Regular vs Healthcare Insurance, Patient Risk Profiles, Insuring The Long Tail
In his 2011 annual letter to shareholders Warren Buffett wrote:
At bottom, a sound insurance operation needs to adhere to four disciplines. It must (1) understand all exposures that might cause a policy to incur losses; (2) conservatively evaluate the likelihood of any exposure actually causing a loss and the probable cost if it does; (3) set a premium that will deliver a profit, on average, after both prospective loss costs and operating expenses are covered; and (4) be willing to walk away if the appropriate premium can’t be obtained.
Many insurers pass the first three tests and flunk the fourth. They simply can’t turn their back on business that their competitors are eagerly writing. That old line, “The other guy is doing it so we must as well,” spells trouble in any business, but in none more so than insurance. Indeed, a good underwriter needs an independent mindset akin to that of the senior citizen who received a call from his wife while driving home. “Albert, be careful,” she warned, “I just heard on the radio that there’s a car going the wrong way down the Interstate.” “Mabel, they don’t know the half of it,” replied Albert, “It’s not just one car, there are hundreds of them.”
Most countries in the EU have a public statutory healthcare insurance, which by default covers everyone. In Germany this is also the case, with close to 130 health insurance funds to chose from - 93 public and 40 private. 100 years ago, there were close to 1,300 health insurance funds and people were automatically assigned to one or the other based on location and profession. After the introduction of free healthcare fund choice in 1990 the funds progressively consolidated, which greatly reduced administrative burden. However with the loss of heterogeneity, the funds also lost to a certain degree the control over their risk exposure. Today in Germany the public health insurance costs a fixed 14.5% of your gross salary and covers 90% of residents, while the private health insurance serves the other 10% and takes into account your age, health status and occupation into account when determining the fee.
In a typical insurance business, there would be two sides involved in the transaction - the insurer and the insured. But in a healthcare scenario there is a third link - the doctor. This complicates the situation as it shifts the risk away from the insurer and towards the doctors. This effect only becomes stronger with the shift towards flat rates and what seems to be akin to unified patient risk profiles. Even if the risk is correctly priced by the insurances and the majority of people just visit the doctor’s office twice a month to pick up their medication, there will be a certain number of patients requiring further investigation and procedures, and the incentive to serve them as well as possible has now been removed.
It is that long tail of high-comorbidity patients that presents both the challenge and the opportunity for both doctors and startups. More on this soon.