Yesterday, I wrote a post about Medical Aid schemes. I also drew some pictures. The basic summary is this:

1. The money in Medical Aid schemes is not owned by the Medical Aid provider (like Discovery). The money belongs to its members.
2. The provider is responsible for administering the fund: collecting contributions, approving claims, detecting fraud, checking that there is enough money to cover all expected future claims, investing the reserves, negotiating lower rates with doctors and hospitals and pharmaceutical companies, etc.
3. In return for this service, they charge fees.

 
So when someone comes along, and says something like “Let me put in a claim for my cosmetic surgery” or “Let me buy this medication for my friend who is not on medical aid, and see if I can’t get my medical aid to pay for it”, then they are not “sticking it to the man”. They are sticking it to their fellow members.

And when a doctor turns around and insists that the Medical Aid must “absolutely” pay for this procedure, what he means is that the Medical Aid must absolutely pay him.

It’s a classic agency problem.

In a normal business transaction, you have the person who pays to receive a service (the patient); and the person/company who is paid to supply that service (the doctor/hospital).

In a healthcare setting, you have:

• The patient receiving medical attention, who wants no skimping on it;
• The hospital giving the medical attention, which is in the business of making profits; and
• The Medical Aid Scheme paying for the medical attention, which needs to be fair to all its members.

 
This is not ideal. It creates all sorts of perverse incentives, where the patient and the hospital are entirely likely to gang up on the Medical Aid scheme in their demand that top dollar be paid.

But I think we can see how it might be more ideal than the normal business transaction – mainly because if you were paying for your own healthcare, then you’d be transacting under duress.

Think about it:

1. You’re sick or in pain.
2. A doctor says that you’ll lose a limb, or die, if you don’t get some help.
3. The hospital sends you a quote for the treatment, which you’ll need to pay for beforehand.
4. The situation is remarkably similar to a mafioso threatening to blow your kneecap or fit you out with a pair of cement loafers.
5. Of course, the hospital is not threatening to cause the outcome: that outcome is already in progress due to illness or whatever.
6. But as far as duress goes, you’re still faced with a pretty bad choice: pay or die/lose-the-leg.
7. And you have to hope that the medical fraternity won’t take advantage of their position and bankrupt you.
8. The same applies to medication supplied by the pharmaceutical companies.

 
And all you have to do is look at Martin Shkreli to know that the most likely attitude is one of “business is business, nothing personal”.

So we should be quite grateful to the big medical aid providers that administer our schemes. Yes, they pay themselves fees. But if you look at a provider like Discovery:

• They act as an arbiter between anxious patients and healthcare providers.
• Where that doesn’t work, they’re big enough to construct their own hospital networks to compete with the other private hospitals on price.
• And most importantly, they negotiate with the collective purchasing power of their members behind them.

 
At least, that’s the general idea.

An Example

So let’s look at Discovery (their 2014 results, released last year in June):

Looking at those fees:

• Brokers get about 2.5% of your contributions
• Discovery Health earns about 13.3% of your contributions in administration fees (including both the Managed Care and Standard Administration fees).
• That is: Discovery Health earns a gross margin of about 13.3% of turnover – from which they’ll pay for their staff and office rentals and so on.

 
I mean, we could quibble about whether that’s reasonable. But a gross margin of 13.3% isn’t large relative to the margins that other non-healthcare businesses earn…

Just saying.

#ToBeContinued (I want to talk about prescribed minimum benefits and solvency requirements!)

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.