The Frontal Cortex

Health Insurance

Why do people buy insurance? On the one hand, the act of purchasing insurance is an utterly rational act, dependent on the uniquely human ability to ponder counterfactuals in the distant future. What if my a fire destroyed my house? What if my new car got totaled? What if I get cancer and require expensive medical treatments? We take this cognitive skill for granted, but it’s actually profoundly rare.

And yet, the desire to purchase insurance is also influenced by deeply irrational forces, and the peculiar ways in which our emotions help us assess risks. The passionate nature of risk – and the ways in which our passions lead to misperceptions – shouldn’t be too surprising. Look, for instance, at the very common fear of flying: More than 30 percent of people admit to being “scared or very scared” whenever they board a plane. And yet, according to the National Transportation Safety Board, flying on a commercial jetliner has a fatality rate of 0.04 per one hundred million passenger miles. In contrast, driving has a fatality rate of 0.86. This means that the most dangerous part of traveling on a commercial flight is the drive to the airport.

What does this have to do with insurance? Let’s consider health insurance, which is the insurance debate du jour. America is that rare developed nation that 1) doesn’t provide universal health insurance and 2) doesn’t require individuals to purchase health insurance. (Massachusetts is the rare exception.) In other words, we trust ourselves to make the right decision when it comes to health insurance. The end result is that lots of healthy young people opt out of the system, choosing to accept the risk of illness in exchange for not having to pay some insanely expensive premiums.

It’s easy to imagine a world in which such calculations were reasonable, rooted in some statistical equations that, under certain circumstances, show that purchasing health insurance is a bad idea. (I’m thinking here of warranties for electronic products, which are almost always overpriced.) Alas, we don’t live in such a reasonable world; our perceptions of health risks shouldn’t be trusted.

I’m going to focus on just one of the myriad biases that warp our health insurance decisions: the availability heuristic. This is the obvious idea (at least it seems obvious in retrospect) that events which are more easily brought to mind also seem more likely. The bias was first demonstrated by Kahneman and Tversky in their seminal 1974 Science paper:

Suppose one samples a word (of three letters or more) at random from an English text. Is it more likely that the word starts with r or that r is the third letter? People approach this problem by recalling words that begin with r (road) and words that have r in the third position (car) and assess the relatively frequency by the ease with which the words of the two types come to mind. Because it is much easier to search for words by their first letter than by their third letter, most people judge words that begin with a given consonant to be more numerous than words in which the same consonant appears in the third position. They do so even for consonants, such as r or k, that are more frequent in the third position than in the first.

What does this have to do with health insurance? I’d argue that the sheer banality of most illnesses means that healthy people underestimate the likelihood of getting sick, just like subjects underestimating the frequency of consonants in the third position. We don’t think about bunions or torn ligaments or strep throat unless, god forbid, the affliction happens to us. Unlike a plane accident or a shark attack, there is nothing newsworthy about ordinary suffering – kidney stones don’t make the front page or the 11 o’clock news. (I’ve got several friends who purchased extended warranties for their computers but don’t have health insurance. I’d argue that this irrational contradiction occurs for two reasons: 1) they are overvaluing their computer at the time of purchase, thanks to the endowment effect and 2) it’s easier for them to imagine a broken computer than it is to imagine a broken body part.) Furthermore, there is something inherently unfathomable about pain unless the pain is ours; sickness is the same way. The end result is that when we’re healthy we routinely underestimate the likelihood of not being healthy, of needing an expensive medical treatment that we can’t afford. The bleak reality of life, however, is that illness isn’t an outlier – everybody gets sick.

It should be noted, of course, that society requires insurance for drivers precisely because it doesn’t trust us to make the right decision. We all think we’re above average drivers, so of course we won’t get into an accident. But then we do and it’s too late. I’m increasingly coming to believe that health insurance is the same way, and that we need society to save us from our own blinkered views of the future.

And if you’re interested in the biases that influence the health care political debate, check out this typically excellent column by James Surowiecki.

Comments

  1. #1 phisrow
    August 26, 2009

    It should probably be noted that we require vehicle insurance less for the sake of the driver than for the sake of anybody he might crash into. Driving being one of those places where anybody with a few thousand dollars worth of hardware(and quite possibly no other assets) can routinely risk doing tens or hundreds of thousands in damage to those around them.

  2. #2 DR
    August 26, 2009

    While granting that among young people the high cost of coverage and a presumption of their own invulnerability are factors influencing non-participation, it would appear in gross that Americans do not undervalue health insurance. In fact, on average, we pay a lot more than its fair value. (Other western industrialized nations get better outcomes for less premium, partly because all citizens participate.)

    It would seem that our current policy debate is not really about whether we sufficiently value health insurance. Those who have it are loath to give it up, and those who don’t have it would generally prefer otherwise. Instead, our debate seems to be about whether we’re prepared to value health insurance as a common good, like schools, roads, and military defense, rather than a private one, like restaurant dining or automobile ownership.

  3. #3 MattXIV
    August 26, 2009

    The “best” distribution of risk is a matter of preference. Generally people prefer less risk at the same average outcome and will accept (the magnitude of the risk matters too of the risk matters too – people finding it exciting to be exposed to small risks, hence they enjoy gambling), but how much a person is willing to pay to offset a given risk is highly variable. A pure average outcomes optmizer would never buy insurance – the average payout on an insurance policy has to be less than the price or the company loses money since it still has to cover the administrative overhead.

    I don’t think there’s any inherent reason to believe that people underestimate the risk of serious illness; routine minor illness happens often enough that and is cheap enough to treat that it isn’t something that it makes sense to pay extra to reduce the financial risk of. The literature suggests that people tend to overrestimate the risks of rare but dangerous events, which would include things such as developing cancer at a relatively young age or being in a serious auto accident that requires a period of hospitalization, which are the kind of things that it makes sense to have health insurance for.

  4. #4 Will TS
    August 26, 2009

    It is not inevitable that health insurance companies pay out less than they receive in premiums. They also make money from investing (or lending) the money they receive as premiums. Some of the largest US insurers make most of their profits from investment activity rather than getting it directly from policyholders.

    So, insurers could make a profit while still paying out more than they receive. And policyholders, on average, could receive more from their health insurance company than they pay for the policy. That probably doesn’t happen in the real world though, because a good, profitable insurance company will maximize profits any way they can. That’s the American way.

    Most ordinary people don’t know or understand the risks that they face. And even if they did, most of them wouldn’t act rationally. Insurance companies know the risks and tend to act very rationally. So people lose and corporations win.

  5. #5 Michael
    August 26, 2009

    The purpose of any insurance is to hedge against risk. The current debate is about whether or not it is the purpose of the US government (aka the “common good” as mentioned above) is to take over in a portion or the entirety of hedging against this risk.

    Unfortunately, Americans immediately assume that it is effective to trade private profiteers for public mediocrity–besides the military, arguably all government programs are run with hefty economic deadweight loss. In other words, there is no synergy.

    I would also argue that nowhere in the US Constitution does it state that Congress can establish or raise funds for the purposes of insuring Americans for health care. However, I praise Massachusetts for exercising federalism–they’re health care legislation is fantastic.

    As a small business owner and student, I pay $2500/yr. for health insurance out of my pocket. I feel as an individual, it is just as essential to have health insurance as it is auto insurance or homeowner’s insurance. Additionally, I feel that this is a personal decision that every American must make, just as personal as it is to have an abortion or not.

    Previously, for the first 23 years of my life, I was under the single-payer health insurance system known as TRICARE. You might’ve heard of it. While doctors didn’t receive as much payment from them, they were eager to perform procedures for military personnel and their family.

  6. #6 dWj
    August 26, 2009

    To extend comment #1: we don’t require that damage to your car be insured, or damage to yourself, only liability. There’s a much clearer public interest in your ability to pay for your harm to random others than to yourself.

    Part of the problem with health insurance is the price; here in New York, if you’re healthy and in your twenties trying to buy individual health insurance, you will massively overpay compared to the actual actuarial benefit, especially if you’re comparing the price of an actual policy to the benefit of a policy one might want (without various mandated coverages for procedures one might not want to insure).

  7. #7 Burt
    August 26, 2009

    In modern society the insurance industry has capitalized not only on FEAR and guilt (how will your family survive, if you die or become incapacitated?) but has insinuated itself into virtually every aspect of many peoples lives.

    Insurance is based on the premise that statistically, sooner or later it’s inevitable that undesirable events will occur to a percentage of the populace, the ratio of those affected to those unaffected form the basis of actuarial risk assessment. It is the insurers’ task to set and collect premiums so that the total pool covers the actual calculated risk and leaves a tidy profit for the company (credit default swaps notwithstanding.)

    They are adept at this practice and further their interests by attempting to convince the client (mark) that the law of averages states that many are likely to run afoul of that (non-existent) law and experience unpleasant consequences but if you are smart you’ll bet against yourself and buy insurance to protect you and your property in case bad stuff happens (and it will.) So if you lose (bad stuff happened) during the allotted time, you win, but if you don’t lose in the time span, we win. It’s no wonder that 10% of the top 200 richest companies in the world (until the recent fiduciary debacle) are/were insurance companies.

    If coverage were simple (not weasel worded and in legalese with its attendant semantic sense of ethics) then it would still be profitable by simple actuarial calculations but perhaps they would be less inclined to construct the giant edifices and favor their OODEPs with obscenely huge salaries (who by most accounts do little or nothing to justify them.)

    The current profit model also includes applying the 3D code (Deny, Delay, Defend) wherever it makes sense monetarily (which is almost always if they stand to lose a large amount) and C/B calculations as to how much money and interest may be realized vis-à-vis not paying legitimate claims in a timely manner vs. an unfavorable class action or government ruling with concomitant fines.

    I don’t bet against myself unless dictated by fiat.

  8. #8 Vince Whirlwind
    August 26, 2009

    I own two insurance policies, but health care isn’t one of them.

    – My home is insured: the cost is small, the risk likelihood of occurrence is very rare, but the impact of the risk eventuating is extreme (no house!). If I owned 10 houses, I would insure none of them.

    – I have 3rd-party personal injury insurance on my car and home: the cost is small, the risk likelihood of occurrence is very rare, but the impact of the risk eventuating is extreme (somebody could slip on my stairs and render themselves paraplegic – bang goes $6,000,000).

    – Health insurance doesn’t compute – the vast majority of occurrences have no treatment that needs to be provided by a doctor anyway (flu, etc…) which just leaves rare events such as broken limbs. The cost of medical care for a broken limb (etc..) is a very small fraction of the cost of replacing your house, and yet health insurance costs much, much more than insuring your house. And if you look at your health insurance policy closely, you will see it hardly covers anything you need anyway – if you end up requiring medical care you will need to pay a lot of money in addition to what the insurance provides.
    Do the sums yourself – Instead of paying $5,000pa into an insurance fund, put it into a bank account that pays a decent interest rate. In the unlikely event you do get sick, you’ll be able to cover it.

  9. #9 just doug
    August 26, 2009

    Technically all insurance is overpriced, otherwise the insurer couldn’t stay in business. On average total premiums must exceed the total claims which makes it all a bad deal – unless there is a large claim in your future.

    Much of what is called health insurance isn’t insurance. Covering things that are certain to happen, recurring Rx, routine care, preventative care, etc. isn’t insurance and adding a layer of bureaucracy to the payment process, whether public or private, necessarily makes it more costly than paying for those services directly out of pocket. Most of the debate arises from people being sold on some form of the idea that everyone trying to force everyone else to pay for their health care will somehow make it free for everyone.

  10. #10 Elizabeth
    August 27, 2009

    For some, health care needs are a familiar experience, ie, they know someone who requires frequent medical care for asthma attacks, allergic reactions, sickle cell disease, cystic fibrosis, etc. Others have never been in a hospital for any reason, no stitches, no sprains, no fractures; they have never even visited anyone in a hospital. I wonder if these two disparate groups of people, given equal financial standing, are more or less likely to have seek and purchase health insurance given their personal experiences with health care needs.

  11. #11 UKVisitor
    August 27, 2009

    The British press has been following this debate. Despite the occasional US-visiting Conservative wingnut, the NHS – i.e. freely available health care – has enjoyed bi-partisan support for decades. Problems that exist (and there are many) don’t drive anyone here to propound the case for a private health system.

    The trouble is, the NHS was founded at a stage (1948) when almost everyone had something to gain from it. The war, which encourage communitarian feelings, was also eased the concept of it being paid for through higher taxes.

    In the US, I get the impression this is a case of the majority fearing they will lose out financially, with only the minority (without healthcare) benefitting. Unlike Britain in 1948, there’s little background in the US to ideas of social equality, even in health care.

    One line of attack is the overall cost. The UK spends 8% of GDP on healthcare. I believe the equivalent figure in the US is 15%. I know part of this extra spend accounts for marginally better results but it also points to a huge degree of inefficiency in the system.

    Perhaps the debate is really about fear of the unknown. In 1948, more or less every doctor (and certainly every consultant) fiercely opposed the NHS. Now it’s been here a while, the same profession is the NHS’s greatest supporter.

    As someone once said, ‘Reality has a liberal bias’.

  12. #12 catgirl
    August 27, 2009

    Have there been any studies looking at how people remember bad things compared to good things. I don’t men catastrophic events, but general bad days and such. My observation has been that it’s easier for people to forget about bad things, which is why people talk about “the good old days” which weren’t necessarily so good.

    This post reminded me of a friend in college. I got a flu shot and mentioned it to him. He declared that he “just doesn’t get the flu” so he doesn’t bother to get flu shots. About a month later, I was letting him borrow my notes because he was home sick with the flu. About two months after that, the topic came up again and he declared again that he “just doesn’t get the flu”. I guess part of this could be the confirmation bias, but maybe there’s more going on here.

  13. #13 catgirl
    August 27, 2009

    The UK spends 8% of GDP on healthcare. I believe the equivalent figure in the US is 15%. I know part of this extra spend accounts for marginally better results

    Overall your comment was good, but it’s not clear that we get better results in the United States because we pay more. We do pretty well in some areas, such as survival rates for some types of cancer (although I think overall cancer survival rates are slightly better in the UK). But there are a lot of areas where we don’t rate as well, such as life expectancy, infant mortality, and subjective satisfaction with health care.

  14. #14 Kevin H
    August 27, 2009

    Not a big deal, but usually the flight is more dangerous than the drive to the airport.

    Lets assume a 10 mile drive and a 600 mile flight.

    .04 * 600 = 24 deaths per 100million passengers
    .84 * 10 = 8.4 deaths per 100million passengers

    any flight that is 22x has long as the drive will be just as risky, which isn’t that high considering the average length of flights.

    so, this flight was actually 3 times more risky than the drive. However, I bet people are more than 3 times as scared, so the basic point still stands.

  15. #15 Was Once
    August 27, 2009

    The thing that bugs me is health insurance is sold on the fear of death that we are so irrationally afraid of in US. What fells most people is not rare cancers and such, but not taking good care of the only body we will have by drinking alcohol, smoking, eating poorly, etc. The insurance companies know this and profit.

  16. #16 martha
    August 27, 2009

    I agree that young people undervalue health insurance for the reasons stated.

    As a “fear of flying” person, I always thought that the relevant statistic should be a comparison of accidents, looking at time in the air compared to time in the car, not miles.

  17. #17 Jotaf
    August 27, 2009

    Kevin H: Who said the mortality rate was per mile? You’re implicitly assuming linearity when there isn’t. For example, it’s commonly accepted that the most troublesome parts of any flight are takeoff and landing; in that regard, the probability of an accident must be more decoupled from the flight duration than what you’re claiming.

    On topic: I can’t imagine what it must be to live in the US. To think that if I have a sudden medical condition (which is not my fault, for God’s sake!) and the doctors will stare at me and say I can just die and rot because it’s not covered, it’s awful.

    So you have a right to have good roads; police protection; you can’t be discriminated against; you have a right to drink clean water; etc. But health – the right to freakin’ live – is a “private affair”.

    Just so some rich bastards can make an extra million.

  18. #18 Theodore
    August 27, 2009

    “Health insurance doesn’t compute – the vast majority of occurrences have no treatment that needs to be provided by a doctor anyway (flu, etc…) which just leaves rare events such as broken limbs.”

    You should try to guess the number of deaths per year from the flu.

    “In the US, I get the impression this is a case of the majority fearing they will lose out financially, with only the minority (without healthcare) benefitting. Unlike Britain in 1948, there’s little background in the US to ideas of social equality, even in health care.”

    The issues are a little more complicated then that. Perhaps the largest problem, is people who think they have coverage still ending up with unbearable medical expenses and going bankrupt. Market forces won’t tend to fix the quality of policies since insurance tends to be chosen by employers and the young and healthy are unlikely to read through the entire policy and then complain to the human resources department. Furthermore, most people don’t know if their policy is bad until they are sick and can’t switch insurance due to the new illness subsequently being called a pre-existing condition. Health insurance wording is something that definitely affects the majority.

    The other analogies are not necessarily apt either. It isn’t a monetary risk vs monetary gain analysis and more of a monetary risk vs health gain. I am willing to spend a large amount more money to ensure that I have health in the future. If I accidentally pay for someone else’s health instead I can live with that. If only there was some kind of option that would analysis risk and then return as much back to the investors as possible. Something like some professions have but you know for the public instead.

  19. #19 UKVisitor
    August 27, 2009

    Theodore

    That’s a good point, but according to UK coverage of the US debate, the wording (as you put it) seems to take second place to the principle of the thing. I’m sure you’re right, but do those crying ‘socialism’ care?

    What’s weird from my perspective is that the lies and threats and prophecies of doom happened exactly the same way here, back in 1948. The same arguments – they’ll take your choice of doctor away! The same implications – it’ll be like communism!

    The UK was lucky. Its health care plan was backed by a charismatic and articulate politican who forced the package through the entrenched opposition of a small minority…

  20. #20 Theodore
    August 27, 2009

    We don’t have much of a real debate here. It is much more a few vocal individuals on one side flat out lying, i.e. death panels, while the other side is trying to educate the people in the middle. The legislation covers a lot of other things including physician reimbursement, medical savings accounts, as well as a government system where someone can easily compare policies. It is good to hear about your successes though what I would expect to happen would be something similar to the process medicare (national healthcare for everyone over 65) went through where the first legislation didn’t do much and was strongly opposed as socialism however future expansion really established it.

  21. #21 Donna B.
    August 27, 2009

    What worries me is I’m hearing so many people say Medicare is wonderful. Yep, it’s so wonderful that almost everyone on it buys an insurance policy to supplement it.

    So, if we go “Medicare for all” we’re going to be taxed higher and still have to pay for health insurance to get decent coverage.

    But my biggest problem with Obama’s plan — if that is what HR 3200 is — is that it is poorly written legislation. One example is the way it expands the power of the IRS in areas not concerning health care.

    I also think it is a hodge-podge of politically influenced bandaids and does little to actually fix anything about the way healthcare is delivered in the U.S., which is quite inefficient.

  22. #22 myler
    August 29, 2009

    I was hoping Jonah would point out the essential difference between insuring our possessions (house, car, electronics) and insuring our health. We are more easily able to justify insurance on an item such as a house, car or electronic that we are purchasing than on an item that is an easily taken-for-granted gift like our health. Even with possessions, we are less likely to insure that which we have already paid for in full, in the past. It is an element of sunk-cost psychology that is particularly irrational.
    Of course, this still leads me to agree with Jonah’s conclusion: we are predictably irrational when it comes to evaluating risk and the only rational policy would be to mandate health coverage for all so that the very real risk (we will ALL need health care) may be spread as thin as possible.

  23. #23 CF_in_Naples_FL
    August 30, 2009

    Nope. The fact is that “insurance companies” stopped selling insurance years and years ago. Now, it’s just a shell game. I stopped paying insurance premiums maybe seven years ago. I had gotten ‘free’ insurance at my job and it was usually MY JOB to negotiate the health care for the various small and medium sized businesses for which I was the CFO. I watched their industry change over more than twenty years.

    The only contact that I will EVER have with a health ‘insurance’ company again is to buy their stock. I’ve made a tidy sum buying and selling their stock of the years: they are VERY profitable!

  24. #24 JK
    August 30, 2009

    Millions of people in this country live in poverty. Health care insurance? Christ man, they struggle daily just to feed, clothe, and house themselves. Millions more simply can’t afford the extortion demanded by the industry. It has nothing to do with their lack of foresight. But then, you know that.

  25. I don’t sell health insurance, but I do sell life, property, liability and others. Companies like mine are not looking to make money off of paying out less than the take in, infact the goal on say car insurance is to be at equilibrium. The goal is to do it well, grow the company and make money by investing in bonds. It’s not sexy, it’s just a gigantic cash machine. I’d say that if you are of average or better means that you would have to be foolish or greedy not put the risk of financial ruin off onto someone else. Insurance in America was started by Ben Franklin and a bunch of other guys so as to spread the risk of a fire wiping out any individual in the group. As far as relates specifically to the article I will say that people are much more comfortable buying life insurance than they are disability insurance or long term care insurance even though they are much more likely to use the latter ( most life insurance is term and thankfully expires unused).

  26. #26 Kevin
    September 4, 2009

    “according to the National Transportation Safety Board, flying on a commercial jetliner has a fatality rate of 0.04 per one hundred million passenger miles. In contrast, driving has a fatality rate of 0.86. This means that the most dangerous part of traveling on a commercial flight is the drive to the airport.”

    You’ve made this argument before (both on this blog and in “How We Decide”), and again I have to take issue with it. Unless your drive to the airport is the same distance as your flight, comparing danger in terms of fatalities/mile doesn’t make sense. While it’s true that a cross-country flight is less dangerous than a cross-country drive, you can’t say the same about a cross-country flight vs a 20min drive to the airport.

    This is obviously a minor point when couched in a discussion about healthcare reform, but still.

  27. #27 Nathan Wiggins
    October 19, 2009

    I really agree with the author. I wonder why younger people just don’t see any value in what I do. I help them with the very thing they go to work for (paying the bills at home, something health insurance will NEVER do) and yet they just feel invincible. They truly are irrational. And contrary to many other comments above, cancer happens more than you think. Believe me, I help pay the claims. No one ever thinks they are going to get extremely sick. Thanks for your info, I will be using it in my presentations to help people to ‘wake up’ to the reality.

  28. #28 peter selby
    July 29, 2010

    I think for many of us that are relatively young Health insurance is barely affordable. I think it is necessary but it is one of those things that I will probably never get the full value out of.

    My family is very careful with our health and diets so using our health insurance is unlikely. And then if we do use it it soon becomes unaffordable.

    But then, Bankruptcy doesn’t sound like much fun either so I’ll probably keep my policy anyway. (yet another way to keep myself insurance poor)

    Life insurance though is quite inexpensive while young (which is when we should purchase it) Even if my 35 dollars a month for 600k is a waste it certainly is peace of mind if I get killed in an accident. To me, that is worth every penny – even if my family never gets to use it.

  29. #29 Alishia Larsen
    February 19, 2011

    I have had quite a few discussion with other people about the openly aggressive and offensive attitude of women and I too wonder if women are actually conscious of making automatic nasty anti-male comments without even bothering to take in account the affect on the listener. I was always of the opinion that women are not capable of feeling or showing any empathy towards males at all.

  30. #30 Jonas Roszel
    February 19, 2011

    I have had quite a few discussion with other people about the openly aggressive and offensive attitude of women and I too wonder if women are actually conscious of making automatic nasty anti-male comments without even bothering to take in account the affect on the listener. I was always of the opinion that women are not capable of feeling or showing any empathy towards males at all.

  31. #31 Anna Larson
    May 7, 2011

    Young people always think they’re indestructible. This new government healthcare plan should provide a lot of choices for youngsters to get coverage. And if they don’t – they’re taxed! That being said, I think many more younger people will atleast buy health insurance because they’re required to, same as with car insurance.

  32. #32 Gary Neal
    June 30, 2011

    Health insurance is definitely a toss up. I like what you said in the second paragraph. It’s this emotional attachment that we have to our health that drives us to buy it. But it’s also a sacrifice to purchase it quarterly and see that money taken out of our budgets. It intimidating enough to see Portland financial planning.

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