## The hidden subsidy in health care reform

I want to show how Obamacare includes a hidden subsidy for the middle class.

It’s a feature of any insurance system with an individual mandate and government subsidies. The government pays full freight for the poor person’s insurance, but some of that subsidy ends up lowering costs for wealthier people.

Here’s an example of how it works. I’ve taken an extreme case and not tried to tailor it to all the complexities of Obamacare, which would make the matter too hard to follow.

Who benefits?

We have two people, identical in all but two aspects. One is the Healthy Guy, but he can’t afford insurance. This person’s expected health costs are \$1,600 for the year, as you can see in column A. The other person is the Wealthy Guy. He can afford insurance but is not in such good physical shape. His expected health costs are \$5,000 per year.

Column B shows what the two parties should pay in an unregulated world, assuming an 80% loss ratio and perfect underwriting. Healthy Guy would pay \$2,000, reflecting his fine physical condition. Wealthy Guy would pay \$6,250. The total of the two is how much the insurance industry would have to charge to insure both – \$8,250.

Wealthy buys the insurance. Healthy doesn’t have the \$2,000, so he goes bare.

But Obamacare has two features – the individual mandate and community rating. The mandate says Healthy has to buy insurance. Community rating says, in essence, you can’t discriminate because of pre-existing conditions.

Column C shows how much these two would be charged – the same amount. And that amount would have to be enough to cover the total expected cost, \$8,250. So each would be charged \$4,125.

Well, if Healthy didn’t have \$2,000, he sure won’t have \$4,125. He’d rather not buy insurance. But that’s where the mandate comes in. He has to buy it. If he doesn’t buy it, the insurance company has been roped into covering \$5,000 of losses for \$4,125.

But if he doesn’t have the money, how can he buy it? Well, the government pays for it. That’s what Column D shows. The insurer gets a check from the U.S. government for \$4,125 to pay for the Healthy Guy’s insurance.

Meanwhile, the Wealthy Guy pays \$4,125 for his insurance, and he has gotten a good deal indeed. He paid \$4,125 for \$6,250 worth of insurance.

The government subsidy of \$4,125 went entirely to the impoverished Healthy person, but the benefit of that subsidy was split between Healthy and Wealthy. Column E shows how the benefit was split. The Healthy Guy got \$2,000 of insurance, for which the government paid \$4,125. The difference, \$2,125, is how much the Wealthy Guy’s rate fell because the Healthy Guy was in the individual market.

Column F sums things up on a percentage basis. The government paid 100% of Healthy’s insurance, but the Wealthy Guy got a break, too – a 34% discount. In fact, in this example, the Wealthy Guy got a bigger subsidy in dollar terms (\$2,125) than the Healthy Guy (\$2,000).

And Wealthy doesn’t even know it. He probably doesn’t know his own expected costs, and he certainly doesn’t know the expected cost of the Healthy Guy. If he thinks about the Healthy Guy at all, it’s probably to grumble about the good fortune of a Guy who gets a free ride from the government. But both parties benefited, even though it doesn’t seem that way at a glance.

Notice that this system works only because you have:

1. An individual mandate.
2. Government subsidies.
3. Community rating.

Were there no mandate, Healthy Guy would remain out of the market, and Wealthy Guy’s premium would jump back to \$6,250.

Were there no government subsidy, the mandate would be a joke for Healthy Guy. He’d simply stay out of the market. Wealthy Guy would still pay \$4,125 for insurance, but the insurer would incur \$5,000 of losses – clearly an unsustainable situation.

Were there no community rating, the government would simply pay Healthy Guy’s \$2,000 premium, and Wealthy Guy’s premium would be \$6,250.

Now I’ve created a simplified example here to make the point. The difference in expected costs between the insured and uninsured isn’t this generally this great. And the subsidy is not 100% – it’s a sliding scale going up to 400% of the poverty level. I’m not pretending that Obamacare will bring anyone’s premium down 34%.

However, the general analysis holds as long as the uninsured have lower expected losses than the insured. And adverse selection practically guarantees that to be the case.

Now obviously the government’s contribution doesn’t come from the Money Tree in Dad’s Backyard. In this two-person universe, wealthy probably pays most, if not all of the \$4,125 in taxes that the government pays out.

Let’s assume all the money comes from the Wealthy Guy. First, in our example, he gets more than half of it back. With the remainder, he has purchased a moral good for \$2,000.

He has also stabilized the health insurance market, which was until recently an important bipartisan goal in the health care debate. Recall the number of uninsured rose 20% in the past decade, and every year another million Americans lose their insurance. Nothing in our old system addressed that problem well.

Tagged ,

## TweetWeek: Jan. 29

For the past couple of months, I’ve been tweeting a lot of news, usually stuff that I don’t have the time or the inclination to blog about.

Those tweets show up on my homepage, actuarialopinions.wordpress.com. But if you’re getting an RSS feed, you never see them. To receive the tweets in real time, of course, you can always follow me on Twitter (jimlynch9999). But not everyone wants to do that. So I’ve decided to try regularly posting a summary of my (non-blog) tweets.

Here’s what was chirping last week:

To assemble that list right now I have to copy these over from my Hoot Suite account. If anyone knows a better way to get at them, let me know.

Tagged

## S&P mulls the new accounting proposals

A recent analysis from Standard & Poor’s concludes that “changes in interest rates could cause potentially significant swings in earnings and capital.”

The ratings firm said that although its credit analysis focuses on the financial condition of a company regardless of accounting, changes like a new format for the balance sheet, income statement or disclosures “may bring to light information that we would need to consider in our analysis,” S&P said.

Other insights:

• The proposals would allow better comparisons of insurers in different countries.
• Long-term historical comparisons would be difficult, since the new standards are radically different.

S&P is the first I’ve seen to acknowledge the QWERTY problem: Current standards are flawed but sophisticated users know how to adjust for them. And a change creates a steep learning curve.

Like most, though, S&P seems to believe the new standards are worth the effort.

Tagged

## Claim of the week: Salty sandwich edition

A New Jersey appeals court has shot down an appeal by a Tinton Falls man who tried suing Denny’s resturant chain over its sodium content.

Nick DeBenedetto, 49, filed a lawsuit claiming the chain wasn’t upfront about the high-sodium content of its food. The appeals court upheld a lower court’s dismissal of the case.

The three-judge appeals panel found that DeBenedetto couldn’t prove Denny’s had a defective or dangerous product, or that he was harmed.

Tagged

## RIMS: Rates flat in Q4

D&O rates fell 4.6% overall, 5.1% for large companies and 2.4% for small companies.

GL, property and workers comp policies renewed at no change.

But these are renewals at already low rates:

“We have seen more carriers exercising underwriting discipline—walking away from business that does not meet their pricing targets—but it is still a very competitive market,” Robert Cartwright, loss prevention manager for Bridgestone Americas Holding Inc. in Exton, Pa., and a member of the RIMS board of directors, said in the statement.

He said that while premiums have stabilized in recent quarters, they still lag 2003-2004. “In some lines, they are back to where they were during the soft market of the 1990s. It remains a buyer’s market,” Mr. Cartwright said.

## Florida’s HO insurance: Overpriced?

I’d love to say yes.

And Karen Clark’s study of cat modeling, released this week, points that way. Fort Lauderdale’s Sun-Sentinel:

Hurricane risk prediction methods that property insurers use to help calculate premiums were off by \$34.8 billion to \$53 billion the past five years, according to a new report by the founder of the method.

The report is here. And here is the report’s money chart, which shows just how far off the modeling firms have been:

J'accuse!

The first table and chart show how much the major modeling firms overshot the number of storms reaching the U.S. The second table and chart show how much they overestimated losses. From the latter table, you can see that all three modeling firms predicted losses above \$60 billion over the period. Actual losses were less than a fourth that, or \$15 billion.

The implication: Modelers projected too high. The rates insurers set – based on the models – were too high.

Update: RMS responds here (pdf).

The actual story, and Clark’s message, is quite a bit more nuanced.

## Attention, sports fans: When they’re not winning, NY teams lose

Today’s New York Times laments the woeful situation in New York sports:

¶The Knicks were founding members of the N.B.A. They play in Madison Square Garden — the world’s most famous arena, or so the slogan goes. But their record goes like this: two titles in 64 seasons, the last in 1973. So much for the Knicks as the embodiment of the sport known as the city game.

¶The Mets have won exactly two World Series in half a century, their last a tidy 25 years back.

¶When the Rangers won the Stanley Cup in 1994, it had been an epochal 54 years since their last one. Now, they are 16 years and counting into a new losing streak.

So New York is a failure in the sports world, a veritable No-Titletown. It would pose for its avatar wearing a paper bag, except for:

• The Yankees, of course, who have won one-fourth of all World Series.
• And the Giants, who won a Super Bowl in 2008 and a couple others in the ’90s.
• And the Devils, who have won the Stanley Cup three times in the last 15 years.
• And the Islanders, who won four Stanley Cups in a row in the late 70s.

The Times article acknowledges these successes, but asks you to look past them. Otherwise, the story isn’t much of a story.

Pricing actuaries should recognize the ploy, though we’re asked to exclude the defeats not the victories.

Underwriters constantly ask us to look past bad experience, as in, “That was a large loss. That could’ve happened to anybody,” or “You’re going to penalize them for ONE BAD YEAR?”

If you look past all the crummy experience, the argument goes, the experience is good.

Of course, if you remove all of the exceptions, nothing is exceptional. That’s what the Times is doing here, and what the desperate underwriter is trying, too.

So now you can be ready the next time you’re told, “Take away those big losses and the program is doing well.”

Respond, “Take away the Yankees, and New York doesn’t win much.”

Tagged ,

## Aon releases political risk map

The map is highly interactive, but here is a screen grab:

A world of opportunity

The real map is here. It gives you the ability to zoom in on a particular country or region or to highlight countries with threatened by a particular risk. Here for example are countries judged to have a risk of nonpayment of sovreign debt:

Payment in doubt

These don’t translate well as I have to shrink the image to fit the blog’s formatting. But on the main map, you can zoom in to check out an individual country, or you can select that country from a drop-down.

One quibble: After you have zoomed in on a country, all other countries appear gray. That prevents you from gaining any information as you scroll. Once you click on a new country, that country changes to the color representing its risk level. I would have preferred that countries kept their “risk-color” even as you zoom in.

But overall, a fun and informative map.

Tagged

## CIAB: Rates fell 5.4% in Q4

Not much different from -5.2% last quarter. Via Business Insurance.

Tagged

## California’s Big Flood: An overview

Note that ARkStorm – California’s Big Flood – would be a huge public disaster \$725 billion, but as an insurance event, \$30 billion or less. That would be the second biggest cat in U.S. history – smaller than Hurricane Katrina, slightly bigger than Hurricane Andrew.

The scary thing is that, as far as I know, no company has even considered a disaster like this before.

Details, via U.S. Geological Survey:

• Serious flooding occurs in Orange County, Los Angeles County, San Diego, the San Francisco Bay area, and other coastal communities.
• Windspeeds in some places reach 125 miles per hour, hurricane-force winds. Across wider areas of the state, winds reach 60 miles per hour.
• Hundreds of landslides damage roads, highways, and homes. Property damage exceeds \$300 billion, most from flooding.
• Demand surge (an increase in labor rates and other repair costs after major natural disasters) could increase property losses by 20 percent.
• Agricultural losses and other costs to repair lifelines, dewater (drain) flooded islands, and repair damage from landslides, brings the total direct property loss to nearly \$400 billion, of which \$20 to \$30 billion would be recoverable through public and commercial insurance.
• Power, water, sewer, and other lifelines experience damage that takes weeks or months to restore.
• Flooding evacuation could involve 1.5 million residents in the inland region and delta counties.
• Business interruption costs reach \$325 billion in addition to the \$400 property repair costs.
• The final tab: on the order of \$725 billion, which is nearly 3 times the loss deemed to be realistic by the ShakeOut authors for a severe southern California earthquake, an event with roughly the same annual occurrence probability.

Abstract and full report are here.