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In the case of health insurance, both stages of the calculation are
preceded by a thorough scientific analysis, especially the research car-
ried out on the appropriate group of people.
19
It can be concluded that
the process of obtaining data, analysing them and using the knowledge
thus acquired in order to determine risk is the initial stage of economic
calculation. The successively growing medical knowledge allows insur-
ers to better and better calculate risk and thus to compete by creating
more ‘advanced’risk groups (classes). The processes based on the
appropriate use of medical knowledge in the development of health
insurance are called Evidence Based Underwriting (EBU) and are
derived from medicine based on reliable (i.e. scientifically supported)
data (Evidence Based Medicine –EBM) (Lipka, 2013a, pp. 94–98).
Properly verified medical knowledge allows, among other things, the
development of more effective procedures that can be used in the
treatment of specific diseases and, ultimately, to include them in the
scope of medical insurance. Thus, it can be concluded that developing
medicine affects the quality of economic calculation.
20
Therefore,
insurers are interested in the latest results of research concerning, for
example, the effectiveness of the use of new medical procedures in the
treatment of selected diseases, as well as scientific studies focusing on
forecasting specific trends, e.g. concerning the eating habits of the
population. It should be emphasized that the constantly growing
number of scientific publications is a great challenge for insurers and
requires the involvement of more and more human resources and their
proper management.
The health insurance market as an effect of entrepreneurial
processes
The core of insurers’business is risk calculation. Its purpose is to
adjust the amount of the net insurance premium
21
to the risk group
(class) represented by the insured person. Each insurance company
creates its own risk groups based on appropriate criteria, thanks to
which it is possible to define rules for the appropriate calculation and
assessment of insurance risk, including health risk. Often the activity of
insurance companies is equated with collecting premiums from the
insured and activities consisting in fulfilling the insurance contract to a
limited extent, which is to be a source of their profit. This is a mis-
conception. The basic assumption of the insurer is the payment of
compensation or benefits due to the occurrence of a given event. Risk
is inherent in the real world and its implementation results in a loss.
One of the ways to eliminate or reduce the negative effects of risk
Insurance as a market institution 19
implementation is insurance. Insurance companies, using an advanced
economic calculation taking into account probability, are able to deter-
mine with increasing accuracy what factors cause a higher (or lower)
probability of a given event. Thanks to this, they can distinguish further
groups (classes) of risk from one general group. These groups differ in
terms of risk and, as a result, the amount of insurance premiums. The
higher the likelihood of a given event (e.g. a serious illness) occurring, the
higher the likelihood of consuming the necessary medical services and,
consequently, the insurance itself. Therefore, young and (in the opinion of
the insurer) healthy people pay relatively lower premiums than the elderly
and those who are already sick. An insurer that, in the conditions of an
unfettered market economy, restricts access to certain benefits denies the
sense of having insurance and is replaced by competitors that are more
enterprising, i.e. better at calculating risk.
Although there may be a lot of individual risk groups,
22
each insurance
company uses a basic division into the so-called standard risk and sub-
standard risk. The first type means a risk that is accepted by the insurer
without premium increases, while the substandard risk means admission
to insurance, but after taking into account the premium increases (Lipka,
2013b, p. 117). Subsequently, the insurer may create further subgroups for
standard risk (e.g. S1, S2, S3, etc.) and for substandard risk (e.g. Sb1, Sb2,
Sb3, etc.). The ability to properly calculate risk and create appropriate
risk groups (classes) based on it is the main tool for creating a competitive
advantage on the market. Therefore, the insurer does not strive to limit
substandard risk only to its appropriate calculation. The rule according to
which the premium paid is proportional to the risk represented by the
insured person is called the ‘principle of fairness’(Guzel, 2013a, p. 99)
and constitutes the basis for the stability of the functioning of insurance
companies.
23
Appropriate risk assessment
24
is of particular importance in the case of
health insurance. Unlike, for example, life insurance, health insurance
may be consumed many times. Moreover, the frequency of using medical
services may result not only from the deterioration of the insured’s health,
but also from certain habits. This is a big challenge for insurance compa-
nies due to the fact that it is very difficult to identify people who use
health insurance without valid reasons, and it is even more difficult to
change this state (Kostrzewski, 2013, pp. 140–141). Moreover, the insurer
cannot change the rules of using the insurance during its term, which
makes the risk assessment process
25
so important.
An error in the form of wrong premium estimation or inadequate
risk classification may result in losses for the insurance company and,
as a result, deterioration of access to medical services. Obtaining
20 Market processes in the health system
information about the health of the insured person is of particular
importance for the insurer, as it is mainly on this basis that decisions
are made whether and on what terms a given person may be covered
by insurance. If the risk assessment did not take into account the fac-
tors that could affect the terms of the insurance, the so-called anti-
selection occurred.
26
This phenomenon has two causes. The first is the
low quality of the risk assessment by the insurer itself, which leads to
an incorrect determination of the amount of premiums or the scope of
insurance. Usually, the insurer is quick to understand the situation and
improves the quality of the risk assessment. On the other hand, the
second reason is more difficult to eliminate, because its source is
deliberate concealment of information by the person applying for
insurance protection. It can therefore be concluded that the source of
anti-selection is the asymmetry of information between the insurer
and the insured. The insurer, wishing to counteract such practices,
undertakes a number of actions aimed at eliminating or at least lim-
iting anti-selection. These include, in particular, the establishment of
an appropriate level of co-payment,
27
i.e. the costs incurred by the
insured when using the insurance. Other possible actions include, for
example, the introduction of limits on the use of medical services or
the application of exclusions of certain risks from insurance protection.
Such activities, although they may be misunderstood by part of the
public, are essential to the creation of solid insurance products. An
emotional approach to insurers’practices (e.g. foreclosure) may obscure
the fact that risks would otherwise be uneconomically grouped. For
example, persons with a sub-standard risk would be admitted to insur-
ance on a standardized basis and, as a result, would pay a premium that
is inadequate to the risk contributed. This would result in over-con-
sumption of medical services and increase costs. Subsequently, the
insurer would have to increase premiums to cover the rising costs, but
some insured persons could then opt out of insurance.
Therefore, in order to avoid such situations, the insurer must be able
to limit or completely eliminate intentional actions of some insured
persons, otherwise known as moral hazard. Moral hazard can be
defined as the insured’s deliberate action aimed at bringing them tan-
gible benefits (e.g. concealing information about their health in order
to be accepted for insurance or pay a lower premium), but without
incurring the costs of such actions. Such attitudes are not any form of
restoring greater social justice and, it is worth emphasizing, they do not
hit only insurers, but most of all other insured people (which is too
rarely mentioned). It is on them, as a last resort, that the additional
costs of such activities are passed on –honest customers of insurance
Insurance as a market institution 21
companies subsidize those who are tempted to abuse.
28
If someone
claims that paying higher premiums by sick people is unethical, then
one should consider whether a young and relatively healthy person
should incur higher costs with a low probability of using insurance. It
can be concluded from this that insurance companies also care about
the interests of their clients who have trusted them. Anti-selection or
moral hazard, which is not dealt with, may cause financial problems
for insurers and, ultimately, loss of the trust of the insured. It is not a
win-win situation.
In the health insurance market, the laws of the economy work the
same as in other markets. Purchasing insurance is an act of exchange
that benefits both parties. The insured person receives a guarantee that
in the event of a given event (e.g. an accident), they will be able to
count on the insurance to obtain access to specific medical services.
Their belief is not unfounded. The insurer, thanks to the appropriate
risk assessment and the ability to reduce the moral hazard, is able to
create a stable insurance programme, thanks to which it can achieve
profit from the invested premiums. The greater freedom of action the
insurer has, the greater the stability of insurance programmes, and thus
the more secure access to medical services for the insured. The insured
person who pays the insurance premium covers not only the adminis-
trative costs borne by the insurer, the costs constituting the commission
for financial intermediaries, or the costs constituting the remuneration
of entities providing medical services, but they also finance access to
these services for those insured who have been affected by certain
events (e.g. accident or illness). For example, if a person with a good
health condition has been correctly classified to a given risk group, e.g.
to the standard risk group S1, and other insured persons in this group
will also represent the same risk, then such insurance will be able to
adequately meet their needs. On the other hand, if the S1 risk group
includes a certain number of people representing the Sb1 substandard
risk (e.g. due to concealing information about their health condition),
the insurer will have to allocate more funds to finance medical services
and increase the premium. For some of the insured with standard risk S1,
it may turn out to be too high and they will not be interested in further
insurance coverage. Hence, specific actions of the insurer are fully under-
standable, because by creating appropriate risk groups, differentiating
premiums, or applying exclusions, they care for the interests of their cli-
ents. On this basis, it can be concluded that, in economic terms, it is not so
much the insurer excludes its clients as its clients exclude themselves. If an
insurer does not meet their expectations, its competitors will. Nobody
who is relatively healthy wants to overpay for an extensive health
22 Market processes in the health system
insurance package that they do not use, but that only pays extra money to
people who frequently use medical services.
This is in line with the theory of price imputation, which says that
productive goods have value because they can produce the consumer
(end) goods and services that consumers desire. Entrepreneurs (includ-
ing insurance companies) bear certain costs, because they assume that
the price they offer for their products will be accepted by customers
(insured) and will allow them to cover the costs and achieve the
assumed profit. The prices of consumer goods and services are there-
fore a derivative of the preferences of consumers who are ready to buy
them (Machaj, 2013, p. 109). Therefore, the consumer pays attention to
the benefits of consuming the final product. They do not think about
the costs of the factors of production that were involved in the pro-
duction of a given good or service. It is similar in the case of insurance,
where the insured expects an appropriate price and quality of insurance
and does not reflect on the risk group they are in. They compare the
given insurance to the competition’soffer and selects the best option
for themself, or they do not purchase the insurance at all, if they are
not satisfied with any offer.
Importantly, while the use of exclusions in health insurance excludes
this form of access to medical services (or may limit the choice between
individual offers of insurers), it does not prohibit such access at all.
Health insurance should therefore not be seen as a form of access to
such services, but rather as a form of financing that access. Insurance
in itself does not increase the supply of doctors, drugs, or new medical
devices. Thanks to insurance, it is possible to transfer funds from
people who were not affected by a given event to those to whom it
happened to cover the costs of treatment. If, for some reason, the
number of doctors, medical facilities, or medical equipment remains
constant, but the number of insured consumers who consume medical
services is growing, costs will increase or even visit limits will be intro-
duced. The benefits of health insurance should not obscure the fact
that it is only one form of financing access to specific medical services.
Therefore, it should be remembered that in the conditions of the
market economy, people who, for various reasons, cannot be covered
by insurance are not deprived of it at all, only the form of (financing)
access to these services changes. The more developed individual market
institutions are, the easier these processes occur.
Exclusions in the health insurance market are nothing special, as
they are in the rest of the economy. Owing to exclusions, it is possible
to establish property rights enabling a rational calculation of the fac-
tors of production. The price system also reflects the economic nature
Insurance as a market institution 23
of goods and services. High prices reflect the relationship between
supply and demand –they inform about the unavailability of certain
goods and, in a way, force their economical use. Exclusions and lim-
itations are one of the foundations of civilization and the economy
(Rockwell, 2012). A car manufacturer negotiating a new contract with
its suppliers has the right to withdraw from the contract if it deems that
it does not meet its expectations. If this is not done, the final product
may turn out to be worse than the competition and the producer will
suffer losses. Likewise, the consumer has the right not to buy a given
product if they deem it not worth the price. What seems to be a
paradox, it is thanks to exclusions that it becomes possible to main-
tain a certain unity and solidarity between members of particular
groups. It is of particular importance for the health insurance market,
because due to the correct risk assessment and a number of other
activities of insurance companies, the insured will be convinced that
their interests are looked after. Thanks to this, they will continue to
pay contributions. Insurance companies will gain their recognition
and reputation of stable institutions that can be relied on in difficult
situations. Departure from this principle will not result in greater
social justice, but only in favouring certain social groups at the
expense of others and the disappearance of the insurance institution.
The question of the trust of members who make up particular social
groups, although he did not directly mean insurance, was well
expressed by Sinek (2009, pp. 114, 122):
only when individuals can trust the culture or organization will
they take personal risks in order to advance that culture or orga-
nization as a whole. […] When we believe someone has our best
interest in mind because it is in their benefit to do so, the whole
group benefits.
This is especially important as the loss of even a small number of cus-
tomers can result in losses for insurers. Usually, people who are already
ill, who try to access certain medical services at a low cost, are more
interested in joining health insurance. Insurance is a more economical
option for them than, for example, direct payments. They may also be
more determined to continue insurance, even in the case of constantly
increasing premiums. On the other hand, relatively healthy people do
not show that much interest in purchasing insurance, as they relatively
rarely use medical services. The difficult role of the insurer is to
rationally evaluate the health risk for these particular groups. The
higher frequency of using health insurance by the insured means that
24 Market processes in the health system
even a small loss of some insured (e.g. persons representing standard risk)
may result in losses for the insurer. For example, it is indicated that in the
United States of America, which has several types of private health
insurance and public programmes, 10% of the population consumes
about 72% of healthcare expenditure, and 2% of the population consumes
41% of healthcare expenditure (Light, 2000, pp. 969–974). The situation
is similar in Poland, where, according to the data of the National Health
Fund for 2009, only 5% of the insured in the public system generated 60%
of all costs. In turn, treatment of 75% of the insured accounted for about
10% of expenses (Dziełak et al., 2010, p. 4). These data show that a rela-
tively small proportion of the insured are able to generate most of the
expenses.
29
Therefore, in commercial insurance, where contracts are
voluntarily concluded, risk assessment is of such special importance.
Therefore, the insurer’s risk is not that a given event will take place, but
whether the frequency of such events (e.g. diseases or the intensity of
using medical services by the insured) falls within the framework assumed
by the insurer. The insurer assumes that a given event will take place and
monitors the level of deviations that occur at the same time. In other
words, for the insurer, the risk will be, for example, that during the insur-
ance period a greater number of people fall ill than assumed, which will
affect the level of treatment costs.
However, in the health insurance market, a situation is possible where
the insurer’s portfolio is dominated by sub-standard risks, if the insured
classified to particular sub-standard risk groups accept an increased
premium for the insurance. Insurance coverage may even apply to events
taking place in the past, if special conditions allow it, e.g. in group
insurance concluded at the workplace, all employees usually form one
risk group with one, average premium. It also often happens that the
employer pays part or even all of the premium. However, this does not
change the nature of the insurance, as the insurer continues to use
advanced risk assessment and constantly monitors the use of medical
services by the insured. Even if a certain group of employees who were
ill before uses insurance, it is possible thanks to contributions paid by
other employees and the employer. If the insurer has not made a mistake
and there is acceptance among employees for incurring appropriate
costs, such an insurance programme, although it has its limitations,
30
is
possible.
Insurers also offer health insurance against very rare risks that affect
a relatively small percentage of a given population. However, if such a
risk occurs, the person concerned will not be able to cover the costs
incurred by themself. Then having insurance makes sense, and the
insurer is relatively easy to assess such a risk, as it does not occur as
Insurance as a market institution 25
often as, for example, the flu. Such events include the risk of developing
leukaemia. It is a very rare disease, but its occurrence is very costly
(Berdine, 2011).
Insurance companies also play a very important role in the accu-
mulation and allocation of capital in the economy. The creation and
evolution of an insurance institution can also be associated with a low
time preference. In the absence of insurance, a person may take action
of gradual accumulation of certain amounts of money towards the
uncertain future. The larger the amounts and if the accumulated capi-
tal continues to grow, the lower the time preference will be for a given
person. On the other hand, insurance allows for a significant short-
ening of this process; they are more attractive, among others, because
they allow for faster accumulation of the necessary funds in a certain
group of people. Insured persons do not have to be afraid that the
occurrence of an undesirable event will occur at a time when they have
not yet managed to save adequate funds, as parallel payments of all
insured persons significantly accelerate this process. Thus, insurance
causes a significant intensification of the positive effects associated with
low time preference. Insurance companies that conduct a reliable risk
assessment, as a result, have significant capital, which they allocate
(invest) appropriately depending on the type of risk. The lower the
frequency of the events, the longer the investment will be. On the other
hand, if there is a significant degree of consumption of insurance in a
given insurance programme, then the time horizon of such investments is
shortened. To some extent, it reflects the attitudes of the insured
and the quality of the assessment and risk management of insurance
companies. The positive contribution of insurance institution to the
development of the capital structure of the economy was also
noticed by Mises (2006, p. 86), who stated that:
A great part of the capital at work in American enterprises is owned
by the workers themselves and by other people with modest means.
Billions and billions of saving deposits, of bonds, and of insurance
policies are operating in these enterprises. On the American money
market today, it is no longer the banks, it is the insurance companies
that are the greatest money lenders. And the money of the insurance
company is—not legally, but economically—the property of the
insured. And practically everybody in the United States is insured in
one way or another.
It is worth emphasizing that in the economic sense, insurance compa-
nies do not perform the so-called transfer of risk, both when accepting
26 Market processes in the health system
a given person for insurance and when investing the funds raised
(net premiums). It is not true to say that the essence of insurance
companies’activity is the transfer of risk. Conclusion of the insur-
ance contract will not result in the insured person no longer having
to worry about unfavourable events, as these have been transferred
to the insurance company from the moment the policy was in force.
The insurance does not eliminate or postpone the causes causing the
given events. It only allows the reduction or elimination of negative
effects resulting from the realization of a given risk. As already
mentioned, the role of insurance is to cover the insured’slosses.Itis
the insurer, not the insured person, who bears the costs related to
the occurrence of a given event, but it is by no means a transfer of
risk. Risk occurs over time; it is not a good that can be transferred
from point A to point B. The expression risk transfer has a certain
metaphorical meaning here and as such is used in the insurance
industry –which is probably intended to be a simplified term for
covering losses incurred by the insured due to the materialization of
a given risk. However, it has no application for economics.
31
The
functioning of insurers on the health insurance market requires the
coordination of many complex processes. Individual insurance com-
panies compete with each other for clients on many levels, ranging
from the quality of economic calculation using probability, and
ending with marketing or sales channels. However, it should be
taken into account that despite the development of the health
insurance market, there are still some factors that effectively prevent
a given insurance product from entering the market. At times, these
factors may be misinterpreted and misinterpreted. Such a case
includes the arguments provided by Hoppe (2009) on the conditions
necessary for the creation of health insurance:
Private enterprise can offer insurance against events over whose
outcome the insured possesses no control. One cannot insure oneself
against suicide or bankruptcy, for example, because it is in one’s
own hands to bring these events about. Because a person’shealth,
or lack of it, lies increasingly within his own control, many, if not
most health risks, are actually uninsurable. ‘Insurance’against risks
whose likelihood an individual can systematically influence falls
within that person’s own responsibility.
While the arguments cited in the text by Hoppe regarding the elim-
ination of state regulations in such areas of healthcare as medical uni-
versities educating future doctors or in the production of drugs and
Insurance as a market institution 27
medical equipment should be considered correct, in the case of dereg-
ulation of the health insurance industry, the presented arguments are
not appropriate. First of all, it should be noted, referring to Lipka
(2013a, p. 87), that ‘Modern methods of insurance risk assessment
enable protection of 97–99% of people applying for insurance, including
many people burdened with various health risk factors’.
Hoppe’s arguments referring to having or not having control of the
insured over their health as a prerequisite for health insurance are very
imprecise. How can the insurer (and the insured themself) check when
this control exists and when not? However, as it has already been pre-
sented, insurance companies create individual risk groups not on the basis
of a clearly defined border defining some kind of awareness of the insured
as to the control of their health, but on the basis of an appropriate risk
calculation. Clients who deliberately try to deteriorate their health in
order to receive an appropriate benefit are certainly characterized by
pathological behaviours. However, their exclusion from insurance cover-
age is determined by economic calculation, namely the lack of acceptance
of other insured persons who do not want to incur higher premiums. The
abstract dichotomy has control –no control has no application here. On
the other hand, how can you then explain people who were ill previously,
but already accepted for insurance? Exactly the same principle as before.
Of course, in this case it is no longer possible to talk about insurance risk,
but about certainty, because the insurer is sure that such persons will
immediately benefit from medical services. However, further, such an
entity will calculate the risk due to having in its portfolio people with
standard or sub-standard risk, who may voluntarily subsidize those who
are already ill. Events covered by insurance are otherwise known as
random events and, as Kowalewski (2001, p. 56) points out:
What is a normal result of human action, in particular action
taken to cause such an event, cannot be considered a random
event. The random event must occur independently or against the
will of the person affected by the event.
Perhaps this is what Hoppe meant, but his argument seems to be over-
simplifying. For example, an insurer by offering insurance covering the
costs of treatment abroad offers the client an additional extension of the
insurance cover by random events resulting from the consumption of
small amounts of alcohol. Therefore, the insured party consuming alco-
hol is aware that the probability of an accident is greater, and although it
does not strive to cause it directly, the line between controlling and not
controlling the risk begins to blur. In turn, the insurer can offer such an
28 Market processes in the health system
extension based on an appropriate risk calculation and a clear definition
of the terms of its liability.
Therefore, in order for health insurance to arise, a given event must first
be insurable, i.e. it must be possible to apply the calculus of probability.
Otherwise, the event will be uninsurable, i.e. it will not be possible to
rationally estimate the insurance premium. Subsequently, it is possible to
indicate the insured risk and the uninsured risk. The insured risk occurs
when it is possible to create a sufficiently large risk group. In the absence
of a sufficient number of applicants, although a premium calculation is
possible, the risk in question is not insured.
It seems that the use of an inadequate description of the rules govern-
ing the functioning of the health insurance market may lead to unneces-
sary misunderstandings with representatives of the insurance industry and
ultimately hinder the introduction of necessary changes. The above
remarks are particularly important as the individual stages of the health-
care reform in the United States postulated by Hoppe are often eagerly
quoted by Austrian School economists in various types of discussions and
polemics. For example, Rothbard (2006, p. 133) points out that: ‘Ludwig
von Mises Institute, instead of offering its own 500-page health plan,
sticks to its principled “four-step”plan laid out by Hans-Hermann
Hoppe (Free Market, April 1993) of dismantling existing government
intervention into health.’Therefore, for greater transparency of such
activities, it is necessary to thoroughly analyse the arguments presented
by Hoppe, which ultimately refer to the proposed changes on the health
insurance market (in the United States of America).
Private and universal (public) health insurance
Insurance is a market institution, that is, one that was established and
evolved on the basis of cooperation. Private health insurance cannot be
confused with the so-called universal (public) health insurance, which is
part of the social policy of states. In fact, there are a number of differences
between private insurance and so-called public insurance.
First, insurance companies use advanced economic calculation using
probability calculus to estimate risk and determine appropriate pre-
miums for individual risk groups. Diversifying premiums, the scope of
insurance, introducing exclusions and limitations is aimed at incurring
costs in an adequate proportion to the obtained and invested pre-
miums. The cooperation between the actuarial
32
and underwriting
33
departments allows for such risk management that enables profit. In
the case of so-called public insurance, there is no risk calculation,
selection, or classification. A uniform, compulsory premium is paid for
Insurance as a market institution 29
