Wednesday, July 18, 2012

Don't Insure Small Items

I just noticed this quote from David Cutler (the Harvard economist who is known for advising Obama on health care):
Each year, millions of people gladly pay an additional 10 to 50 percent of a product's original price to extend a warranty. These snap purchases help fuel a booming, $15 billion-a-year business and feed a lucrative profit stream for retailers that sell the warranties and companies that underwrite them. Many consumers do so because they say the plans provide them with peace of mind.
The decision to buy an extended warranty, however, defies the recommendations of economists, consumer advocates and product quality experts, who all warn that the plans rarely benefit consumers and are nearly always a waste of money.
"The things make no rational sense," Harvard economist David Cutler said. "The implied probability that [a product] will break has to be substantially greater than the risk that you can't afford to fix it or replace it. If you're buying a $400 item, for the overwhelming number of consumers that level of spending is not a risk you need to insure under any circumstances."
What is the theory by which 1) we should not buy insurance plans for fixing $400 electronic items, but 2) we should buy insurance plans that cover a huge number of sub-$400 healthcare expenses, from routine office visits to the cheapest prescriptions?

2 Comments:

Blogger Glowing Face Man said...

I think what he's getting at is something like the following. One naive way to calculate the value of an insurance policy is to multiply the payout by the probability that it will be payed out; if there's a 10% chance of getting a 100$ payout, according to this calculus that policy would have a value of $10.

But this simple reasoning ignores the fact that we aren't playing with infinite money. A health insurance policy gains some additional, harder to quantify value when it becomes literally life and death: we don't buy health insurance out of crude economic calculations, we buy it so that if we're gravely injured, the doctor will try to save us.

But I agree with you that health insurance has gotten out of hand. Better for routine things to be payed in cash, which would instantly make them affordable due to market forces anyway, and as for things which would never be reasonable to ask cash for, do single payer for that.

7:37 PM  
Blogger Jim Oliver said...

The incentive alignment in health insurance is bad so I am perplexed that people choose to use insurance for health expenses that they can afford. (I have a $10,000 deductible health insurance plan, partly because I want to minimize fighting with insurance companies.)

My current explanation for why low deductible health insurance still dominates is that it gives people peace of mind, one less thing to worry about. It was OK while health spending was below 10% of GDP but that peace of mind has become too expensive now that health spending is 18% of GDP. At 18% of GDP, I think that we need individuals to make more of the spending decisions directly.

IMHO The health care industry is not that as bad as people think in this regard because A patients GP can seek the best options in his behalf even if the patient is too upset by the sickness to make the decisions himself. I have had situations where Doctors have found much cheaper options for us after we have explained how much we will pay with our $10,000 deductible health insurance plan.

4:27 PM  

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