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New topic 2015-09-25 21:48:47 description

Whole-Life Revenue Model

Just to clarify the jargon, life insurance companies are of two types: one-year term of risk ("term insurance"), and whole-life term of risk ("whole-life insurance"). In this chapter, we use whole-life insurance as a model for the idea we have for health insurance, but there are many significant differences.

The premium is lower for term insurance because you buy it one-year-at a time, it expires if you don't renew it, but the premium may go up in subsequent years, and the insurance company makes most of its profit when people don't renew it. Most health insurance is run on a one-year term basis, rather inappropriately, because it protects against risk rather than to reimburse claim losses. As a matter of fact, a well-run term insurance company might never pay a claim, although it does happen. So in the long run, term is more expensive for healthcare than whole-life. In a whole-life policy, by contrast, the premium is level each year until you die. Because the subscriber of whole-life has contracted to pay the premium for many years, the insurance company is comfortable with making long-term investments, which pay them more for the float than short-term. Furthermore, the insuring company can enjoy long-term compound interest, which is eventually what makes whole-life coverage cheaper than term, assuming you are even allowed to keep renewing it.

In whole-life coverage, a whole lot of wheels are invisibly turning as premiums are paid yearly, your lifetime gets shorter but your life expectancy increases, new investments replace old ones. To ensure a margin of safety, premiums are higher than actuaries say is actually necessary, and yearly discounts are often (but not promised to be) paid back, or reinvested at more compound interest. Underneath all of this turmoil, the risk of your dying is gradually increasing, and a few people actually do die and collect benefits, terminating the policy. Life insurance is generally a state-regulated activity, and state taxes vary. There are special taxes for certain types of insurance, and there is a distinction between estate tax and inheritance tax. All of this and more are all taken care of for you by the company and is particularly suitable for children and infirm elderly. Just sign on the dotted line, pay the premiums, and wait to die. Simple.

As a matter of fact, the whole-life approach is more suitable for paying the constant nibbles of health insurance than it is for the single lifetime benefit of paying for a coffin, but the two businesses took different paths, long ago. If you simply wanted to set aside enough money for a funeral, you could buy an index fund, put the certificate into a lock-box, and direct your heirs to use it when the time comes. Although passive index-fund investing has made it possible for an individual to manage it all by himself, it's a nuisance and management gets particularly awkward for children and old folks. But that's not primarily why we began looking at other models; we're looking for somewhat higher returns than are currently offered. And that, in turn, is spurred by the realization that protracted retirement costs are just part of the costs of not getting sick. If you treat prolonged retirement as an inherent cost of health insurance, it's almost five times larger than the direct healthcare costs. Social Security was supposed to take care of it, but it simply cannot cope with such rapid increases. Are you supposed to starve to death? You can't keep working forever, your insurance doesn't cover it, and our whole economy was once based on the idea of dying at "three score and ten." But now the average person lives to be 84, soon to be 90, and we haven't even cured cancer yet. Making retirement cost an entitlement without funding it put the whole economy into a predicament with no ready answer, as soon as we started curing diseases.

So the Health Savings (and Retirement) Account was devised to be a Christmas Savings Fund for this need, but even HSA can't produce money out of thin air. So we now turn to professional investors, professional accountants, and others with sharp pencils, for help. Life insurance makes payments year by year for the final moment when you have to pay for your funeral. It was expanded to help support your widow. It's big and well spoken, housed in impressive big buildings. Maybe it can help by adding investment experience, computers, actuaries, and business degrees. Just a little extra efficiency would pay for a lot of extra administrative help; even half a percent extra for 90 years would make a big difference. And the sums involved are significant. Lifetime healthcare costs are estimated to average $300,000 per person. To add a generous retirement, would make it well over a million dollars -- per client. And please hurry up. Inflation is constantly making things worse.

As a matter of fact, judged from the outside, life insurance doesn't seem to be as frugal as it might be. Its marketing costs are high, and its investments are certainly conservative. Its executives are certainly well compensated. There would appear to be room for efficiencies. If health insurance adopted a whole-life approach for its revenue, it is not claiming too much to conjecture it would add 1% extra return to pay for retirement claims losses.

Originally published: Wednesday, June 29, 2016; most-recently modified: Wednesday, June 05, 2019