Recently, I’ve heard at least two people communicate some skepticism around the solvency of South Africa’s medical aid schemes. I then started bringing the question up in polite conversation, and was taken aback by some of the opinions that are out there.

Much of the narrative sounds a lot like:

1. I pay Discovery Health thousands of rands a year.
2. And do you know that they refused to pay for my new reading glasses?
3. Bastards.
4. They ought to be strung up.
5. Stealing our money.
6. Offering this good-for-nothing cover.
7. What is the point.

I usually try to respond with something along the lines of:

“You do realise that Discovery Health is not actually the one paying your claims though, right? Discovery Health is just an administrator, for which they charge a fee. The money in Discovery Health is my money, and your money, and the money of every member that contributes to the Medical Aid. The more money that gets paid out for reading glasses, the less money there is for hospital visits, and cancer treatments, and all the other things that money is intended for.”

At which point, I usually get told that I don’t know what I’m talking about. Because somehow, the complainer always *knows* that these *thieves* are *making billions* and *keeping all the profits*.

So I thought that I would dedicate some posts this week to talking about Medical Aid schemes: why they’re important; some of the issues that come from them; and whether we’re facing their imminent bankruptcy.

Why We Need Insurance*
*some of this next part is lifted from an older post. In case it sounds familiar to the long-term readers.

Life is full of risk. Some of those risks are potentially bankrupting. For example: if the risk of you developing cancer is realised, the cost of your treatment could be extreme.

If we all faced that possibility as individuals, then that would generally suck. Especially if you’re the one that ended up on the losing end of the odds.

However, what we all have in common is the fear that it can happen to us, which is what makes space for insurance.

In history, I think that you’d find that the first “insurance” policies were informal. When you got sick, your community/village/church would step in (hopefully) to help out and keep your family safe until you got better – with the unspoken quid pro quo being that you’re expected to help out should it happen to any of the others in your community.

It’s only a logical step from there to whole villages being helped out by other villages in the case of floods, famines, etc.

And eventually, someone entrepreneurial stood up and said “You know what, this would all be a lot easier if we all would just put some communal money aside for that rainy day”.

The idea:

1. Everyone should contribute some money every month into a central pot.
2. When anyone that’s a member of the fund needs a payout, then we’ll give you the money.
3. If you don’t pay in, then you won’t get anything paid out.
4. And if you defraud us, it’ll be the hanging, drawing and quartering end-of-the-story for you, my boy.

The logic behind it:

1. Let’s say that it costs $120,000 to rebuild your house if it burns down.
2. That’s a lot of money for one person to save (ie. to self-insure).
3. But let’s assume that only one house in 100 will burn down every year.
4. If those 100 families club together, then they’d just have to come up with $120,000 annually between them.
5. That’s $1,200 each per year. Or $100 per family per month.
6. $100 per month? Rather than having to fork out $120,000 in the event of someone knocking over a candle?
7. Sounds like a good deal.

Medical Aid schemes are no different. We know that there are devastating forms of illness that are difficult and expensive to treat. And therefore, we club together, pool our contributions, and commit to paying out what needs to be paid out.

And in today’s world, medical aid schemes also need to cover the higher healthcare costs of the aged, in addition to dealing with the devastating illnesses that crop up from time to time.

An example

Meet John and John’s father:

John is a young adult and doesn’t get sick very often. John’s dad has just retired, and goes to the doctor more frequently.

John and his dad have pooled together their money into a family medical aid scheme. They each contribute R5,000 per year, and this covers the full medical costs of the family:

But unfortunately, this doesn’t cover anything other than the current healthcare costs. What if someone gets unexpectedly unwell?

So someone (like the government) says that there should be some reserves kept to cover unexpected healthcare costs. Say, 25% of current claims (this is not a random figure – it’s the current requirement for SA medical health schemes).

There are two options here: either John and his dad reduce the amount of claims that they’re putting through, or they increase their contributions.

Because it’s hard to just “claim less” when you’re unwell, the members vote to increase the premiums:

Which is great. Until the following year, when they discover that medical inflation is 20%, significantly higher than standard inflation, and they’re left with:

Which leaves John and John’s dad in the same boat as last year. Either:

1. Increase the contributions; or
2. Decrease the allowable claims (ie. squeeze the benefits); or
3. A bit of both.

So in case you’re wondering why every year it seems that medical aid contributions go up while the benefits go down…that’s why.

In fact, it’s even worse than that: because as the medical aid members get older, they collectively need more medical attention, in addition to healthcare inflation that is generally higher than normal inflation.

Which exacerbates the problem, because now you’re measuring whatever increases the market can handle against increasing demands for benefits. So the Medical Aids are forced to charge higher contributions and limit benefits in order to remain sustainable.

Either way, the important part is that this is our collective money that we’re talking about – the administrator (whoever it is) is simply spelling out the issues and making the best of it. And also, rather high contributions and fewer benefits than a medical aid scheme that goes bankrupt.

But perhaps that’s just me.

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.