Healthcare Needs Insurance Companies Like a Fish Needs a Bicycle

My reveries about toast landing butter side down — the subject of an upcoming blog entry — were pleasantly broken by the discussion on this blog of Ezekiel Emanuel’s analysis of healthcare spending, in which Emanuel goes to town on Left and Right policy ideas for cutting spending. Among his criticisms of Left ideas:

[I]t turns out that the combined profits of the country’s five largest for-profit health insurance companies — United, WellPoint, Aetna, Humana and Cigna — were $11.7 billion, only 0.5 percent of total health-care spending. Even confiscating every penny of those profits would add up to less than half of the cost-saving threshold.

I liked how he quoted the savings as a dimensionless number (the percentage of total healthcare spending). I was also willing to accept his numbers — I’m a sucker for anything dimensionless. However, I was surprised that ridding us of insurance companies saves hardly any money.

To help me think through Emanuel’s argument, I turned unconsciously to a favorite reasoning tool: the method of easy cases. Reasoning tools are so useful because we are flooded with arguments; keeping up with them is a nightmare if one handles each argument using a separate approach. By discussing the method of easy cases, I want to show you a general-purpose tool — one that helps us evaluate this and many other arguments.

The idea behind this tool is a tale of bad news, good news. The bad news is that our minds have severe hardware limitations; for example, our neurons fire slowly and our short-term memory has only a few slots. The worse news is that the world is complicated, and its complicated problems often overwhelm our hardware. The good news is that by simplifying — by thinking about easier versions of a problem — we often recover our reasoning powers.

This tool is widely useful in physics and engineering, which is why I made it the subject of Chapter 2 of Street-Fighting Mathematics. I would also like a general audience to benefit from these reasoning tools. Thus, for the manuscript of my new book Numbersight: A Street-Fighting Mathematician Teaches How to Make Better Decisions, I am on the prowl for examples where the method of easy cases helps interpret numbers around us. Thank you, Dr. Emanuel!

Let’s agree with Emanuel that insurance-company profits are not significant. Does it follow, as he argues, that abolishing insurance companies is not important in reducing healthcare costs?

To test the argument, I reached for an easy case. The easiest cases are often extreme ones. Thus, I summoned my powers of exaggeration (usually not considered a mathematical skill) to simplify the world. Imagine that insurance companies collect money as premiums, turn a fraction of those premiums into dollar bills, and (here comes the exaggeration) use those bills as cat litter, burning them in oil drums in the backyard. They then pay out the remaining premiums as claims. In this world, wouldn’t eliminating insurance companies be a good way to reduce healthcare spending?!

Picturing this world showed me the flaw in Emanuel’s argument: he discussed only the profits of the insurance companies, rather than their total contribution to healthcare spending. Indeed, insurance companies create costs within themselves and throughout the system. As a small example, I recently went to the local emergency room, was double-billed because I was admitted before midnight and discharged after midnight, and was lucky to spend only half an hour on the phone with the hospital and insurance company requesting a corrected bill. And almost everyone I know has a similar or worse experience.

The flaw of ignoring the total contribution to healthcare spending, is not simply theoretical. In the New England Journal of Medicine, one of the world’s leading medical journals, Harvard physicians Steffie Woolhandler and David Himmelstein studied the “Costs of Health Care Administration in the United States and Canada” (N Engl J Med 349:768-75). Their conclusion (on p. 771 of the article): Insurance-company overhead consumes 5.9 percent of U.S. health-care spending — more than 10 times the 0.5-percent figure that Emanuel was discussing just for the profits.

Photo: oskay

Worse, this 5.9 percent underestimates the problem. It doesn’t include the cost of employees in doctors’ offices who fill and file insurance paperwork (this factor is tabulated in the paper) or the value of patients’ time spent talking to insurance companies and their touch-tone computers (“Please listen carefully to all the options as our menus options have recently changed.”).

After thinking it through with the method of easy cases, I stick with my old belief, shared by most industrialized democracies: We need insurance companies in healthcare as much as a fish needs a bicycle.


This is really goofy. Is your contention that eliminating private insurance will eliminate all overhead? I'll go to the ER, see a doctor, and he'll get paid magically by my just wishing it to be so? Surely there are administrative costs in other industrialized democracies.

It's sort of imaginable to have a health care system with no payment overhead - I never pay anything, doctors never bill for anything, they just get a flat salary paid by the state with no monitoring of procedures etc. - but I don't think it's what anyone's proposed and it has its own issues re incentives and monitoring. (Another way to get there is to have everyone pay cash for all procedures. Again, little overhead. You could do the same for, say, car accidents. And yet we have auto insurance.)

I think you're directionally right - you're surely right that single-payer systems empirically have *less* overhead - but you've made your case way, way too easy.


Joe J

Although it would be possible a single payer system could have less overhead. It is far from a certainty. With the levels of USA beurocracy it very well may increase the overhead/fraud as is seen in VA benifits and Medicare.


So you propose what? We give it all over to the government? They certainly aren't known for inefficiency.

/sarcasm off

Enter your name...

And your theory is that if we didn't have "insurance companies" doing this, then billing would magically become unnecessary? How will the healthcare workers get paid in your world? How will the hospital buy supplies?

Put another way: Have you noticed that Medicaid also has a non-zero overhead figure?


Are you suggesting a single-payer system would be better? If this single-payer is the US Federal Gov't, are you also saying they would be more efficient than what we have now?


Isn't the flaw in your conclusion that you assume that whatever administrative entity replaces insurance companies will be more efficient? I can't see how the job of processing the paperwork can be eliminated. Assuming there are no health insurance companies, who is left to sort out the costs? Forget insurance coverage and let everyone fend for themselves? Unlikely. Let the "government" take over the role? We all know how efficient that would be! Ignore the paperwork and let doctors and hospitals bill the government directly with no audit of the charges? Not likely to be a cost effective approach for long. It's easy for you to say we don't need insurance companies - what's your alternative?


I think it's nuts to assume those are all unnecessary costs. Given how Medicare is frequently bilked out of money through outright fraud (the size of those numbers being harder to estimate) it seems reasonable to assume that %5.6 of spending on billing issues may represent a larger number that would be spent on fraud otherwise.


This may be the worst article in terms of value vs. words ever on this blog. I agree with everyone who has already commented? What are you suggesting? Single payer? Because of your limited thought experiment that looked at - as you admit - one easy case (which wasn't really explained very well).

Eric M. Jones.

Shooting from the hip--

1) Where's Blue Cross/Blue Shield that has an effective monopoly in most places?
2) 0.5%??? How is is that the listed "for profit" companies spend roughly 80% on medical benefits. Aren't we missing a huge pile of cash?
3) Listing the top five....Is this like saying (for example) country X has the world's third-largest army when they actually have an army 1% as big as the other two. What's the contribution of the unnamed companies?

I smell hot steaming questionable economic legerdemain here. I'll bet it'd be easy to counter the stated arguments.


Consider also that the insurance companies at least have an incentive to reduce overhead costs (lower costs = higher profits), while in the single-payer as government agency, the incentives are to increase overhead, since many bureaucrats try to increase the size of their "turf".

Joshua Northey

And yet by many accounts the VA has a better healthcare system than the general population AND lower costs...


But the healthcare industry needs insurance companies. If insurance did not exist costs would not rise so fast since people would not be able to pay the constant increases. Insurance is the primary cause of rising costs due to the ability of people to pay.


So my question is, why isn't health insurance more like automobile insurance? You don't submit a claim every time you get your oil changed and your tires rotated, do you? It's used for major damage. And you're employer doesn't provide it for you. (I know a lot of the *historical* reasons, I want to know why we're *keeping* it this way).


"Insurance-company overhead consumes 5.9 percent of U.S. health-care spending "

By all means, let's turn this activity over to the federal government and get that number up as high as we can. Evidently this works on whatever planet you live on. Not so much here.

David Henderson

I love all the people defending the current system without really considering the purpose of insurance. Insurance is supposed to protect one in the face of unexpected catastrophe. That is you and the insurance company are gambling on the proposition that a catastrophe will or will not happen. So thinking of it in terms of its reality, buying insurance for healthcare is like buying insurance for fueling my car.


Mr. Mahajan,

So what is your solution to this "problem?" What do we replace the insurance companies with? Are you saying we eliminate the health insurance system completely so that we just pay for every procedure out of our pockets outright? Do you think the government would manage this better?

Who would manage all the processes involved? Elves?

By your math health insurance companies make up 6% of health care spending, what about the other 94%? What makes that up? It's interesting that people such as you analyze insurance companies and their affect on the costs of health care yet they never look at the affect of regulations, fraud, mismanagement, beauracracy and other factors have on the cost of health care cost.

You mention your experience where you were billed incorrectly, yet how would you explain a friend of mine who visited his doctor, discovered that he had 2 herniated disks in his lower back, had corrective surgery and is now going through rehab all in the span of a month and only paid $500 out of pocket? Or my other friend who discovered that he had a torn meniscus, corrective surgery and rehab in the time span of a month and paid $1,000? A similar situation happened to me and a pinched nerve. Are our experiences irrelevant?

Shall we discuss my British friend who is still waiting on an appointment to get her torn ACL checked in order to them schedule reconstructive surgery? She has no idea when it will happen. It could be next year. Is that better?

I am not saying that insurance companies are perfect and the ONLY way that health care can work, but having traveled the world and saw health care in socialized models I can say pretty firmly that our system is way better.


Matt C

Twh you are exactly right. Companies like qliance and one medical group are doing exactly that, charging a per month fee to users for basic care while combining with a high-deductible (e.g catastrophic) plan. I expect more and more consumers to move to this direct primary care model as costs continue to rise

Joshua Northey

You could basically make this same criticism more effectively with the following paragraph.

Corporate profits are not directly related to how much "surplus" a corporation is capturing. Companies frequently overpay management, build fancy new facilities, undertake risky research or do other things that can adversely effect profits. Many wildly successful companies claim no profits year after year because they take their would be profits and do other things with them. If you want to reduce costs by going after the surplus insurers are taking out of the system profits are by no means a useful way to gauge that surplus.

Another Caltech PhD

Right... because the US government is so efficient. You do realize that most of Europe has a debt problem because government overhead is far larger than the 5.9% figure you obtain with insurance-company overhead? In Switzerland, there are insurance companies that will handle this overhead for the government. Therefore, the insurance company is viewed as a necessary component of the healthcare puzzle. Otherwise, you get the mess that is Greece... humongous government and humongous problems with fraud and corruption. Stop being an utopian idiot and wake up to smell the (stinking) roses. Fraud and corruption can only be stopped through regulation and regulation is best done with private companies in a heavily competitive market.