Stupak has no concept of how insurance works

Michigan Democrat Bart Stupak had an op-ed in yesterday's Times defending his amendment to the House health reform bill (which passed a couple of weeks ago -- a similar amendment was voted down in the Senate, setting up a collision for the conference committee to work out). Stupak's (I keep trying to type Stupid, and I swear it's nothing more than a Freudian slip) defense of his amendment demonstrates that one of two things is true: a) he has no idea how insurance works, and doesn't recognize that his plan will torpedo abortion coverage; or b) he knows full well how insurance works, and intends to torpedo abortion coverage. Since I saw the problem after a one-semester course on insurance law, and since I'm nothing if not really cynical, I'm betting on the latter.

In his words:

Under our amendment, women who receive federal subsidies will be prohibited from using them to pay for insurance policies that cover abortion. The amendment does not prevent private plans from offering abortion services and it does not prohibit women from purchasing abortion coverage with their own money. The amendment specifically states that even those who receive federal subsidies can purchase a supplemental policy with private money to cover abortions.

Some opponents of the amendment have tried to argue that it would effectively end health insurance coverage of abortion in both the private and public sectors. This argument is nothing more than a scare tactic.

These comments reflect a complete lack of understanding of the basic functioning of insurance markets. Insurance works because a large group of people who might incur some significant financial liability offload the risk that they bear onto an insurance company. What they're effectively doing is trading a small chance of incurring a large loss for a 100% chance of incurring a small loss (i.e., the premium). Insurance companies use complex statistical and actuarial methods to calculate a) the number of their policyholders who will probably suffer a loss; and b) how big that loss will be.

The statistical and actuarial models the insurance companies use only work because the average policyholder doesn't know whether he or she will incur a loss. In a pool of policyholders, you'll probably have people who know some information that the insurance company doesn't about the likelihood they'll suffer a loss. This is called information asymmetry. If all of the people in the insurance pool had this kind of information asymmetry, the models would be wrong. An insurance company would charge too little for the actual risk of loss that they carry, and once those losses started to happen, the insurance company would very quickly find itself underwater, because it won't have enough capital to meet its obligations. (Incidentally, insurance companies' capital reserves are so heavily regulated [page 2] to guard against this and other systemic risk problems.) Insurance only works because the average policyholder doesn't know for sure that he will have a loss.

The problem just described is called adverse selection. It's pretty easy to understand -- if you know you're going to take a big hit, and you can pay someone a tiny fraction of that amount in order to have them take care of it, you'd be irrational not to do so. Insurance companies are obviously aware of this natural tendency, so they guard quite carefully against adverse selection. That's why they're so obsessive about the forms that you fill out, especially with respect to pre-existing conditions. They're making sure that you don't insure against a known loss. Of course, they go way overboard with the pre-existing conditions thing, but that's a problem with the profit incentive of publicly-held insurance companies, and that's a post for another day.

Anyway, back to abortion. Stupak says that insurance companies can offer supplemental policies to provide insurance coverage for women who receive federal subsidies and thus couldn't (under his language) buy a policy with insurance coverage. Leaving aside the question how one would determine whether a woman has spent federal money on an insurance policy (since money is fungible, any money you get could arguably be described as allowing you to purchase something else by freeing up your resources), why in the world would an insurance company want to create a pool of policyholders who are all essentially adverse selectors?

Sure, there would be some women who would buy the coverage because they want to be covered just in case (just as there are policyholders now who have no idea that they're going to take a hit, but they want to be covered "just in case"). But this is a policy offering coverage of one very discrete product. It's like offering a separate policy for men who want coverage for their Viagra prescriptions. Sure, there might be some men who say "well, who knows whether I'll ever have ED, but I better buy this coverage just in case." But obviously the vast majority of those who buy such coverage know that they're going to make a claim on it. The same would hold true of abortion.

Coverage of specific health procedures only works in insurance policies that are able to spread the risk over everyone. Otherwise, adverse selection will very quickly act to torpedo an insurance market. I suspect that this is EXACTLY what Stupak wants.

Op-Ed Contributor - What My Amendment Won’t Do - NYTimes.com