Saturday, August 8, 2009

The Unconscionable Math of Insurance Fraud by Insurance Companies

E. and I were driving home from a family function last week and caught the end of the This American Life episode on "fine print." Among the stories was a heart-wrenching tale about the problem of rescission, which is basically where insurance companies take premiums for years and, right when you need an expensive procedure, drop your insurance because you "lied" on your application. This really affects people who get their insurance on the private market. During the episode (described in more detail by James Kwak at Baseline Scenario), the health insurance companies being grilled during congressional testimony argued that rescission affects about 0.5% of their clients.

But, in a truly amazing post, Taunter explains how conditional probability can explain why this 0.5% can sound so small but amount to an unconscionable fraud on the part of insurance agencies. Using the Monty Hall Problem (and, implicitly, Bayesian reasoning), he explains why the insurance executives essentially bank on rescinding one in two claimants for those in need of service! He points out that you have a three times better chance to survive a game of Russian Roulette. It is an amazing lesson in conditional probability and Bayes Theorem that could be an incredible teaching moment.

Until the patients needs an expensive procedure, patients are paying their premiums into the coffers of the insurance company and the pockets of their executives. The expensive procedures, of course, are why people need insurance. The insurance companies, though, get to keep all those years of premiums for all of those years even though they don't follow through on their commitment to pay out, getting rich off those years and years of premiums. The procedure goes something like this: take money from a group of people and promise them a return in the future, use the money to pay off claims of others (minus a heavy for the service), and when it comes time to pay out, renege. Taunter points out that this seems vaguely Madoffian.

The justification of this procedure is that, without it, insurance prices would rise for everyone in the system and that people should be punished for fraud. Of course, many of these people did not commit any sort of fraud and instead got confused by the leagalese and convoluted medical language which were intentionally designed to get people to slip up. It is probably true that insurance premiums would probably go up, but it doesn't really matter if people aren't getting a service that they pay for (in other contexts, that's called stealing). But, it is also an argument for why the "free market" does not always know best and why health care reform is so important. I hope that in the coming days and weeks, the Obama administration and Congress get their footing and actually start to stand up for reform.


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