

First off guys basically everything can be viewed as a derivative.

Please keep in mind Canada, the Uk, Sweden all deal with the profit sector to stay in business. Even ACA deals with the profit sector. There is still the profit =motive to deal with.

[
Cooperative solidarity is relatively un-American. This is rooted in the American ethos based on the ideas of the founding fathers: individual freedom (Americans might even wonder: Is there any other form of freedom?), free will and self-determination. The European ethos is based on the French revolution. That was also about liberty, but even more about equality and brotherhood. Slicing and dicing goes against the moral values of equality and brotherhood.

While cooperative solidarity maybe relatively un-American that does not mean that it doesn't exist.

Derivative contracts are agreements made for the purpose of financial gain/security. Cooperative solidarity doesn't have a purpose of financial gain: Its purpose is to do the right thing... together.

Rik
[/quote]


The French model tries to combine freedom with patriotism or nationalism, these are dueling priorities at combat with each other. For the most part the American model avoids this but yes at times it falls in the same trap. The French model makes revolution sacred and a sacrilege to question.

The basic American model is freedom with a distrust of government, thus the checks and balances system. When it makes govt sacred and a heresy to question we in America have a problem.

WellSpyder, on 2013-November-20, 08:44, said:

Indeed it does - but there are a bunch of offsetting factors. Car insurance lacks the complexity of healthcare insurance. For example, you're never going to have to make decisions about your car insurance while unconcious, and there is never a need to have your car repaired at a dealer that may or may not be in network for your insurance provider urgently because you are bleeding out.

The result is you can make much more informed decisions, and the claims processing process is completely different. When I make a claim with car insurance I ring up my insurer and they arrange to have the car taken to their approved provider. There is no doubt or uncertainty about if my treatment is going to be covered, or if the provider is in network. They insurance company will cover all damage up to a pre-agreed insurance value X, and I have a co-pay way, and if damage to the vehicle exceeds X they will just pay out X to me in cash. So we have the following attributes

A) No material time pressure on decision making
B) No questions about in or out of network providers - you have time to ensure that you never violate the process. I have days to drop off my car after an accident with an insurance company.
C) Clear liability caps and co-pays - only one service (car repair) is offered. The company is on the hook for max X. Imagine if at a hospital you ran up a 10k bill and they just ejected you onto the street to die because you'd hit the lability cap. Cannot happen in healthcare! Car insurance companies do it all the time.

It's all very simple, and all very clear cut, and is totally in contrast to healthcare. Home insurance on the other hand is a more reasonable example (check out the buy vs rebuild triggers in your home insurance contract), but again it's all much more clear cut.

If you mean third party person insurance (coverage for you cleaning up a third party), that's usually massively government regulated for the same reasons as healthcare - and is widly regarded as very inefficent compared to no fault accident compensation schemes run by the state a la new zealand, because it doesn't cover what happens when an uninsured driver hits you.

blackshoe, on 2013-November-20, 20:05, said:

If this was the case of course, people with government plans in the US would be less satisfied with their care than those not on government plans - but the VA and Medicare both score very highly. Similarly the universal healthcare systems get higher patient satisfaction than the US healthcare system as a whole.

FM75, on 2013-November-20, 17:11, said:

For healthcare this is not true btw. As it's the foundation of your analysis, you might need to reconsider the analysis. Why is it not true? Because you have to deliver emergency care without checking if the person can pay. Emergency care costs, depending, 100 to 1000 times as much as preventing it in primary care (Costs drawn from studies in Australia, it is likely to be higher in the US where the cost of acute care in hospitals is much, much higher than here but primary care isn't so much).

The uninsured who are unable to pay for catastrophic care end up in hospital anyway (if a guy collapses in a mall carrying no ID he gets treated at a hospital). This care is very expensive and the uninsured guy is unable to pay (that is why he is unisured, he is poor). The hospital however has to recover its cost somehow! so it bankrupts the poor dude, making him unable to break the poverty cycle, then still has to recover the costs, so it cranks the costs up for all its other patients - aka those on insurance.

The end result is you end up paying for a universal healthcare system, but a very bad one. If the guy could have gone to a GP and gotten insulin or whatever, he wouldn't have collapsed! The cost of that hospital visit is probably north of 20k including ambulance costs, the costs of treating him at the GP level is about 1/100th of that a year. So you're overpaying massively compared to a universal healthcare scheme where our collapse guy could have got primary care.

The other alternative is to let people who don't have their insurance company approved ID chip installed literally die on the streets, so your pick really. I understand that the government or corporations chipping people is part of apocalyptic US right wing fantasies about judgement day, so people might be in favour of that?

FM75, on 2013-November-20, 19:50, said:

Repeating your statement doesn't make it true.

There are insurances where the premium is not calculated based on risk. Given your absolute statements I need to give only one example to show that your statement is false. I have already given you three. That should be enough to prove that your statement that every insurance is a derivative contract is false.

I will take this a step further. There are insurances with a negative correlation between the height of the premium and the risk: The higher the risk, the lower the premium! What kind of derivative contract is that?!?

Now that doesn't make any sense from a financial point of view. High risk customers pay a small premium. For the insurer, it would be financially better to dump these customers, yet they don't. And that is the whole point. Not all insurances make sense from a financial point of view because they are not financially motivated. (I could even say that "genuine insurances" don't have financial motives, but that would be because I have defined the term "genuine insurance" like that .)

Your statement is only true for those insurances that are purely financially motivated (from the side of the insurer as well as the side of the insured). But many insurances are ideologically motivated, rather than financially.

That is also why your view is so cynical. Many insurances have come about to do something good for society. The motives for the invention of the insurance were social: If we share the cost together, whether we happen to be hit by the risk or not, we will do better as society. The fact that some insurers have reduced this social phenomenon to a financial instrument, a cold risk/reward calculation for capital profit, doesn't mean that all insurances are reduced to "just financial derivatives".

Rik

mike777, on 2013-November-20, 21:04, said:

Exactly.

There are these people who claim that everything is...

I once saw a drummer who claimed that everything was a drum set. And yes, he could make good sounding music drumming on anything: tables, chairs, door posts, blackboards, you name it.

I am a chemical engineer. One of my professors claimed that everything is a chemical reactor: Matter and energy may or may not be flowing in, matter and energy may or may not be flowing out, a reaction may or may not take place inside and matter and energy may or may not accumulate inside it. And yes, he could do nice calculations on pots and pans during cooking, on meeting rooms with smokers and limited ventilation as well as on growing plants and animals.

Obviously they are both right and wrong. Just because everything can be used as a drum set or everything can be modeled as a chemical reactor or every insurance can be modeled as a financial derivative, does not mean that it is sensible to do that. And -for all practical purposes- that means that an erlenmeyer flask is not a drum set, a snare drum is not a chemical reactor and not every insurance is a derivative contract.

Rik

FM75, on 2013-November-20, 19:50, said:

In a pure derivative, there is equality between parties as the value is determined by a 3rd agent. In health insurance, the insurance company has an unfair advantage.


For example, if I am speculating long on frozen orange juice futures, I don't have to suddenly pay more for the contract, or If I want to roll it over have to switch to a contract that only pays after the first $10K of loss, or have the contract denied because there have been previous freezes in Florida.

There is also a discrepancy between insurers' risk and insured's risks - without insurance, the individual has to pay the published rate for care, while the insurance companies pay a much lower, negotiated rate. Again, in an OJ contact, one side does not get to pay a lower loss because of the number of contracts held.

A true derivative product has its value determined by the performance of a separate asset. I doubt many would call a term life insurance policy a derivative based on a cost-to-return ratio that changes a determinable amount each year.

Cthulhu D, on 2013-November-21, 01:29, said:

I got rear-ended in 1987, on my way home from work on a Friday. When I got home, I called the insurance company office in Sacramento (I was in San Diego, Sacramento was closest). They made an appointment for me to bring the car to an adjuster to have it checked out. There was no visible damage, btw, and the car drove just fine. So on Monday I did that. The adjuster looked over the car, walked into his office, came back and handed me a form with the results of his inspection and a check for $2000.00. He then asked me if I had a repair shop in mind. I told him I did. He said "Fine," and sent me on my way. I took the car to the shop and handed the guy the paperwork from the adjuster. He looked at it and said "$2500? Okay." (I had $500 deductible on collision). I went to work. The following Friday morning he called me to say my car was ready. On the way to pick it up, I stopped at home to check my mail, and I found a letter from my insurance company with a check for $500, which they'd collected from the insurance company of the guy who hit me. So I wasn't out of pocket at all.

Health insurance doesn't work like that. It can't.

Cthulhu D, on 2013-November-21, 01:29, said:

I was talking specifically about the people who seemed to be getting screwed out of their "if you like it you can keep it" and "we your employer can no longer afford to provide you" insurance under Obamacare. And from what I've heard and read, it seems like that's only going to get worse.

Trinidad, on 2013-November-21, 02:56, said:

+1 for effective argument, +2 for rhetorical style.

blackshoe, on 2013-November-21, 08:33, said:

From Jonathan Chait at NYMag.com channeling ArtK78:

Quote

Quote

That last bit assumes that people will sign up for Obamacare because they support it. I suspect some (many?) will sign up because the law effectively gives them no other choice (save, of course, to accept the penalty).

It's an interesting evolution. When Social Security was first introduced, participation was voluntary. This was still true, for the military at least, when I first enlisted (1967). When I later enlisted again (1975) it was no longer true. I don't know about other sectors, but I seem to remember that newborns now require Social Security cards, so it sounds like nobody has an option any more. Well, except maybe Congress.

I also remember that my first Social Security card, which unfortunately I no longer have, had emphatically printed on it "THIS CARD IS NOT TO BE USED FOR IDENTIFICATION". The use of SS numbers as military ID numbers came into play sometime between 1970 (when I got out of the army) and 1975 (when I went into the Navy).

I wonder - if the ACA is so good for the country, why do we have to threaten people with fines if they don't sign up?

blackshoe, on 2013-November-21, 16:20, said:

I could imagine for the same reason as why car insurance is mandatory: To make sure that someone else (in this case an ER) doesn't need to pick up your bill.

Rik

From trhe Y66 post:

Quote

Perhaps. Perhaps not.

This may depend a little on the meaning of "constituency". When I was 18 I signed up for the draft. In 1957 this was required by law. It is true that I did consider going into the military but I chose not to. I still registered for the draft. I had to. I'm not so sure this put me in any "constituency".

I don't mean to fuss over words, but the administration does seem to argue that people signing up for the ACA is evidence that people favor the ACA. The latter does not follow from the former if people are required to sign up.

I really don't know how the people who are most directly affected by this law feel about it. Let's say that "most directly affected" means, for the purpose of a study, "required by law to sign up". Are there polling numbers that sample specifically this population?

There is always a danger when trying to help people of helping them in a way that they in fact do not wish to be helped. This is especially the case when the helper and the helpee don't know each other.

kenberg, on 2013-November-21, 20:33, said:

Ken,

I am required by law to sign up or face a penalty. My old Blue Cross policy, a $10K deductible, would now cost me $600+ per per month. I have signed up for a $1700 deductible gold plan on the healthare website for under $400 per month. I am quite happy with the law.

What exactly is it that caused all these existing policies to suffer such huge cost increases overnight?

What percentage of your income goes for healthcare premiums now, Winston? What percentage before ACA?

blackshoe, on 2013-November-22, 01:29, said:

It's a mixture of things. The well known explanations include:

1. Cherry picking examples
2. The ACA transfers money from healthy young people to people with pre-existing conditions
3. Many red states refused the Medicaid expansions subsidies that the ACA provides
4. "Apples and oranges" type comparisons. Many of the the cheap plans that people liked didn't provide any kind of coverage
5. There are well documented cases where insurance company's cancelled people's cheap plans and tried to steer customers towards more expensive plans without making them aware that better alternatives exist

One last point that is much less well known but has a lot of explanatory power:

There was a statistically significant change in the cost of health care plans that happened when the ACA was passed.
Few of the cost savings provisions had been put into effect, and yet the rate of increase in plan costs decreased significantly.

Many of the cheap plans that were discontinued were deliberately designed to sunset at the end of 2013.
Insurance companies can craft some very attractive policies so long as they are only covering people for a short time window.