MAY 21, 2009 10:49AM

Let's Spread the Risk! (I mean Health care; Not Flu.)

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As you all know by now, how health care in the US should be overhauled has been the subject of intense discussions over the last few months. So far, based on what I've been reading on the interwebs, it seems what everyone's focused on are peripheral topics, like how the US Government is never good at managing anything except for the military (and I'm sure some would argue that they can't even do that); or how a single-payer system would lead to the fall of Western civilization (or at least the United States, which is of course synonymous with Western civilization, depending who you ask). I've yet to read anything about the important concept of spreading the risk, with a few exceptions (see here).


What's this spreading the risk thing, you ask? As usual, I live to enlighten. This is a concept used in such diverse businesses as the insurance industry and casinos (among others). Spreading the risk assures that as the number of people in a given group gets larger, a company or governmental agency can more easily spread the risk (that would be the risk of a payout) among the pool of participants. They can therefore better estimate the average cost (or payout) per person in the event that one or even several of the group are victims of a catastrophic event. In other words, even if a few people succumb to a tragic blimping accident, the agency still has enough money or funds (minus administrative expenses) collected from all the participants to cover the costs associated with it. Not just because the agency has more income than expenses, but because the agency has better control or knowledge about disastrous outcomes (like tragic blimping accidents). This concept is based on the law of large numbers: the larger the pool of people, the more accurately the agency can estimate the mean value of the sample population or group. The curious (and possibly masochistic) reader can read more about this subject here, here or here.


My wife has begged me to simplify this, so here goes:


Say you've got a casino. It's a small, pathetic little casino, so it only has about 100 desperate gamblers in it at any given moment. Now say it's possible for one guy on his last dime to win $10,000. This is a 1% probability. In order for your pathetic little casino to avoid bankruptcy in the case this happens, each of those 100 patrons needs to lose at least $100.00 at the tables (pass the loaded dice).


But, what if two gamblers win $10,000? Well, the casino is still screwed. In order to avoid the casino going under if that happens, each patron needs to shell out at least $200.


But say that you've got one of those really cool, swanky casinos that have tame lions or topless servers or something. This casino has 10,000 gamblers at any given moment, each losing, say $110.00. Now if 100 of them (1%) win $10,000, since the casino has already earned $1,100,000, paying out $1,000,000 isn't a problem. Even if 105 people win $10,000, your casino is sill laughing since the total payout is still below $1,100,000. So, by increasing the number of patrons, the casino can spread the risk of paying out 10 grand in the event more people win than anticipated (a 1% probability).


Easy, right? Stay tuned for my lectures on the Poisson-gamma and Conway-Maxwell-Poisson distributions.


As discussed in the first comment below this article here, the best method to spread risk is when you include everybody from a given population. The comment writer used the example of the people contributing to social security in the US.


With this in mind, the concept of spreading the risk can easily be applied to health care. As just mentioned, it'd be better to spread risk by including everybody in a given state with its own health care system than having several smaller groups contributing to private insurance. Remember that under the current health care policy in the US, each heath care plan is considered a distinct group. There are probably hundreds of these plans or groups in each of the 49 states, if we exclude Texas, which is apparently about to secede.


I'm sure I had you at 'topless', but if you'd like more proof, check out what the American Medical Association had to say in a January 2008 op-ed titled, interestingly enough, "Spreading the Risk":


One of the greatest challenges in reforming the U.S. health system is how to make health insurance affordable and available for chronic-care patients, and anyone else who has expectedly high medical costs.

The current approach surely isn't working, given how it contributes to the rising number of people without health insurance.

In employer-based insurance, the low-risk patients subsidize high-risk patients; all pay similar premiums rather than being assessed charges based on their likelihood of using health services. That makes care more affordable and accessible for the high-risk patients.

But many low-risk patients, especially young adults and some lower-income workers, have joined the ranks of the uninsured rather than pay the high premiums insurers deem necessary to support all patients. In the individual market, high-risk patients struggle to get any insurance at all. Insurers instead cherry-pick low-risk patients -- or, as recent cases in California have shown, kick some patients off the rolls the moment they are deemed to be high-risk.

The solution to solving both these problems is replacing the current market-regulation approach to high-risk patients.

Instead, risk-based subsidies -- paid out of general tax revenue -- should be used. Such an approach would ensure that high-risk patients get the care they need at an affordable price. At the same time, and equally welcome news, low-risk patients could see their insurance costs drop as their dollars are no longer required as a subsidy.

This approach, as outlined in a Council on Medical Service report approved by the House of Delegates during the AMA's Interim Meeting in November 2007, is consistent with the Association's plan for reducing the number of uninsured.

That plan has three pillars. First, it allows income-related, refundable tax credits or vouchers for the purchase of health insurance, which those with low incomes could receive in advance. Second, it lets individuals, rather than employers or governments, choose their coverage. Third -- and this is where risk-based subsidies come in -- it has fair rules of the game that include market regulations and protections for high-risk patients. 

Risk-based subsidies would create incentives for insurers to cover high-risk patients by setting up high-risk pools, risk-adjustment funds or reinsurance arrangements that mitigate health plans' financial risk. Thus, plans wouldn't have an incentive to cherry-pick healthier patients, and could give high-risk patients lower rates as well.

The Council on Medical Services in 2003 had already stated that risk-based subsidies could be financed through general tax revenue, rather than premium surcharges. But their new report makes clear that those subsidies are preferred to existing ways of covering high-risk patients, and answers a question often raised about the AMA's individual-focused approach -- how would it address high-risk, high-cost patients?

Work is already under way to show that risk-based subsidies would make health coverage available to those patients. For example, at least 32 states operate high-risk pools, with at least five of those states operating demonstration projects funded through federal grants. The AMA has pledged its support to such projects. 

Everyone, whatever their health situation, needs and deserves access to affordable health insurance. Risk-based subsidies, as part of the AMA's plan to cover the uninsured, will go a long way toward making sure that such access is secured.


What the AMA says here is, in my opinion, a good start. But it doesn't go far enough, since the proposal still focuses too much on individuals rather than on the collective. As opposed to the US, governments in other developed countries get this, which is why so many have opted to include everybody under a single public health care program, either for a province, such as Canada, or a country, such as France. In these countries the role of the government, other than administrating claims, consists of trying to lower the long-term mean of the outcome (that is, the costs). They do this by implementing provincial or national policy measures, such as vaccines and anti-smoking campaigns.


Is America's reluctance to join in because of the word 'collective' up there?


Other posts I wrote on public and privatized health care systems can be found here, here, here, and here.


Update Sept. 3rd, 2009 


This post is a response to Whole Foods CEO John Mackey about personal responsibility. In a few words, it won't help us saving our health care system: Advocating personal responsibility in health: Bullshit! The article was extremely well received.


Update Sept. 19th, 2009 


This post describes that 45,000 people die every year due to the lack of medical insurance coverage. This is equivalent to having an airplane crashing every day for an entire year. I compare the results with the effort placed by the federal government to reduce the number of fatal motor vehicle crashes which stands at 40,000 deaths per year: "Death Panel" Results: 45,000 Annual Deaths!

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Rdan: I am glad you liked the example. Unfortunately, I believe it may be too theoretical for many. Yes, I am Canadian (and now US Citizen as well). I descibed myself a little bit in my first post. I will try to read yours when you post them.