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Well, the title might be overplaying it a little bit. But I have been thinking about a financial product that I think I ought to be able to buy, but can’t (at least to my knowledge).

To start off, let me explain the problem that this product needs to fix.

To put it succinctly, I think that the form that medical insurance commonly takes in this county is absurd. The root of the problem with medical insurance in this country is that it is commonly bought or subsidized by a third party. This gives people every incentive to use as much as possible regardless of need. To make matters worse, insurance commonly covers too much. Insurance ought to be used only to guard against those things that we do not expect. To use it for anything else is create economic inefficiencies.

Many medical expenses are common and predictable. Examples of these type of expenses would be going to the doctor for the flu or a back ache. We know that it is likely that we are going to need those common medical services and the insurance companies know it too. Thus, insurance companies don’t really provide any insurance against common medical expenses. Instead they act like one of those budget plans you can set up with your utilities provider where they agree to bill you a set amount each month even though they know that your usage will vary.

Now it makes economic sense to engage in such a service with your utility company because they are going to be the ones who bill you in any case. But I don’t think that it makes economic sense to use insurance to pay for common medical expenses. By paying for those common medical expenses with insurance we added a third party and extra costs to the transaction for no real benefit.

In other words, whoever is paying for the insurance might just as well pay the medical service provider directly. Otherwise they are going to have to pay the same money to the insurance companies with transaction fees added all for the dubious benefit of having their medical expenses smoothed out on a quarterly bases.

But as obvious as this seems, very few people pay for common medical expenses themselves. Those with insurance use it for just about everything and those without wait for their problem to get bad enough to warrant a trip to emergency room.

Why does our medical system work this way?

Well, the short answer is that insurance benefits are not taxed. Thus, an employer can give you more value by providing you with insurance than they can by giving you enough money to pay for your common medical expenses (because that money would be taxed). But this favorable tax treatment is backfiring badly.

Because our medical expenses are being paid for by a third party, we have no incentive to economize. In fact, we will get more value from our insurance if we use it as much as possible. But by doing this, we drive up the demand for medical services and thus raise the price that everyone has to pay for those services. The worst part about this is that even those people who do not have medical insurance have to pay the resulting higher prices.

But the problems don’t end there. The employers who are subsidizing insurance would like to subsidize the cheapest insurance out there. This creates an incentive for insurance companies to both provide you with insurance and to try to see that you use it as little as possible. What this amounts to in practice is that the insurance company second guesses every decision that you and your doctor makes. This makes for an inefficient decision making process and creates bad feelings all around.

Now people who study the economics of health care have been aware of this problem for some time. That is one of the reasons why a lot of people pushed so hard for tax protected savings accounts for medical expenses. It was hoped that people would start using these accounts for common medical expenses and leave the insurance for the rare mega expenses that insurance should be used for.

I am all for tax protected savings accounts (until we can get an honest flat tax anyway). But they have their problems.

For example, lets us say that I am a financially responsible person and I save $2,000 a year for medical expenses. Let us say I do this for two years and then in the third year I spin out on black ice and have to spend $10,000 in medical expenses. This uses all my money and then some.

What shall we say then? Should we buy insurance cover that type of expense? I would argue no. The only problem is that I think that the financial product that we should buy is not available.

But if I were king, there would be a product where you would agree to pay a company $2000 a year for 10 years (I am just pulling these figures out of my head, there is nothing special about them). In exchange, that company would agree make up to $20,000 available to you at anytime for medical expenses. At the end of those 10 years, that company would give you the 20 grand minus what was used on medical expenses.

Now I am sure the first question on your mind is how would our hypothetical company make money? The answer is that the company would structure the deals so that the vast amount of people would have a lot of money left at the end of those 10 years. This would enable the company to make money off of float (investment return on money you can’t keep).

To my mind such a product would give you the closest thing you can get in this world to having your cake and eating it, too. Since that twenty grand of coverage would be their money, people would have every incentive to consume medical services rationally. Yet you would be able to spend up to 20 grand on medical expenses as soon as the ink dried on the contract if you needed to. Of course, both you and the company would be hoping that you would never need to. But if you did, you would be covered.

Of course, such coverage would have its cost. You would be giving up investment income and you would likely be losing purchasing power to inflation on the 2 grand that you turn over each year. But I think that such things would be a small price to pay for both having coverage that you need and a built in incentive not to abuse that coverage. Plus, if you were lucky you would have enough money at the end of the contract to cover yourself in future.

I should point out that people would still want insurance to cover themselves against those medical problems like cancer where 20 grand would not even begin to cover your expenses. But I think that insurance for mega medical problems would be pocket change if everyone had the product that I outlined above.

Now I know that those people who are economically literate can think of lots of problems with my hypothetical financial product. I have thought of a number of such problems myself. Just to give a partial list….

How would you prevent fraud? Is it realistic to expect float to cover expense for such a company? If so, would the product really be affordable? What would happen when someone’s medical expenses went over 20 grand and they went bankrupt? Why shouldn’t you invest that 2 grand a year yourself and just borrow money if your medical expenses exceed what you save?

In part two, I will explore such problems and explain why I don’t think they should prevent my hypothetical product from working. But you will have to wait for another day for that.

One Response to “The Financial product this country needs.”

  1. […] _uacct = “UA-1202685-1”; urchinTracker(); Map of the Ethereal Land The Ethereal Voice Front Page – Politics – Money – Knowledge – Art – Food – Fun Masthead About The Financial product this country needs. By Ape Man | May 9, 2007 – 9:27 pm Posted in Category: Front Page, Money Well, the title might be overplaying it a little bit. But I have been thinking about a financial product that I think I ought to be able to buy, but can’t (at least to my knowledge). To start off, let me explain the problem that this product needs to fix. To put it succinctly, I think that Click Here to continue reading. […]

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