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Cup In, Cup Out

November 4, 2009

Chris Garlasco, Owner & Managing Partner - Founders Insurance Group

The following blog entry is one of several that I wrote a while back, but for one reason or another, I decided not to post. I have decided to “dust” this one off as a result of America’s health insurance debate. I am sure you can guess what side that I am on, but rather than speak to the issue directly as everyone with a bully pulpit has done, I want to talk, in very simplistic terms, as to how insurance actually works for you, the consumer. I believe that understanding the very basic premise of insurance is
what is missing from the debate. It really doesn’t matter whether the private sector or the public sector runs the health insurance world; the principle of insurance remains unchanged.

I have a “newbie” in one of our offices that has plunged into the insurance from another sales profession. While I was courting this person to join our firm, I was asked to explain our seemingly complex world in a few sentences. Anyone that knows me is aware of the fact that a “few sentences” for a guy like me is nearly impossible. What follows is my simple explanation:

The insurance company is like a giant cup. The company collects money from all of its policy holders and places it in the cup. The money is then taken back out of the cup in the form of claim payments and company expenses. Any money that is left over is profit. It sounds simple and it actually is, somewhat.

There are a number of other factors that affect the “cup” but in laymen’s terms, the “cup” is the name of the game. If the amount that has to leave the cup is in danger of exceeding what is heading into the cup, the rates go up. Lots of factors affect the need to raise rates. The most common one is simple: losses. If the cost of the losses grows beyond a certain point, more premiums need to be collected. Another reason could be regulatory issues. If the company needs to keep more money in reserve, again rates are affected. Rising expenses in the form of employees, taxes, and other overhead can also affect rates. There is a fairly lengthy list, but you get the idea.

Our “newbie” then asked the question that is on everyone’s mind, “how about raising rates simply to increase profit?” I answered the question with another question, “How about competition?” Competition is the great equalizer. Companies are motivated to control expenses and excessive losses in order to gain profit. Raising rates for the sake of increasing profit generally leads to customers heading for the exits, thus defeating the purpose of the rate increase. When a company is faced with taking a large rate increase rather than an inflationary one, there is generally a problem and insurance companies know that this presents a danger to keeping their existing customer base. The exception to this is when there is a problem throughout the industry and the competition is also faced with large rate increases. So remember, cup in, cup out.

The final question is does the government understand the principle of insurance? We are hearing lots of numbers thrown around, but none of them make any sense from an insurance standpoint. It’s a lot of fuzzy math that appears to be devoid of recognized insurance principles. If those numbers can’t be placed into a sustaining actuarial model, the end result will be similar to the financial failure that currently is today’s Medicare. As for competition, there are more than enough companies to provide competition, but the government must allow them to cross state lines as they do with Auto, Home and Life insurance. Insurance is a product that was created to help us afford another product that we normally cannot afford. In this case, it’s the cost of health care. True reform will address the cost of the care or we are simply placing a band aid on a dysfunctional system. The two thousand page document that the House has just released looks nothing like insurance.

Chris Garlasco

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