Health Insurance Rate Hikes and Adverse Selection

I recommend reading the WSJ Health Blog entry entitled “WellPoint’s Argument for 39% Rate Hike: Adverse Selection”, by Jacob Goldstein.  This article explains how adverse selection is causing health insurance claims costs to increase substantially in the individual health insurance market in California. The adverse selection has come primarily in the form of healthy policyholders dropping coverage in the face of job losses due to the recession as the sickest individuals do all that they can do to hold onto their policies. Thus premiums on such policies are increasing (in line with increases in the underlying claims costs) by as much as 39%. This makes total sense because after all, the net effect of this “downard spiral” is that the morbidity risk of the average remaining policyholder in Wellpoint’s California health insurance risk pool has substantially worsened.  In other words, there are real economic factors behind these so-called “skyrocketing” premiums, and it is not due (as some in the Obama administration and news media suggest) to some newfound avarice on the part of various and sundry sleazebag insurance CEO’s who are “putting profits ahead of people”.

Keep in mind that since insurance is state regulated, HHS Secretary Kathleen Sebelius has no legal authority to undertake a regulatory enforcement action against private insurers.  This is why the White House is urging repeal of the health insurance industry’s exemption from the McCarran Ferguson Act of 1945 as part of its latest health care proposal (specifically, see page 3 of the proposal under the section entitled “Strengthen Oversight of Insurance Premium Increases”). Thus the administration’s current political strategy is to create a regulatory “carve-out” of the health insurance industry so that the feds can regulate health insurance premiums.  Presumably the rest of the insurance industry would, for the time being, continue to be regulated primarily at the state level, as has been the case for the past 65 years.

Assorted Links (2/23/2010)

Here’s a list of articles that I have been reading today (organized by topic):

Economics and Public Policy

“Over five years, my research shows an extra $600 billion of public spending at the cost of $900 billion in private expenditure. That’s a bad deal.”

“In an earlier post, I stated that conservatives who decry federal spending are nevertheless loath to name specific programs they would cut.  One exception is Paul Ryan, whose “Road Map for America’s Future” advocates substantial reductions in Medicare and Social Security spending. 

You can read an interview with Ryan in yesterday’s NYTimes.  He’s from Wisconsin, so he’s a cheesehead!”

“At the time of the euro’s launch in 1999, Milton Friedman famously observed that the euro would not survive the first major European economic recession. In the end, Friedman will prove to have been right.

Politics

Unintended Consequences

I am reading a fascinating book at the moment, entitled “Think Twice: Harnessing the Power of Counterintuition” by Michael J. Mauboussin.  The book is about decision-making, and it provides some very useful advice for groups as well as individuals concerning how to avoid making bad decisions that generate (mostly undesirable) unintended consequences.

The following excerpt from Mauboussin’s book (entitled “Unintended Consequences: Feed an Elk, Starve an Ecosystem”) provides a particularly compelling example.  It brings to mind Hayek’s notion of “spontaneous order”, which refers to “…the spontaneous emergence of order out of seeming chaos; the emergence of various kinds of social order from a combination of self-interested  individuals who are not intentionally trying to create order.” (see http://bit.ly/bbJrVf).   In Hayek’s world, the price system plays a particularly critical role in that it helps coordinate the activities of these self-interested individuals.  Unfortunately, in the public sector such price signals are either muted (often due to various legal/regulatory restrictions) or not present, and when this occurs the risk of (adverse) unintended consequences naturally increases (as in the cases described below).  This helps to explain why, as John Steele Gordon points out, government can’t run a business.

Unintended Consequences: Feed an Elk, Starve an Ecosystem

“When you are dealing with a system that has lots of interconnected parts, tweaking one part can have unforeseen consequences for the whole.  Take the example of Yellowstone National Park.  In retrospect, it looks like the park’s woes started when explorers in the mid-1800s couldn’t find enough food in large areas of its 2.2 million acres.  Formally designated in 1872, Yellowstone had seen much of its game – elk, bison, antelope, deer – disappear at the hands of hunters and poachers in the preceding decades.  So in 1886, the United States Cavalry was called in to run the park.  One of its first orders of business was to resuscitate the park’s game population.

After a few years of special feeding and favorable treatment, the elk population swelled rapidly.  Indeed, the animals became so abundant they started overgrazing, depleting essential flora and causing soil erosion.  From there, events cascaded: The decline in aspen trees, consumed by the hungry elk, shrunk the beaver population.  The dams the beavers built were important to the ecosystem because they slowed the spring runoff from streams, discouraged erosion, and kept the water clean so that trout could spawn.  Without the beavers, the ecosystem deteriorated rapidly.

Yet the managers of the park were oblivious to the fact that the elk population explosion was responsible for the trouble.  Indeed, after roughly 60 percent of the elk population starved to death or succumbed to disease in the winter of 1919-1920, the National Park Service overlooked the lack of food and falsely blamed the deaths on another group of Yellowstone residents: the predators.

Taking the situation into their own hands, they killed (often illegally and illicitly) wolves, mountain lions, and coyotes. Yet the more they killed, the worse the situation grew. The population of game animals began to experience erratic booms and busts. This only encouraged the managers to redouble their efforts, triggering a morbid feedback loop. By the mid-1900s, they had all but eliminated the predators. For example, the National Park Service shot the last of the wolves in 1926, only to reintroduce them roughly seventy years later.

And so it went. The bungling supervision of Yellowstone illustrates a second mistake that surrounds complex systems: how addressing one component of the system can have unintended consequences for the whole. Alston Chase wrote about the National Park Service, “They had been playing God for ninety-five years and everything they did seemed to make the park worse. In their attempts to manage this beautiful wild area, they seemed caught in a terrible ratchet, where each mistake made the park worse off and no mistake could be corrected.”

That unintended system-level consequences arise from even the best-intentioned individual-level actions has long been recognized.  But the decision-making challenge remains for a couple of reasons. First, our modern world has more interconnected systems than before. So we encounter these systems with greater frequency and, most likely, with greater consequence. Second, we still attempt to cure problems in complex systems with a naive understanding of cause and effect.

The US. Government’s decision to allow Lehman Brothers, the investment bank, to fail in September 2008 is a good illustration. The government’s position was that since the market largely understood Lehman’s poor financial condition, it could absorb the consequences. But the bankruptcy announcement roiled global financial markets because Lehman’s losses were larger than people thought initially, contributing to an increase in global risk aversion. Even parts of the market that were perceived to be safe, like money market funds, received a jolt. For example, the Reserve Primary Fund, one of the oldest and largest money market mutual funds in the United States, announced it had lost money for its fund holders because the Lehman Brothers debt that it held had been wiped out. The announcement shocked investors and undermined confidence in the broader financial system.”

“Paulson’s Gift”

Professors Veronesi and Zingales at the University of Chicago Booth School of Business have coauthored a new research paper entitled “Paulson’s Gift” which empirically calculates the costs and benefits of the US government’s October 2008 bailout of the financial sector of the US economy.  Here’s the abstract from their paper: 

“We calculate the costs and benefits of the largest ever U.S. Government intervention in the financial sector announced the 2008 Columbus-day weekend. We estimate that this intervention increased the value of banks’ financial claims by $131 billion at a taxpayers’ cost of $25 -$47 billions with a net benefit between $84bn and $107bn. By looking at the limited cross section we infer that this net benefit arises from a reduction in the probability of bankruptcy, which we estimate would destroy 22% of the enterprise value. The big winners of the plan were the three former investment banks and Citigroup, while the loser was JP Morgan.”

Assorted Links (2/3/2010)

Here’s a list of articles that I have been reading today (organized by topic):

Economics and Public Policy

“Obama’s proposals for increasing the tax burden on U.S.-based multinationals would harm our most dynamic companies.”

“…Paul Calello, the head of Credit Suisse’s investment bank, and Wilson Ervin, its former chief risk officer, propose a new process for resolving failing banks.”

  • Stop! (from The Economist)

“The size and power of the state is growing, and discontent is on the rise.”

Foreign Policy

“Recent events and trends within Asia may well portend a stepped up pace for Asian regionalism—and heightened danger that the United States will find itself on the outside looking in.

Politics

“FDR’s war against business showed that a president must choose between retribution and economic recovery.”

Assorted Links (2/1/2010)

Here’s a list of articles that I have been reading today (organized by topic):

The Economy

“It’s the normal V-shaped bounce after a deep recession.”

Economics and Public Policy

“The administration might be settling for superficial progress on financial reform to avoid being on the wrong side of public anger; a better approach would channel the anger into making meaningful reform.

“In some corridors, ‘high-speed’ rail won’t be much faster than trains in the 1930s.”

Politics

“Washington is sick and broken—and it can solve all our problems.”

“Unlike this president, John Kennedy was an ironist who never fell for his own mystique.”

Terrorism

“The real scandal surrounding the failed Christmas Day airline bombing was not the fact that a terrorist got on a plane — that can happen to any administration, as it surely did to the Bush administration — but what happened afterward when Umar Farouk Abdulmutallab was captured and came under the full control of the U.S. government.”