Economics 101

What do Casinos and Your Health Insurance carrier have in common?

They both have an intricate understanding of statistics and the law of large numbers. They understand that the larger the number of participants, the safer they are. If the number is large enough, statistically, they will make huge amounts of money. It’s the original suckers bet – and we’re the suckers.

Want to bet me $1,000.00 on a toss of a coin? Not for me – too much of a risk. How about you pay me $1,100.00 if my side comes up but I pay you only $1,000.00 if your side comes up? I’m still not interested, as I could easily lose $1,000.00, but you’ve got my attention. Okay, same bet but we agree to repeat it 500 times. Let’s go – I’m in!

So long as you aren’t cheating, I’d be a fool not to take that bet. Without a doubt, at the end of those 500 tosses, I’m going to have $50,000.00 of your money or something very close to it. I cannot lose – guaranteed – this works every single time.

This is statistics, plain and simple, coupled with the law of large numbers. Never heard of it ? Well, it is the very foundation that Las Vegas, Atlantic City, and your Health Insurance carrier are built upon. How else do you think that those casinos can build those huge hotels on prime real estate, give away low priced buffet dinners, and pay people to come in by bus?

Take our coin toss – you know that – heads or tails – it’s a 50-50 chance to win. Flip it ten times, and one of us might get a lucky streak and win 8 out of 10 times. But flip it 500 times, or 5,000 or 50,000 times and guess what? Percentage wise, the number of times that that coin comes up heads will be very close to 50% - that’s the law of large numbers.

Okay, so it may not be exactly 50% - perhaps it might come out to 49.8% or some fractional number like that. However, because I took the 10% advantage (getting $1,100.00 when I win and paying $1,000.00 when I lose) I am guaranteed to come out ahead. Guaranteed.

Now when we deal with more complex systems – a slot machine, a roulette wheel, or a health insurance policy, the percentages are still there, but they are quite a bit more complicated to figure out. This is where the actuaries come in. Actuaries are a special breed: Part Accountant, part statistician, and part odds maker, they analyze insurance data and, using the law of large numbers, can uncannily predict how much money your insurance carrier will pay out in benefits for you next year. Mark this up by a certain percentage, and this is how they calculate your premiums.

Insurance, it seems, is a fairly straightforward business. But there is the little fact about the business that your carrier does not want you to know or even think about.

Let’s go back to our little coin toss experiment, where I made that neat little 10% margin. That 10% margin is 10% of the total amount bet. So if we bet $1,000.00 a pop, and toss the coin 500 times, we would have bet a total of $500,000.00 and I would have a profit of 10% of that or $50,000.00. If we decided to up the ante (because you are bad at statistics) and bet $2,000 a toss, times, we would have bet a total $1,000,000.00 and my 10% margin would net me a cool $100,000.00. It does not matter what amount is bet, so long as the number of bets is sufficiently large, the 10% profit will always be there.

This has a very real implication in the world of insurance – your premium – or ‘bet’ if you will – always yields the carrier the same percentage profit. This means, and I am putting this in Caps because it is so important – THE MORE MONEY YOU PAY IN PREMIUMS, THE MORE MONEY THAT THE CARRIER MAKES. In other words, in spite of how much they may try to spin the truth, AN INSURANCE CARRIER HAS ABSOLUTELY NO BENEFIT OR DESIRE TO KEEP THE MONEY THEY PAY OUT AND THEREFORE YOUR INSURANCE PREMIUMS LOW. In fact, the opposite is true – the more money they pay out = the more money you pay in premiums = the more money the carrier makes.

Now, carriers may claim that they are trying to keep premiums low, or that, because of their efforts, you are actually paying less for your health care. In fact, they spend a good deal of money promoting themselves this way. Meanwhile, behind closed doors, they are secretly laughing at us all.

Laughing all the way to the bank. You can bet on it.