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Thursday, February 16, 2012

Price, Quantity, Marginal Benefit, and FREE STUFF! 

I think when people fantasize about all the free stuff insurance companies (and governments) can easily give them, they forget to think about both price AND quantity AND behavior on the margin. Case in point: I recently posted this (funny, I thought) comment from Coyote Blog on Facebook.
It is insane that “insurance” covers routine birth control in the first place. It makes as much sense as your home insurance covering air filter replacements


Which prompted this response

actually home insurance covering air filter replacements would save a lot of money for them. planned pregnancy lowers costs for insurance companies. and same with air filter replacement: A dirty air filter is the #1 reason for HVAC system failure. A dirty filter restricts the air flow into your HVAC systems air handler. This restricted air flow places additional strain on the air handler fan motor and could, over time, burn out the motor and cause your system to overheat and ultimately fail. Filter replacement is a small price to pay to extend to life of one of the biggest financial investments in your home....not an exact analogy but close enuf. let me know if i need to spell out what is good about planned pregnancies.


So, snark about planned pregnancies aside, this is a great example of incomplete business thinking plus wishful assumption, and it's why Coyote and I find the analogy funny, while my commenter thinks Coyote may be on to something.

This falls under the "If everyone else is an idiot, how come I'm not rich" category. In other words, these casual ideas about contraception or filter maintenance just might not cause insurance executives around the country to suddenly slap their hands to their fat foreheads and say "why didn't we think of that?". The fact of the matter is that if you can reliably take a few percent out of the loss and expense costs of homeowners policies without reducing coverage, you should go forth and make A LOT of money putting State Farm and Chubb out of business. If you don't believe me, I'd be happy to bore you about combined ratios.

You have to think about the total cost of providing the additional coverage against the marginal cost savings available. If everyone simply used birth control or replaced their air filters regularly, it would certainly lower the total societal costs of unwanted pregnancies and HVAC failures. The real question for the insurance company, however, is depressingly complex and conditional: Is the price X quantity of all the air filters/birth control PLUS the costs of administering all those small claims greater than the probability-weighted (insured) savings from fewer unwanted HVAC failures/unwanted pregnancies ALLOWING for the fact that the insured population is likely to replace filters/use birth controls even if the insurer doesn't pay for it AND some of the events we are preventing may not be covered? Will the total costs of millions of air filters or birth control pills outweigh the marginal cost of the handful of insured HVAC events or the covered expenses of an unplanned birth?

This is the more business-like way to think about it as you design your world-dominating insurance empire. First of all, air filters make for very small claims. Frequent, small-dollar claims are what insurers call "working layers" and they are very expensive. It costs nearly the same to handle a large claim as a small claim (this is, in fact, the reason that Medicare appears to be more efficient than private care, but actually is not). The claims handling is a much larger percentage of the total cost of paying claims. In fact the insistence on making insurance companies/the government go deeper into working layers, where incentives actually work, is one of the huge problems with the healthcare reform plan. Government should offer catastrophe protection, where markets truly do fail, and leave the working layers to the marketplace. Anyway, air filters are arguably even worse than working layers, because all insureds would use them. The further you go below the working layers, the more you are talking about a benefit plan, paying for frequent or ubiquitous expenses.

In addition to adding up all the costs of regular air filter replacement through the insured population, considering the cost of handling the thousands of air filter claims and weighing that against the small number of additional HVAC-related insurable events we might prevent, we must consider whether our insureds WANT to have their HVAC blow up or, for instance, have allergies. So the insureds may have other motivations to replace filters without the inducement of paid insurance. They may replace the filters TOO often once they are free (supply and demand, of course). Basic HVAC failures (such as the fan failure suggested by my commenter) are not even generally covered by homeowners insurance policies, or fit under the deductible. The fact that my HVAC lasts longer may be good for me, but it isn't helpful to my insurer.

The actuaries at Wishful Statist Steamboiler Inc. are realizing their filter program may be a good way to go out of business rapidly.

Now most people don't want unwanted pregnancies, by...definition. Many will, therefore use birth control, although we know many will not. Three questions:

1) How many of these people will fail to use birth control because it wasn't subsidized? Before you answer, remember that the law in question covers the EMPLOYED population at larger organizations. So these are people who can plan ahead enough to hold down a job at an organization that screens their background and they are adults earning an income.

2)How many of these adult, earning individuals will not use birth control ONLY because their insurer didn't give it to them (as opposed to they didn't have any in the back of the car after the office party)?

3)How many covered workers would take advantage of free birth control if they could get it? (I know this one -almost everyone, so count on high quantity). Won't the cost of this benefit be the cost of the contraception for the insured population plus expenses?

We may have an actuary in our readership who can provide some of the probabilities. There are hundreds of them working on problems exactly like this. But in general, requiring an insurer to pick up these routine maintenace costs rarely results in a net gain in total claim costs. So the company will increase premium. If we tell them they can't do that, they'll reduce or, ultimately, withdraw coverage. Insurance margins aren't great as it is.


If you keep adding this stuff to coverage and instituting price controls, a shortage will arise. I know my commenter remembers gas lines. It seems to me our desire for free stuff often tempts us into avoiding the hard work of estimating cost vs. marginal benefit, or even adding up the costs of what we propose. Especially around election time.

UPDATE: consider this widely cited article from the New England Journal of Medicine on the potential savings from preventive care and John Cochrane's excellent Op-Ed covering many of the above points.

UPDATE: Aegon says "So basically the only moral incentive is that it'd be awfully nice of companies to cover it. " Right, but they don't cover it because they think it would cost more, which means mandated coverage would come back as a premium increase. Since there is high use of the pill through the insured population, the premium increase would be the cost of the pills plus the expense of handling pill claims. Updated above to clarify.

20 Comments:

By Blogger Aegon01, at Fri Feb 17, 12:36:00 AM:

It doesn't save money for companies, but it saves a pretty penny for individual women, and if you're a student, for example, you try to save every penny you can (if you have any cents. See what I did there?). So basically the only moral incentive is that it'd be awfully nice of companies to cover it.

The cost of the pill is not very high. It's about $300 a year, which is about a month of rent for the average student. If more women have access to it, that's a good thing. But I'm not going to argue that birth control is a basic human right or anything.  

By Blogger MartyH, at Fri Feb 17, 01:24:00 AM:

Imagine if your homeowner's or renter's insurance policy explicitly gave you the right to get a free gun and ammo.

As I understand the current situation, Congress passed a vague and sweeping health care law, delegating much of the implementation to the HHS Secretary. The Secretary chose to mandate contraceptive coverage in health insurance policies.

Here's my question: Is the situation any different than Congress passing a vague and sweeping gun rights law, delegating much of the implementation to the ATF Director. The Director chooses to mandate gun ownership coverage in homeowners' and renters' insurance policies. Basically, if you have homeowner's or renter's insurance, you can get a gun and ammo paid for through your insurance company.

I would guess that Brady Coalition members may have a problem with this, in the same way that the Catholic Church does with the contraceptive situation. Only the Brady coalition would be on thinner ground-their objection would be philosophical, not religious.  

By Blogger John Cunningham, at Fri Feb 17, 08:54:00 AM:

Whiskey Tango Foxtrot?? when did homeowner's insurance ever cover the HVAC heating/cooling systems? I never had it on any house I owned.
further, I understand that BC pills run about $10/month at Walmart. If you cannot afford that, or cannot afford $6 for a box of rubbers, you should not be fucking.  

By Blogger W.LindsayWheeler, at Fri Feb 17, 10:27:00 AM:

Remember that song: "What's love got to do with it"?

What does business science or science for any matter have to do with Liberals? Liberals don't care about no stinkin' science, rules, laws, etc. Laws, doing what is right, laws are for schmuchs. Liberals do what they want to do, to hell with all this margins cost/benefit ratios cr*p. They have "good intentions", and that is ALL THEY need to do whatever the hell they want to do! If they can stick to those uptight religious freaks, well, by-golly, let's do it! Yee-haaaa!

Got help the poor and anybody else--everything for free! Yippie, the hippie generation comes to Washington!

Now the refrain starts, "Going to Hell in AmeriKa, Going to Hell in AmeriKa..."  

By Anonymous Anonymous, at Fri Feb 17, 11:00:00 AM:

Hey, if insurance companies are providing FREE birth control stuff at the behest of the Kenyan, what are these same insurance companies going to give me, a non-user of birth control stuff, as compensation? What's fair is fair. Let's not increase the gap between them and us! If I don't get free birth control stuff, shouldn't the Kenyan order them to give me, say, a six pack a week, maybe a lottery ticket (it is, after all, a government run lottery so there would be no cost) or something free at Walmart?  

By Blogger Aegon01, at Fri Feb 17, 03:50:00 PM:

John C,

Yes, you can buy the pill for $10-15, but I'm guessing that a lot of people are going to think "You get what you pay for", so they'd probably either shell out a bit more or just not buy them at all. Same way it may not be a great idea to buy a 50 pack of Lifestyles for $30 when you could buy 30 Trojans for $30. Some people won't care, some probably will.

But also, telling people that they probably shouldn't fuck rarely works. People fuck anyway.  

By Blogger Aegon01, at Fri Feb 17, 03:52:00 PM:

And chill out with the nicknames, Anon at 11. Criticism based on substance is encouraged, but we didn't like it when Liberals were calling Bush and Cheney names.  

By Blogger Bomber Girl, at Fri Feb 17, 03:54:00 PM:

Birth control is a pretty basic female health care need, there are very few who don't use it at some point in their lives so it would seem to be logical to make it part of the basic cost of "insurance" aka health care. $30 bucks per month is not an insignificant amount per month for many.

Birth control at Walmart is free; just take a look around at the shoppers, that should do it.  

By Blogger pam, at Fri Feb 17, 04:06:00 PM:

I have been hesitating to comment but Bomber Girl inspired me. I worked with some women for whom the $30/month was a hardship. And before you remind me how inexpensive condoms can be --heck, they're in bowls for the taking at many clinics--their husbands refused to wear them.

I have no easy answers.  

By Anonymous feeblemind, at Fri Feb 17, 05:05:00 PM:

If grocery stores were ordered to provide free bread, how long would bread be available?

My experience is that when vendors can't recover the costs of their products through sales, the products get discontinued. So from my perspective, the surest way to eliminate birth control devices is to provide them for free.

But being of feeble mind, perhaps I am missing something?  

By Blogger Georgfelis, at Fri Feb 17, 06:35:00 PM:

And don't forget that wine has health benifits too, so these insurance companies should provide a free bottle a month or so. And not Mad Dog 20-20, something good.

And laughter has health benifits too, so every house should receive the Comedy Channel free.

And so on, and so forth....  

By Blogger DKoprovic, at Fri Feb 17, 07:49:00 PM:

My dentist gives out free toothbrushes with every visit. Judging by the state of the teeth in his waiting room, I don't think free means it will be used effectively--or at all.  

By Anonymous Tom, at Fri Feb 17, 07:52:00 PM:

If they can make a company provide something for no charge, what CAN'T they make any of us provide without charging for our time, materials, etc.? What are the limits, if any?  

By Anonymous Anonymous, at Sat Feb 18, 03:42:00 PM:

The pill is a lot cheaper than many realize. At many pharmacies they have generic programs - actually cheaper than my own insurance copay, and I have great insurance. At Kroger (and subsidiaries) these are $9 a month, or 3 months for $24.
http://www.kroger.com/SiteCollectionDocuments/pharmacy/printable_$4_list_2011-09-27.pdf
(at the bottom under Women's Health)
It's not that women cannot afford the $8/month to have sex, it is that they want to spend that $8 on something else. Seriously, this is $2/week to be able to save and set aside for family planning.
And it is not about quality being you get what you pay for. These are the same pills that many women of means get. They are generic, and have been used effectively for decades.
This debate is not over access to contraception or the cost of contraception.  

By Blogger Aegon01, at Sat Feb 18, 05:25:00 PM:

I asked Facebook what it thought, and I ended up with one interesting argument. I don't buy into it completely, but I'll copy and paste it here:

"It may be an individual decision, but it is also a social concern that affects everyone in society. The economically disadvantaged having more and more kids leads to population growth, which leads to an overabundance of labor, which leads to there not being enough jobs and everyone's wages going down (supply and demand, yes?). It is in everyone's best interest to decrease unwanted pregnancies. In the early twentieth century, some people thought we could use eugenics to do this. Thankfully, that idea was discredited (though not before reformers seriously fucked up a lot of people's lives). You can't expect millions of people to make the decision to just not have sex, nor is it fair to ask them to. But we can provide them with the resources to not reproduce until they are ready. The problem is that this is not only an individual issue. It's a bit like polluting the river where it crosses your land--it's going to build up and flow downstream."

DISCLAIMER: This was written by a guy who leans quite a bit farther to the left of me. I don't buy into it that much, but it was interesting and I thought I'd share it.

Georgefelis, that's a stupid point. You're comparing birth control to something that isn't even medicine. Not to mention, I'm sure wine has done its fair share to undermine birth control in the first place.

feeblemind, that's a better argument. The answer is that we'd be paying for free bread with taxes, a prospect I'm not happy with.

Like pam said, I don't really have any answers. Maybe the first one would be to tell everyone about the $9 Pills.  

By Blogger Andrew H., aka "Mindles H. Dreck", at Sat Feb 18, 09:02:00 PM:

I just want to point out that the question of whether it is better for society if contraception is free (at the point you obtain it; nothing is free) is different from whether an insurance company would save money providing it. A third question is whether society would spend less money on benefits in total if we subsidized birth control in this way. I only addressed the second question and very nearly conceded the first en passant in the post above. My commenter also seems to move between these three arguments without acknowledging the difference.  

By Anonymous DOuglas2, at Sat Feb 18, 09:42:00 PM:

Here is an interesting study on the issue, it doesn't quite answer your question "How many of these people will fail to use birth control because it wasn't subsidized?"

The because of a federal deficit-reduction act provision, the subsidy towards provision of contraceptives at college health centers was greatly reduced. This report looks at what changed as a result in the use of birth control.
Basically pill use went down between 2-4%, those that went off the pill used substitutes such as emergency-contraception, condoms, or not having sex. Rates of STD and pregnancy didn't change.

www.psc.isr.umich.edu/pubs/pdf/rr11-737.pdf  

By Blogger Georgfelis, at Sun Feb 19, 02:40:00 PM:

Aegon01: Thats a stupid counter-point (See, I can do that too) The question is: Does the Federal Government have the constitutional authority to force a State insurance insurance company to provide for no charge an item, which costs them money, under the justification that the providing of that item would really be of no net cost due to reductions in the numbers or magnitude of their other expenses.

The answer is : No. And twice that when the attempt to made to provide a product that the consumer is forced to pay for indirectly, even though that product violates the religious beliefs of the consumer.  

By Blogger Aegon01, at Sun Feb 19, 04:28:00 PM:

Liberals basically say "suck it up" when things you don't like are paid for with tax money, since things also include wars. War violates the religious beliefs of Quakers, but that doesn't prevent the government from taxing them for it.

Again, I actually agree that birth control probably shouldn't be free. But your analogy wasn't very good. It'd be like the government giving people free wormwood instead of aspirin.  

By Anonymous Ignoramus, at Sun Feb 19, 08:30:00 PM:

Where's my free Viagra?

It's a critical men's health issue for us salt-and-peppers. It goes to our fundamental sense of being and self-worth, and our longevity.

Viagra is not per se prohibited by the Catholic Church, the way that contraceptives are.

That Kathleen Sebelius (who I'm told is a woman) has picked one but not the other shows invidious discrimination.

Seriously, the contraception contretemps has been mapped out by Obama & Co for some time. It's purposefully divisive. Among Catholics it's a wedge issue. If the Republicans aren't careful they lose here. It's the wrong ground to fight on, given a big front.

Santorum is Dead on Arrival because of this. He doesn't know how to separate Church and State. Romney isn't much better.

Even Sarah Palin knows how to separate Church and State, if you listen to her. It's easy. Big State or Small State. There's a place for free will, whether it comes out for good or bad.

It gets muddied when you mix "should contraception be made illegal?" with "should the state force tax collections to give it away for free?" There's lots of middle ground between those two poles.

Meanwhile, Paul Ryan is kicking ass on the issues that matter.  

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