Overrinsured?

Peace of mind doesn't come free

A previous essay characterized insurance as a clever idea. Yet all good ideas can be carried too far. In America we might be nearing that stage of excess.

Economists speak of “moral hazard,” the tendency of people to do risky things when they are shielded from the costs if those things go wrong. When governments bail out corporations, the directors of the corporations are encouraged to repeat the actions that made the bailouts necessary. When individuals have loans forgiven, the individuals don’t learn to be more cautious in taking out loans.

Moral hazard is a possibility with every kind of insurance. Drivers with auto insurance might not be as careful as drivers who will have to bear the full costs of wrecks. Lawyers with malpractice insurance might take greater risks in interpreting the law than lawyers without.

Beyond moral hazard is the cost of administering insurance programs. All the people who work for insurance companies have to be paid, typically from the premiums of policyholders.

Connected to cost is the adversarial relationship that can emerge between insurers and insured. A company that sells you homeowners’ insurance is happy to collect your premium but unhappy to pay your claims. It has an incentive to deny the claims. You say your roof damage is from last week’s hail storm, which would be covered. The company says it looks like normal wear, which would not be covered. You and the company fight it out, perhaps in court.

This adversarial dynamic can be particularly distressing in the field of medical insurance. Companies make decisions about what kinds of treatment are covered and what kinds are not. Cost is an important consideration. Doctors prefer to prescribe treatments based on their professional judgment as to what’s best for their patients, regardless of cost. Some treatments are expensive, and if the insurance companies don't cover them and patients have to pay out of pocket, the patients might not be able to. So doctors sometimes feel obliged to prescribe suboptimal treatment. Many clinics have staff whose primary job is to negotiate among the companies, the doctors and the patients.

Insurance of all kinds has evolved over time. Until the beginning of the twentieth century, American insurance was mostly a private matter between individuals and companies. But government entered the field in a large way during the 1930s with the creation of the Social Security Administration, which provided unemployment and accident insurance and old-age pensions. Many people still have private pensions, but Social Security has become a mainstay for most. Nearly half of retired Americans rely on Social Security for a majority of their retirement income.

The establishment of Medicare and Medicaid in the 1960s added medical insurance for the elderly and the poor to the expectations people had of government. Today a third of all American spending on medical care comes from these and other federal programs, including those created under the Affordable Care Act of 2010. The rest comes from private insurance, often associated with places of employment, and from patients’ own pockets directly.

Other government insurance is more specialized. The Federal Deposit Insurance Corporation protects bank depositors from loss in the event of bank failure. The Federal Crop Insurance Corporation protects farmers against the vicissitudes of agriculture. The National Flood Insurance Program pays property owners for damage from floods.

There are benefits to all this. People are better able to survive the blows of fickle fate. Up to a fifth of lung cancer patients never smoked. It was simply their bad luck to develop the disease. People who keep their shoulders to the wheel can still be laid off in a recession. America’s wealth allows us to help the unlucky.

But there are costs. The direct cost is the expense of the programs. Social Security, Medicare and Medicaid consume half the federal budget. Some of this is covered by taxes in the present, the rest by borrowing against the future.

The chief indirect cost is the moral hazard. People who expect to receive a government pension are less likely to save on their own. This is worrisome because Social Security wasn’t designed to be the sole means of support for retirees, but rather a backstop for those who suffered financial misfortune. Homeowners who get federally subsidized flood insurance are more likely to rebuild in flood-prone areas.

People are generally better stewards of their own money than of other people’s money. Insurance schemes diminish individual stewardship by mingling the money of lots of people. Government insurance programs mingle the money of even more people, including those who aren’t part of the covered group.

There was a time when Americans were more on their own than they are today. They were worse off in some respects, especially being insecure in the face of misfortune. This was why their democratically elected government created the programs we have today.

But they were better off in other respects, including paying lower taxes and having less government debt hanging over their heads. Many Americans were very attached to the ideal of self-reliance. Many still are.

Where does the balance between security and self-reliance lie? That’s a question every generation has to answer for itself.