Thursday, October 16, 2008

Capitalism/financial crisis tutorial Part 15

I hope that you have been finding these useful, especially the young people, who I think of all the time.

Today you need to think about the role of insurance companies in true capitalism. Like everything else, the insurance business started as an honorable occupation, and has now been warped by the looting mentality. Thus insurance companies started out as a firm and valid foundational part of capitalism, and have degenerated into one of its destabilizing rather than stabilizing forces. Here is why.

The concept of insurance came from the exact same place as capitalism itself, which is those "corn farmers" I told you about who grew their own subsistence corn and then sold their surplus corn on the market place for cash. What were the basic subsistence needs for humans for most of their existence? Food, clothing and shelter. These are all summarized in the concept of a home and the ability to cultivate food (farm). Eventually those took the form of houses and barns. Back when families were large it was easy to build one's own house, even if it was a simple structure, such as in the 1800's, such as a log cabin for the dwelling and a farm for storage. Now remember, up until the middle of the last century, all humans relied on open flames as their source of heat and light, so devastating fires to house or barn were a constant risk and a frequent occurrence. "In the good old days" extended families and indeed even the entire community would come together to rebuild the home or barn of a community member who lost it in a fire. You still see that in Quaker and other communities. People would hold a "barn raising" to build a new barn for a new family, and they would rebuild the barn or the house if there was a fire. So this is the origin of "insurance," before it became insurance, which is the concept that no one was really alone, and if one suffered a loss to fire, others would come together and help you to rebuild.

As humans industrialized, they started purchasing homes, and started living in communities other than their extended clans who were settled in a particular area. So people started to get the idea that groups of individuals would pool money in advance of a tragedy, so that members could draw upon that money to replace what was lost in, typically, a fire, the continuing risk. I know most of you young people only think about auto insurance and health insurance, because you have grown up in that era. But that has little to do with genuine insurance as it first emerged as a step forward in capitalism. It all was about protecting one's ability to "subsist," which is to eke out a living in farming and in protecting your dwelling or place of business from fire.

So here is a VERY simplified model of how the concept arose and how it actually worked, in the beginning. Suppose in a certain community in the USA there were lots of farmers. Rather than count on each other (who work day and night already in one of the hardest jobs that exists) to rebuild when there is a fire, they get together and decide to form an insurance company. So let's say that 1000 farmers each pay $50 a year into that insurance company. That is what we now call the "premium." It's not a collective savings account because it is sharing the risk, not putting money aside to handle the risk. So the way it works is that 1000 farmers have paid $50 each year in order to buy the right to have their dwelling or farm rebuilt and replaced if there is a fire. The insurance company therefore has $50,000 at the beginning of the year. Suppose there is one fire that affects one farmer out of the thousand. The insurance company then dips into the $50,000 and pays a previously agreed amount to pay for the barn replacement. Let's say that the barn and equipment is a $5,000 loss, so they pay the $5,000 out of the $50,000, and they still have $45,000 available for any subsequent fires. If a fire typically costs $5,000 in damages, that means they are funded by the farmer's first year premiums to handle a maximum of ten fires that year.

Now, people who are in the business know the risks. So these farmers, for example, would be pretty wise about knowing how many fires tend to occur in their areas. Think about California, for instance, and their fire prone areas, in the news recently because of the risk from drought, high winds and deforestation, replaced with brush. So a group of farmers in California, if they were going back in time and making a farmer insurance agency such as the one I've described, would take into account how frequent fires are occurring (and the cost of replacement) when they figure out how many members they need, how much premiums to pay, so that they have sufficient funds to handle the year's anticipated risk. Same thing if the farmers were in upstate New York. Now, you might think that they had a lower risk of fire, lacking the same weather risk as California. But in the "old days" there was much more fire risk in "winter states," because open fires were used within homes and barns for both light and for much needed heating. So a group of farmers in New York would know about the number of times fellow farmers have had a burn due to a winter fire accident, and thus would plan accordingly. If you see what I mean and am following me in this example and explanation, you'll see that "insurance used to be local and property oriented, property that was vital to survival, one's home and farm." Insurance had nothing to do with the replacement of luxuries, as it does today, or in the providing of services. The pure and fundamental form of insurance was a "collective" and local community approach to save each individual's residence and farm by sharing the risk and paying out from a well planned pool of insurance fund that was funded via one a year premiums.

OK, now what happened to the money all year? As local banks sprang up, the money was put in a bank for safekeeping. The first function of banks when they were first "invented" was to keep money safe. The second function was to take some of the safe money, loan it to local people, charging them a small amount of interest. That interest was shared between the bank and the depositors. Thus insurance "companies" gained a modest interest on their money just from virtue of keeping the paid premiums in a savings oriented bank.

This is how insurance was win-win. Insurance replaced the hope that extended family and community would "rebuild" via "barn raising" someone's tragic loss to fire with the certainty that one could hire people to do the job using one's insurance benefit. A family could rest easy knowing that having paid their premium, their potential loss was covered. Remember, this was not a hobby; this was life and death because farming is dangerous and wooden structures with live fires burned often, with fire companies and rescue facilities unheard of and not yet developed. So insurance became many farmers' first exposure to a bank and it was a positive one. They knew their money was safe and they also knew that the insurance company would pay if they had a fire loss. The insurance company provided a living to one or more employees by paying salary from the premiums and also the interest payments the premiums earned. Banks had a good pot of money that was stable (not being frequently withdrawn from them) so they could make good loans to other customers, and earn some interest for the money. And insurance companies as an entity could grow and offer more services as they profited from premiums not consumed by payouts and also by interest payments from having their money on deposit in the bank.

Jumping forward, this is where a good thing became an enormous temptation to go from "making a good living" in service of a noble cause, to "let's make a killing in the market." In the 1950's it was kind of a golden age of modest profit and safety. Large insurance companies made lots of money but not "looting," because they became so large that they had huge premium deposits in the bank that even at low interest rates of payout earned a lot of money just by sitting there in a bank. The banks, both savings and loan and commercial banks, lent the insurance companies money out, so there was ample money for home buying and building modern consumers, and also for the companies and corporations that employed them. But at the same time insurance companies had entered the stock market, investing the funds they had from premiums in order to get a higher rate of return via stocks and bonds rather than savings account interest. There is nothing wrong with that, and in fact, that is great capitalism so long as the ability to pay out if the insured has a claim is maintained. So long as there is enough money in the premiums to pay customers when they have a loss, no problem. But there developed two "risks" that the insurance companies did not manage.

One is that insurance companies became imprudent in what segments of the stock market they invested in. They used to be the MOST conservative of investors, investing premium money in only the "blue chips," the most secure and safest stocks. But in the 1970's and 1980's they got wild and crazy in the "greed is good" attitude that overcame prudence and ethics in capitalism. And so they lost their stabilizing force and started taking greater and greater risks in order to make more and more "crazy" money. So in a matter of decades many insurance companies went from being bastions of conservative investors (whose first responsibility is to provide insurance to their customers), to being "money making financial juggernauts," who jumped into insane and risky "new products" such as yep, you guessed it, derivatives, and risky stocks.

Worse, the insurance companies decided that their customers, those they insured, are the enemy. I'm not referring to deplorable insurance rip off scams, which is a real problem. What I mean is that rather than providing complete assurance of paying the customer in their crisis, they started "writing policies to deny payments" as an admired art form. Yes, I saw that first hand when I worked briefly for a certain insurance company that has been in the news. The most admired "underwriter" (the guy or gal who develops the insurance policy for the customer) is the one who could put in as many "strings attached" in the "small print," to weasel out of payments. People learned that the hard way during hurricanes such as Katrina, where they found agents arguing with them because policies denied payment if the exact same damage to a house was done via wind or water. So you see what I mean? Insurance companies used to be founded and operated with the honest Joe and Mary who needed coverage during crisis in mind. So farmers got together to ensure (pun intended) that none of them would suffer loss of their house or barn to fire without getting compensation for rebuilding from the premiums they had paid. But now, it's like the insurance companies "don't want to pay." Again, I'm not talking about being cautious amidst rampant attempts to rip off via false claims. I'm talking about the giggling that goes on behind closed doors in insurance companies as they figure out ways to look like they are insuring a customer, and then take their premiums, but have worked into the paperwork clauses that would "exclude" payment in circumstances that the insurance company hopes will arise and thus they can keep the premium but not pay the insurance benefit to the customer who has a loss. Then they turn around and enter the crazy gambling casino that the financial markets have turned into in the past decades, in order to "make a killing."

I was incredibly sad when I saw that this was the motivation of the modern insurance company. I remember the days when insurance was sold in order to protect the insured, not loot them and loot the financial markets. Making a decent living for thousands of people and good, steady modest profit no longer was "good enough" for the insurance giants and masters of the universe.

This is why the health care insurance mess is far, far, FAR more complicated than all of you realize. Giving everyone "cheap and available" health care insurance does not solve the larger problem of providing good quality care to everyone. I mean, it's damned if you do and damned if you don't, to put it bluntly. If you don't have insurance, like me, you are murdered whenever you have medical problem and have to "pay out of pocket" (and they charge you different much higher rates if you are a poor cash payer for the same "service" than if you are a person who is well to do and covered by insurance.) So society is structured to require health insurance or you just plain don't get the care, and you are punished for being poor because if you do pay cash, they charge you at least twice as much for the same "procedure."

But even if you have insurance (either private or through a welfare agency), you are screwed. This is because insurance companies, sometimes in collusion with doctors, and sometimes in opposition to ethical doctors, "decide" what medical care they will "pay for." I saw this first hand working in the area of psychiatric medicine in a hospital. Insurance companies are pill pushers, and make no mistake about that. They really are no longer interested in paying for what they (and also health care professionals) derisively call "talking cures." It's very difficult to obtain payment for even something as reasonable as once a week one hour general counseling sessions for someone who has schizophrenia. Instead they have "guidelines" for what types of pills and for how long they will pay for someone who has schizophrenia. It's all about money for them, and, in fairness, they have fallen into the well meaning but wrong headed trap of trying to "commoditize" medicine. But anyone who is honest and well informed will acknowledge that someone with a mental illness or a disability is not at all the same in their treatment needs as someone else with "the same illness profile." Here's an easy example. Suppose you have two patients who are diagnosed as "paranoid." Insurance companies (and worse, overworked, desensitized and often arrogant health care providers) like to provide one treatment for one problem. But there is a huge difference, I can tell you as a counselor, in treating someone who is paranoid due to a trauma that they have received versus treating someone who is paranoid based on ungrounded (though real in their pain) fears and neuroses. Yet an insurance company will see "paranoia" in their request for payment insurance forms and want to plop a standard pills based treatment profile with no distinction. I'm being a little harsh, but not really. Just ask anyone who has tried to get individual attention (and payment) for a loved one's mental illness. My patients (by the way, "health care professionals" don't like that term and like to call them "clients," thus further promoting a political correctness of health as a "business" and a "choice" of commodity) got individual treatment from me only because I was free, being an unpaid intern. When I had to leave at the end of my internship most of them lost the individualized treatment that I provided.

Suppose that going back in time, a group of families had gotten together to organize a mental health insurance coalition, just as did the farmers to protect against fire. They pay their premiums and then would get a payout if one of their family members comes down with a mental disorder. Just as with the farmer barn fire example, you expect payment that would cover a total "replacement," in other words, appropriate individualized treatment for the entire illness. You'd not have a company agree to rebuild only one horse stall because "that's all you really need." You'd not have a company agree to pay for a roof, but not the walls of the barn because "if you tried really hard you'd find out you don't need the walls, just protection from the rain." But that is what health insurance companies do now. They will pay for a "roof" but not the walls, or "one horse stall" but not rebuild the barn. Now, I am damning a whole industry with a broad brush, and I recognize that. But even the well meaning people are swept away by a totally warped process and system that has completely lost its insurance ethos roots. Insurance companies want to be first and foremost "profit centers" and "movers and shakers" (influence); they no longer want to be comprised of the very ethics and priorities of the people that they insure. Traditional insurance companies were made up of people who faced a common problem and risk together. Now its "just a business." Worse, it's a business they seek to weasel out of performing wherever they can.

So there you have it, in a nutshell. This is how the honorable profession of providing insurance has morphed into just a money making engine that calls itself "capitalism," but who has abandoned the subsistence and surplus prudent model of genuine capitalism. I hope that you find this "crash course" helpful (though I'm sure you need some sadness insurance now, LOL *sigh*).