The Amazing Keynesian Resurrection

I am dumbfounded at how talk of taxes and spending is focused almost exclusively on the demand-side stimulus effects rather than supply-side incentives.

This is certainly true for the question of maintaining the Bush tax cuts. Almost to a person, the question hinges on whether the "rich" will spend their tax cuts or save it. Funny how saving is seen as a negative! But even worse is the lack of serious argument on the effects of higher marginal rates at higher income levels on labor supply, entrepreneurial effort, and investment. I had to chuckle when one liberal outlet noted that while some of the highest income tax returns are due to small business income, those returns only represent a minor percentage of all small business. How is that relevant? And maybe we should actually be concerned with those small businesses that are actually profitable?

But the frosting on the Keynesian birthday cake came today with Bill Gross' (head of PIMCO, Pacific Investment Management) propoal for Fannie Mae and Freddie Mac to somehow reduce mortgage rates on millions of mortgages. The rationale? Here it is:

"That [action] would obviously benefit the homeowner to the extent of one-third of its future payments,” he said.

“In terms of real dollars, it’s a $50 billion to $60 billion push or stimulus going forward. In my estimation it would lift housing prices by 2 to 5 percent, which is an important policy objective of the administration.”

So let me get this straight. Since the Federal Government has tapped out the public's appetite for borrowing and spending, let's do it by subterfuge: take from bondholders and give to homeowners. Voila! Redistribution and Keynesian stimulus all at once.

Bondholders should be furious at such ideas. If homeowners want to refinance, let them do so on their own. And if they cannot, well, that is the deal that they entered into.

Information Economics and Medical Testing

I have been talking to some colleagues about the issues around medical tests, in particular whether some tests provide such low quality information as to be of negative value. The PSA test for prostate cancer is a case in point, especially for men of my age. Should men around the age of 50 get the PSA test? My understanding of this test is that it reports a number from 0 to infinity, with higher numbers and a positive rate of change being thought to signal the presence of prostate cancer. Critics of the test note a high rate of false positives.

There are many other situations where medical tests are possible, from full body scans to mammograms. None of these tests are perfect. They will fail to detect cancers (false negatives) and they will signal cancer when none is present (false positive).

There is definitely a community of health professionals who advise many patients to not get the tests – and this is not because the tests fail to provide value in excess of their cost, but because the tests are actually thought to be of negative value even without considering their direct cost.

Note that this idea conflicts quite extremely with an idea that many economists would hold, which is that any information is good. As one of my colleagues puts it: The test has been done, and your doctor has emailed it to you. Would you actually pay for an email filter that would prevent you from seeing that message? If the test has negative value, you would pay for a filter. If the test is of even small value, you would open that email!

This is an important question, of both personal and social value. It deserves adequate consideration. I am going to give some initial analysis, using a framework from Bayesian statistical and decision theory, which I think is the optimal approach.

I am going to begin with what I call a Robinson Crusoe world, where the decision maker acts individually and only in consideration of his situation. So third party effects, such as influence by doctors, will be ignored.

The information setup is as follows. Bear with me if you have not done Bayesian analysis for a while, but it is pretty straightforward. This is all standard stuff; if you want to read more I highly recommend an old survey by two of my UCLA professors: Hirshleifer, J & Riley, John G, 1979. "The Analytics of Uncertainty and Information-An Expository Survey," Journal of Economic Literature, American Economic Association, vol. 17(4), pages 1375-1421, December.

In a Bayesian decision setup, we have three kinds of variables: states of the world; messages, and actions. Here, we will have only two states of the world: cancer, or no cancer. Messages are what the test provides. Now the PSA test is a continuous variable, and later I will return to that characteristic. For now, think of the test as returning one of two messages, m1 or m2. Message m1 can be thought of as a low PSA, below a critical value, while message m2 can be thought of as a high PSA, above the critical value.

There are four possible (message, state) outcomes, illustrated by the two-by-two matrix at the top of this post: Two of these have the message being consistent with the state, (m1,s1) and (m2,s2). Then we have two outcomes where the message is in error: a false negative of (m1,s2) and a false positive of (m2,s1). Note in this I am assuming that m1 is the message that we will think of as being the “no cancer” message, i.e., a low PSA.

The key probabilities for decisionmaking will be the posterior probabilities, which are derived from priors and the joint message/state probability density. More precisely:

(1) Pr (s1|m1) = {Pr(m1|s1)Pr(s1)} / Pr (m1)

(2) Pr (s2|m1) = {Pr(m1|s2)Pr(s2)} / Pr (m1)

(3) Pr (s1|m2) = {Pr(m2|s1)Pr(s1)} / Pr (m2)

(4) Pr (s2|m2) = {Pr(m2|s2)Pr(s2)} / Pr (m2)

Note that the message likelihoods – Pr(m2|s2) for example – are a function of the test’s characteristics and quality. For better information quality, we want large differences in the probabilities of a message conditional on different states.

The last two posterior probabilities are the important ones as they are our posteriors after getting the bad message: the probability of not having cancer dependent on getting m2, and the probability of having cancer dependent on getting m2. Note that these two posterior probabilities will differ from their respective prior probabilities, depending on how far the ratios of Pr(m2|s1)/Pr(m2) and Pr(m2|s2)Pr(m2) are from 1. If Pr(m2|s2)/Pr(m2), for example, is much greater than 1, then the posterior probability of having cancer conditional on getting the bad message will be much higher than the decisionmaker’s prior probability. This means that m2 is a highly informative message.

Now we can consider taking actions conditional on a message. I will presume the action to be “treatment,” with the implicit understanding that that might just mean further testing. The decisionmaker wants to take actions that increase their utility, or well-being.

Suppose we take the action of treatment if we get the bad message, m2. Then we can write our expected utility conditional on m2 to be:

(5) E(utility|action,m2) = GAIN*Pr(s2|m2) + LOSS*Pr(s1|m2) - c

where GAIN is our health improvement from treating a real cancer, and LOSS is our health decrement from taking treatment when we do not have cancer (since we got a false positive test). Note that I do include the cost of the test, c, even though I am most interested in whether the before-cost, gross value, of the information can be negative.

Our expected utility conditional on message 1,

(6) E(utility|no action, m1) = -c

since all we do is pay the cost of the test when we get message m1. I could put an additional cost in here, if there were “angst” caused by the test, but I will pass on that idea for now.

The crux of the issue is illustrated by Equation (5), the expected utility conditional on message m2. The value of the test is going to be greater, the greater is the GAIN from treating a detected cancer and the greater is Pr(s2|m2). The value of the test is going to be lower, the greater is the LOSS from undergoing treatment when we do not have cancer, and the greater is Pr(s1|m2) – the probability of a false positive. (Note that false negatives do not enter our analysis directly, but they do indirectly since the probability of a false negative, Pr(m1|s2) equals 1-Pr(m2|s2), so the lower is the probability of a false negative, the higher is the probability of a correct positive.)

One might jump on the fact that the expected utility conditional on message m2 can be negative, even without considering the cost of the test. This is true, if the LOSS and/or the probability of a false positive are large.

However, we need to take a rational decisionmaking viewpoint. If the expected utility conditional on m2 is negative, then we should just never take the treatment! Granted, we will pay the cost of the test, but as I said at the beginning, some people seem to think that tests can be of negative value even without considering the direct cost of the test. From our point of view here, that cannot be true. Of zero value, that is possible, but not negative.

And there is yet another level to the analysis, which will show even more strongly the likelihood of a strictly positive value to any medical test that reports a continuous variable and that has the property that the test becomes more precise as we increase the cutoff. See this report from Johns Hopkins for some discussion, in particular the following:

"In general, a PSA value of 4 ng/mL is considered the cut-off for suspected cancer (although it may vary slightly by age), and levels above 10 ng/mL indicate very high risk. It is values between 4 and 10 ng/mL that are the most ambiguous; men in this range may benefit most from refinements in the PSA test. The risk of cancer based on PSA levels follows:

PSA levels under 4 ng/mL: "normal"
4 to 10 ng/mL: 20 to 30% risk
10 to 20 ng/mL: 50 to 75% risk
Above 20 ng/mL: 90%."

If the expected utility conditional on m2 is negative, then we should increase our cutoff to reduce the probability of false positives and increase the probability of a correct diagnosis (conditional on getting m2). For instance, if a PSA of 8 was our cutoff in the above analysis, then let’s use a cutoff of PSA=50.

In equation 5, increasing the cutoff will clearly increase our expected utility conditional on m2, for Pr(s2|m2) will increase and Pr(s1|m2) will decrease.

Now it is of course true that by increasing our cutoff, we are decreasing the chance of getting a bad message, that is, of getting m2. So we will be less likely to take action, but when we do, we can be pretty sure that we are doing the right thing.

With a low probability of m2, the overall value of the test may be negative, for we are always paying for the test and very rarely taking action. However, my point again is that the test must have value in the gross, before-cost, sense. Or to use the email analogy, if someone already emailed me the results of the test, I definitely do not want to delete that message before seeing it!

I could bring in considerations of angst of getting a test result that is not high enough to take action but enough to make one nervous, or issues of self-control -- an inability to commit oneself to not taking action (or not worrying) if the test result is not extremely high. But that will be for another discussion.

Can Someone Explain Why Net Neutrality Makes Sense?

Google and Verizon have made a proposal to deal with access over the internet.

The proposal says Internet providers should treat all providers of Internet content the same, and should not be able to block them or offer them a paid “fast lane.” It says the Federal Communications Commission should have the authority to stop or fine those who break the rules.

Eric Schmidt, head of Google, justifies their position with this:

Freedom from such discrimination is crucial for consumers and for fostering innovation among Internet entrepreneurs, said Eric E. Schmidt, Google’s chief executive, in a conference call with reporters. “The next two people in a garage really do need an open Internet,” he said.

Yes, and the next two guys in a garage also need free access to a supercomputer, lots of talented college graduates, and venture capital funding at TBill rates.

I suspect strongly that some consumers and some providers of content value the speed of access more highly than others. Economic efficiency calls for them to get that, so long as they pay the cost. Perhaps CEO Schmidt and others assume that their proposal will somehow result in everyone getting the technologically fastest access possible, regardless of cost? More likely, we will all get a mediocre level of service.

The US Postal Service has always given equal service at the same rates for urban and rural customers, even though the costs obviously differ. And Ma Bell (AT&T for youngsters) gave basic access to the phone system at the same prices.

I note that Ma Bell no longer exists in its same form, and the US Postal Service is about to die (only a slight exaggeration).

So I remain unconvinced. If I want to go faster than someone else, or let my customers go faster, why can't I buy a Corvette?

Sound familiar? Mark my words -- the next crisis.

President Obama today launched a call for more Americans to receive a college education:

"That's why I'm absolutely committed to making sure that here, in America, nobody is denied a college education, nobody is denied a chance to pursue their dreams, nobody is denied a chance to make the most in life just because they can't afford it," Obama said. "We are a better county than that, and we need to act like it."

Hmmm....So what were the critical elements of the subprime crisis? A push on the part of the US government to increase home ownership, especially among segments of the population that had traditionally not owned houses or held mortgages. A huge subsidy from the government to those who borrowed to buy a home (through FannieMae and Freddie Mac and through home mortgage interest tax deductibility). An industry of subprime mortgage brokers who, fed by large up-front fees paid for mortgage origination, found millions of willing borrowers -- even though the brokers often knew that the loans were not appropriate and had little chance of being repaid, unless home prices continued their seeming relentless climb.

What do we have with education and student loans? Well, certainly the push for more to attend college (do we remember the studies showing that home ownership leads to all kinds of social good?). We have a subsidy, in the form of student loans -- and with the recent changes in the student loan program (packaged as part of the health reform bill !!), those loans are made and owned by the US government. In the subprime mortgage industry, FannieMae and FreddieMac decided to dramatically increase their purchase and repackaging of subprime mortgages in response to the Federal government's wishes: if your boss wants more home ownership, you better not stand in the way. It is still unclear how the new Federally owned and managed student loan program will work out. In the old days, private banks made student loans. Now it will all go through the Feds, with the taxpayer on the hook through our general taxes. If the Federal government wants more Americans to attend college, how do you expect the political appointees in charge of student loan origination to behave?

Last, we have a growing industry of what I will call subprime educational institutions, or degree mills. These institutions, whether for profit or nonprofit, will benefit from enrolling students, helping them navigate the Federal student loan process, and collecting tuition. The increase in demand for degrees is palpable, and supply will increase to meet the demand. These degree mills will lack significant "skin in the game" just like subprime mortgage brokers -- they will enroll students who have little likelihood of benefitting from the program or even graduating. But tuition is collected up front, and then it will be up to the Feds to collect on the student loans. Even some of the better colleges and educational institutions will be tempted by the increase in demand, and new technology -- online education -- makes it even easier to provide the coursework (for subprime mortgages, the technological innovation was in software to process mortgage applications).

Hell, we even have the equivalent of the credit rating agencies -- let's call them Educational Testing Service and ACT, Inc. What -- there are only two main educational testing services? That is even less than the three main credit rating agencies!

Oh, and the new student loan reform also gives subsidies to those student borrowers who take work in public service, and it caps payments at 10% of income.

All of this reform is promised to save us, the US taxpayers, lots of money.

I have a bridge in Brooklyn you might be interested in.

Multiple Choice: An Airline Pricing Question

It appears as a stylized fact that airlines are getting an increased portion of their revenue through pricing channels other than the "basic ticket." Examples: baggage fees; ticket change fees; food and drink charges; charges for pillows and blankets; optional and priced plans for early check-in; charges for extra leg room. Kevin O'Leary of discount carrier RyanAir has repeatedly suggested charging for the loo, but I don't think that has been implemented yet.

Why the increased reliance on these new revenue channels?

a) Behavioral economics: Consumers don't notice such charges as readily as ticket prices. (I try this with my cat -- hide the pill in her food, but she outsmarts me every time. But don't let me influence your choice; cats might be smarter than people. One of my favorite econ profs used to famously tell his graduate students: You all think you are smarter than dogs, but you aren't -- you're just quicker.)

b) All these things have positive marginal costs, so the airlines are simply learning to price services in line with their costs.

c) Price discrimination. People who travel with lots of bags, for e.g., are more likely to have an inelastic demand for travel, so use baggage charges as a price discrimination scheme. This is similar to IBM in the old days charging their mainframe computer users by the number of "cards" that they consumed. (For youngsters, in the old days, data and even programs were coded onto paper cards and fed into computers. Yes, it was a pain in the butt.)

d) That perennial issue of taxes, and avoidance thereof. According to an IRS ruling in January, the kinds of fees being discussed are not subject to the 7.5% airline transportation tax. See here for details on the ruling, including the IRS private letter.

e) Because they can.

And the answer is.....

On the Proper Role of Government

As reported in CNET:

On Thursday, Sen. Charles Schumer (D-N.Y.), posted an open letter to Apple CEO Steve Jobs, expressing "concern" over the iPhone 4's reported reception problems.

Need we say anything more?

Goldman Coughs Up

So Goldman Sachs wil pay the largest penalty ever assessed on a Wall Street investment bank, $550 million. By settling with the SEC, Goldman avoids going to court with the government. I imagine however that there will now be a slew of private suits, even though investors will get $250 million and the US Treasury the rest. Goldman states in the settlement document,

"It was a mistake for the Goldman marketing materials to state that the reference portfolio was 'selected by' ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse to CDO investors. Goldman regrets that the marketing materials did not contain that disclosure."

This is exactly what I have said all along. Their marketing materials were clearly deceptive. Nobody with good conscience should have prepared those.

Now GS has to follow through with some employee discipline.

Subsidize the Media?

Lee Bollinger, ex-Provost of Dartmouth College and current President of Columbia University, wrote in an editorial in the Wall Street Journal that we should consider public funding of the press.

You cannot be serious.

Sure, I can see the arguments -- we fund research in academia, and that is unbiased. Plus we fund NPR and hey, the British have the rock solid BBC. As an economist, can't I see all the positive externalities coming from the New York Times?

Bollinger states that in regard to public funding of academic research,

...there have been strikingly few instances of government abuse. Indeed, the most problematic funding issues in academic research come from alliances with the corporate sector.

Well, I wonder what evidence he has to support this claim. In my view, government funding of research is great at pushing forward the mainstream, generally accepted vision. Climate science is a great example.

Bollinger's argument shows why you cannot use the standard kind of economic efficiency arguments on everything. If we agree to subsidize everything that gives positive externalities at the margin, where will we stop? There are way too many activities that generate benefits that cannot be appropriated through market transactions. A free market is not going to be perfect in that regard. But holding it to the standard of optimality is not right. We have to compare it to the real alternative, which would be public funding of some activities. Can you imagine what it would look like if we were to start funding the media. (Hint: What would happen to Fox? Or Drudge?)

PS. There once was a time when I used to listen to the BBC on a shortwave radio, they were so good. That time is long past.

iPhone on June 24th

The prices he gave were $199 for a 16gb model, $299 for 32 GB. Decent.

Looks like its new phone time. The FaceTime program is really neat.

And here is a picture that Jobs showed, I took it from macrumorslive.com, where I was following Jobs' address. Note that Tuck's Bridge program is all about the intersection of business and the liberal arts. Maybe Steve needs a third dimension: business, technology, and the liberal arts. Nice.

Video Calling -- How Cool is That?

I'm watching a live blog of Steve Jobs' address to the WWDC in San Francisco.

He saved one of the coolest features of the new iPhone for last -- video calling.

Are we in the 21st century or what?

An Insurance Story

I busted one of the panes in the rear window of my Toyota Tacoma yesterday. I was putting a piece of cedar decking into it, and just nicked the edge of the window -- shattered it.

Called a window replacement service and almost had a heart attack: $1200 for the Toyota OEM replacement window. $1200 for one stupid Finlander moment?

But...I could get a third-party replacement, installed, for $295. A call to a second service confirmed the OEM price but got the third party window down to $220.

Now isn't that amazing. The OEM window costs 5.5 times as much, and we are not talking small change here. There might be some, hopefully minor, quality difference -- on the fit, most likely. I will find out tomorrow when I see the window.

Why the huge price difference? Two things. One, a monopoly position in the OEM window, due to the brand of Toyota. Second, insurance. Most people with comprehensive insurance will just pay the deductible and will therefore go for the more expensive but brand name window. Me, I cannot justify sending that kind of money to Toyota no matter who is paying, so even though I have comprehensive, if that third party window is OK it is going in.

What a lesson in what insurance can do to demand and prices! Do we wonder why medical services cost so much?

One of my colleagues had a very interesting proposal for health insurance that I have not come across. There are proposals to pay health care providers a lump sum -- bundled payment -- for a patient with some diagnosis. Say you need a hip replacement; then your insurer would pay the provider a lump sum of like $12,000. My colleague takes this one step further: he would have the insurer pay the patient the $12,000 and let them get their hip replaced wherever they wish.

That would create some very neat incentives! The problems, and they are important, are several. Foremost is the risk that the lump sum won't be enough to cover some complications. That puts additional risk onto the patient. Second might be the issue that some folks would rather take the money than the new hip. So we would have a nation of limping, but wealthier, elderly.

More on Carried Interest

I received the following comment on my initial post on carried interest:

One way of framing the carried interest question is to find the policy that preserves
the favored tax treatment in the aggregate. If I hold an index fund, my dividends
are taxed at a 15% rate and my realized long-term capital gains are taxed at a
20% rate. Now suppose I hire you to pick my stock for me. However we tax you,
there should be a consistency so that the aggregate dividends and capital gains
are still taxed in a favored manner.

My way of thinking of this would be the following: Suppose a set of friends get together to buy stock. There are five of them and they each put up 20% of the capital. They do well, and decide that one of them who has been bringing the best advice to the group should become the "general partner" and do most of the work. For that, the other four agree to reduce their share of any portfolio gains from 20% to 18%, so that the fifth partner will get 28%.

Since the aggregate capital gains are still the same, the argument above would imply that the manager/GP in my example should get capital gains taxation on his 28% just like the other four "limited partners."

This is a nice analogy, and analogies are nice for framing the issues and perhaps particularly for thinking about horizontal equity issues (are folks in this situation being treated similarly to folks elsewhere doing essentially the same thing?).

But this argument does not trump, for l return to the issue of economic efficiency -- what activities do we want to favor from an "activity level" point of view? By giving our newly minted General Partner the ability to get capital gains treatment on his larger share of the pie, we are enabling division of labor in investment activities. If we made the GP pay ordinary tax rates on any larger share he was given by his partners, we would reduce the incentives the partners would have to take advantage of comparative advantage and specialization.

Do we want to encourage such division of labor? Well, that is the question -- do we want to encourage the supply of specialized labor into management of private equity and venture capital? Perhaps. Capital gains rates are low after all because we want to encourage long term investments over short term.

The Carried Interest Dilemma

A couple colleagues and I were discussing the "carried interest" issue today. In a nutshell, a private equity firm, and other investment vehicles as well, such as venture capital firms, are organized as a partnership, with limited partners (LPs) providing the cash to invest and the general partner (GP) providing the management (and maybe a little bit of cash). The GP is often compensated in two parts, as memorialized in the phrase "2 plus 20": the GP gets 2% of the assets as a management fee, but they also get 20% of any gains when the investment is closed out.

The controversy is over Federal taxation. Now, the 2% is taxed as ordinary income (high rates!) and the 20% is taxed at capital gains rates (lower). Many folks feel that is unfair, letting these rapacious private equity fellows pay such low taxes on huge capital gains.

Before going too far into this, the right question of course is: what will be the different economic outcomes of different tax policies, and what do we think of those outcomes? Fairness is not foremost in my mind -- incentives, behavior, and outcomes loom larger.

It is not hard to think of analogies where similar compensation is paid. The taxation of those situations is instructive. For analogies, how about employees' grants of stock or stock options? Suppose I give stock to an employee, to create incentives for her to increase value. At the time of the stock grant, my understanding is that the value of the shares at that time is income, taxed at ordinary rates. Any capital gain in the stock would be taxed at capital gains rates, assuming the holding period was long enough. If I give the employee options, there is generally no tax due with the option grant, but when exercised, the difference between strike price and market value is ordinary income, unless the stock obtained through exercise is held for a certain period of time.

Another interesting case to consider would be if I lent money to an employee with the requirement that they use it to buy stock. My guess is that what would be taxable at ordinary rates here would be any difference in the interest rate charged the employee versus market rates. If there was a capital gain on the stock, then those would be taxed at capital gains rates.

This latter situation is close to what is happening with private equity. The GPs are being given an interest free loan to buy 20% of the portfolio. They should certainly pay taxes on that interest free loan.

A paper that comes to this conclusion is: Cunningham and Engler, The Carried Interest Controversy: Let's Not Get Carried Away, 61 Tax L. Rev. 121 (2007-2008).

But there is more than just the interest free loan, as the GPS essentially get to buy the shares at a zero price as well.

The more appropriate analogy seems to be the options one. The GPs are being given a call option on 20% of the portfolio, with a strike price of zero. Following the employee stock option tax policy, the grant of the option is not a taxable event. But when the option is exercised, it would be taxed at ordinary income rates, unless the GP somehow maintained their investment position for a period of time after that.

The idea of not taxing the granting of the option but taxing the gain at ordinary rates seems a nice balancing of our desire to stimulate incentives for creating long term value against the creation of excess incentives to enter one specific industry or profession. The tax advantage is essentially one of deferment of taxes -- no tax liability upon grant of the option, but upon exercise.

I think this solution balances nicely the incentives we want to preserve for investments that create value against giving excess incentives for supplying talent to certain industries.

Apple the Second Largest Company by Equity Value

Many stories have reported that Apple today overtook Microsoft in the market value of its equity.

What is more interesting is that Apple is the second-largest company in the US by market value of equity -- second to Exxon Mobil. See here.

Including debt to get total company, or enterprise value, would change the rankings as Apple has no debt and Microsoft has some. And of course other companies may have a lot more.

But it is still very impressive for a company that was almost dead a little over ten years ago.

I still remember the first Apple I bought...an LC 475. It had something like 4mb of ram -- I had to always play around, shutting off some of the built in system components, to get it to run certain programs. That was the first machine I bought for home use, and I have never bought anything other than an Apple since.

Nuke the BP oil leak?

I think BP is in big trouble, as is the Gulf of Mexico. It is a real tragedy for sure -- the only surprising thing so far is the seemingly small amount of actual damage to wetlands, beaches etc. Perhaps I am not paying enough attention, but the internet is not exactly overwhelmed with pictures and evidence of oil everywhere.

But the stories starting to come out on how BP folks made ill-fated decisions that possibly led to the disaster are scary for the company. Larry Kudlow on CNBC has been railing against BP for days on end...he just referred to them as an enemy of the US. Now that is because of something the company is supposedly doing in Iran, but Kudlow mixes Iran and the Gulf in a pretty vitriolic diatribe against the company.

Then there are these stories about how Russia used tactical nukes to stop blowouts back in the USSR days...supposedly did it five times and it worked four out of the five. Hmmmm...what about that fifth time?

Here is the Russian newspaper story that I guess discusses the use of nukes in blowouts. If you cannot read Russian, try this. Where is Red Adair when we need him?

Cyanobacteria in lakes vs. bacteria in pools

The local vigilantes on my beautiful New Hampshire lake have been spotting and reporting cyanobacteria blooms for two years now. Cyanobacteria are naturally occurring bacterial that do at times give off toxins that can cause harm to mammals. Dogs have been known to become sick, although I am unaware of any confirmed cases of human illness. Last summer I got very concerned when some local researchers reported -- in an unpublished paper that nonetheless got much local press-- a statistical correlation between living close to freshwater lakes and onset of ALS, or Lou Gehrig's disease. I don't know where that research now stands, but in my considered opinion it suffered from serious defects. One of these potential defects was the way cases of ALS were reported. I actually got an email from someone on my lake who said that anyone knowing of ALS cases around our lake should report them to the researchers. Hmmmmm....I wonder if a similar email went out to folks who don't live near a lake?

Anyway, the risk from cyanobacteria is incredibly small, especially if one doesn't swim directly in visible blooms (I like to cite a WHO report that said if you are standing in kneedeep water and cannot see your toes, you probably should not go swimming. Hell, even those of us from the UP would figure that one out!)

But finally, the CDC has come out with a report saying that 1 in 8 public swimming pools pose immediate infection risks.

I always told people who asked about cyanobacteria in my beautiful clean Goose Pond: maybe if you are worried you would prefer to go to the pool at Storrs Pond in Hanover and swim in chlorinated water that a bunch of little kid have....well you don't want to know.

Risks are everywhere.

Is Greece Facing a Liquidity Problem or it it Truly Insolvent?

I imagine that the Jean-Claude Trichet has dealt with more pleasant situations than the one over the weekend.

Last week, Mr. Trichet was broadly quoted as saying that the European Central Bank had not even considered the option of buying European government bonds.

Today, the ECB announced that it would indeed be buying government bonds, but that the Bank did not bow to any pressure in coming to this decision -- see here for a sample of one of the hundreds of stories.

OK, no political pressure but certainly a lot of bond market vigilante pressure!

The issue for the US back in 2008-09 was whether banks were insolvent or illiquid. The line there is a gray one to be sure. I support the lender of last resort stepping in during liquidity crises, which in modern banking systems are inevitable, but not to rescue truly insolvent institutions.

The question then is: is Greece insolvent or just illiquid?

This looks to me like massive monetization of European debt, which will not be good for the Euro. And, unlike the US, much if not most of Europe has very little leeway for additional taxation. The US can solve its debt problems, in the worst case scenario, by increasing taxes, most favorably through a VAT. I am certainly not advocating that we do this; I would prefer to see the pressure kept on to cut spending. But if need be, I think the US could raise several percentage points of GDP through a VAT with very little cost to the economy. I don't think that Greece, or many other European countries, could do that.

Seems to me that insolvency is the more likely situation, and bailing out insolvents cannot be good policy. The only offsetting arguments are that the state of the markets do raise liquidity issues for other countries, if Greece were to be let go.

Tough decision for the ECB.

Are Apple's Actions Anticompetitive? Doubtful

As has been widely discussed, it appears that Apple will be preventing iPhone applications developers from using anything other than Apple-approved development tools -- ruling out, among other tools, Adobe's Flash CS5. See here for more of the facts and here for more editorial comment.

Do these kind of restrictions rise to the level of being anticompetitive in the sense of antitrust? Let me sketch some possibilities, none of which I think make for a reasonable business strategy nor do they meet any kind of anticompetitive test. The most likely explanation is a very non-strategic one, simply that Apple wants to make sure that its iPhones and iPads meet the kind of quality test that its vertically integrated Mac platform does. Applications can impact the overall user experience in a variety of ways, and Apple has all the incentive in the world to make sure that they do not impair performance.

It pays to go back and re-study the Microsoft antitrust case. There, the government's claim was that Microsoft was excluding other internet browsers such as Netscape from the original equipment market, mostly by bundling its own browser (Internet Explorer) with its operating system, Windows. The alleged reason for this exclusion was Microsoft's desire to protect its market power in the operating system market. Interesting - the actions were not designed to gain market power in the browser market, but to protect a position in operating systems. Supposedly, Microsoft feared that as other browsers got traction, software developers could write applications that would interface directly with the browser (so called middle-ware) rather than having to interface with the operating system itself. Once applications could be written for browsers, Windows would potentially face more potential entry into the operating system market, since new operating systems would not face the chicken-and-egg problem of not having any applications that could interface with it. That is, the argument was that Windows had a nice network externality working for it, through software developers, and the middleware concept was seen as a threat to the market power that that network externality conveyed.

Now this is not the only possible angle to thinking about Apple and the exclusion of non-approved development tools, but it is an interesting one to consider. That is, could Apple be excluding some development tools to protect its position in a related market?

What market might Apple be trying to protect? Maybe its the Applications Store platform? This is what the post by John Gruber linked to above builds on. Can one build a coherent argument that Apple is restricting development tools so that the Apps Store becomes a standard, for purposes of exploiting market power? This is not unlike some of the earlier antitrust claims, more popular in Europe, that Apple put restrictions on iPods and iTunes so as to lock customers into both platforms.

I think there is one big weakness in any anticompetitive angle to this story, and that involves the inherent lack of power of a standard on an applications store platform. Recall the essential source of market power in the Microsoft story: the software development network externality, whereby the fixed costs of writing for different operating systems gave the operating system with the largest installed base an insurmountable advantage.

I cannot see anything working the same way in the mobile phone applications market. One possibility would be to get all developers writing for the iPhone platform, thereby giving the iPhone and iPad the chicken and egg externality benefit. But the mobile phone market is way too competitive for this story to hold water. The market share of iPhone is around 25%, with very strong competitors. Maybe for the iPad, but that is a whole new market that is too early to even assess for viability. I also do not know how much credence the "fixed cost of development" story should be given here. With Microsoft, I could see that writing something like a whole new spreadsheet package for a new operating system, and overcoming the advantage of installed base of existing products, would be a real challenge. But for mobile apps? Are the fixed development costs really going to prevent apps developers from writing more than one version of a product, if there were two platforms with different requirements? Isn't the gaming market a point against this argument, with popular games being written for the different platforms all the time?

Maybe the Apps Store market itself? Could Apple be trying to protect a dominant position in selling applications? Doubtful. For one, if that were the objective, I fail to see why restricting product would be beneficial -- does Amazon restrict products from its site? Second, it is way too easy for competing applications stores to launch and compete.

I am left with Occam's Razor, having to accept the simplest explanation: Apple wants to approach what it would have with a fully vertically integrated chain from hardware to operating system to applications. That means putting some restrictions on the applications.

There's an Ad for That!: Apple's Amazing Innovation Juggernaut

Apple was on a tear this week. Last Saturday, they had a very successful launch of the iPad, opening up a whole new category for exploration and innovation. Our lives, in short, just got even more interesting and better. Then later in the week, they gave a preview of the new iPhone operating system, which powers not just the iPhones but the iPad as well.

Among the new features was an ability for application developers to include advertisements that run inside of applications. This takes the amazing evolving world of mobile applications to a new revenue-generating level.

The opportunities are going to be pretty incredible. Advertisements will be able to use the GPS capability of the iPhone. So, if you are using an app that looks for restaurants, and you are standing in Marquette, Michigan, well then I would hope that Jean Kays Pasties on Presque Isle Avenue would drop you a nice little note inviting you in to try one of the Upper Peninsula's true delicacies.

Think of how this is a change from Google's search-based advertising. With Google, ads are focused on the search terms that you type in. With Apple, the ads are tailored based on the app you are running (and there are thousands of those) and then the infinitely variable physical location. Plus who knows what else?

The other thing that Apple did was to take another step in the standards war going on over HTML and Adobe's flash. Apple will restrict developers to using programming languages approved by Apple, and that is presumably not going to include Adobe's package that converts Flash based apps to run on the iPhone. I am not quite sure what is going on here, but certainly Apple's control of the entire vertically integrated package of software and hardware has been key to its success so far. I can see obvious potential for some third party programs and languages to impinge on the overall value of a device, from the consumer's perspective. Whether Flash presents those problems, or if something else is going on, that I cannot say.

Stupak to Retire

More fallout from the health care bill. This time, Representative Bart Stupak of Michigan has announced -- or will soon announce, I guess -- his retirement.

Stupak it turns out represents my home territory, the Upper Peninsula of Michigan. I thought I recognized a faint Yooper accent. I saw him on CNN yesterday while he was giving a speech in Bessemer, Michigan.

Well, well. Interesting times for sure. Stupak was the leader of the pro-life argument against the health care bill, and had been leading a bloc of pro-life Democrats against the bill. At the very end, he voted for the bill after getting the promise of an executive order from the President that promised to continue current Federal prohibition against financial support of abortions.

Folks will have different takes on what this means for, well, just about everything. The weekend papers will make for good reading.

An Important Referendum in CA

Steve Chapman writes in the Chicago Tribune about the upcoming ballot initiative in California to legalize possession, growing and sale of small amounts of....marijuana!

Now I think there is the small problem of Federal laws against drugs like marijuana, but I am guessing the cooler heads in the Obama administration might decide that it would be better to let CA give it a shot.

What a noble experiment that would be. Question: what would happen to anyone in prison for possession or sale of amounts that would now be legal?

Lights Out!

A while back I got an email from my neighborhood association that had the bright idea to get rid of our street lights. The thinking behind this brainstorm was twofold, one being to combat global warming and the other being to save money.

I replied with what I thought was a pretty witty piece about taking us back into the Dark Ages. While I would support preserving the night sky for stargazing, I could not see any evidence for significant cost or carbon savings, certainly not enough to offset the disadvantages of dark streets. The idea seems to have died, as the neighborhood is still lit at night.

But I must have been wrong, as now the whole world is turning out the lights. I can't wait for someone to estimate the additional crime and accidents that will occur during that hour.

The Health Care Bill

It should not be all that surprising that we finally got a health care bill passed. Before the Scott Brown victory in Massachusetts, the House and Senate had already passed separate bills; all that remained was to combine the two. The House had the courage to pass the Senate bill with the hope that a reconciliation bill of some kind will remove the most egregious parts of the Senate bill.

The opposition of the populace, as measured by polls and other more informal means, ended up being set aside in favor of the hope that by November all will be forgotten, by a respectable belief on the part of some that the bill is really good for the country, and no doubt by a lot of armtwisting and dealmaking on the part of Pelosi, Reid and the President.

I do believe that the Anthem/Wellpoint increases in individual insurance rates in California, discussed by me in prior posts, played a not-insignificant role. Those increases pointed to the failure of the individual insurance market and defused some of the critics of the bill. The President and others hammered on those increases as evidence of what would happen if the bill did not pass -- and to extent they are correct; the individual markets are in a bit of a death spiral due to adverse selection and other issues.

I would really like to see a news reporter did into that Anthem decision to see if the Anthem folks understodd the gravity of their decisions at that time.

But this is now all water under the bridge.

On the positive side -- always an optimist -- the bill does some good. I have said for some time now that this country passed the point of not wanting to have all citizens have decent health insurance. This bill goes a long way to fixing that basic social safety net issue. Let's not deceive ourselves, however, there will still be a lot of uninsured people, just as there are a lot of folks who do not file their tax returns.

And there is no doubt, as I note above, that the individual and small group health insurance market was headed for disaster. That was making it extremely difficult for self-employed people and for small businesses (if you worked for an employer who did not offer insurance, you had to buy it on your own in a lemons market). That probably induced many people to work for large companies rather than striking out on their own. Removing that wedge between self-employment and working for large companies could be good for entrepreneurship and innovation. I have little doubt that access to health insurance was a large factor in many decisions as to what kind of career to pursue, at least at some point in one's life.

If the new exchanges function well, my hope is that the bill will be altered in the future to allow people in companies that offer plans to buy insurance from the exchanges as well. As the bill stands, that is not allowed (I am not sure why). If that would happen, then the link between place of employment and health insurance will indeed be broken. That in my mind is one of the better things that could happen. Sorry, but I just don't believe that an employer has the ability or incentives to offer me the best kind of insurance. I don't have Dartmouth offer me retirement investment services; they just give me a portion of my salary and let me invest it in my choice of independent, professional investment funds. Health insurance should be handled the same way.

It is too bad that the tax on plans was taken away because of union opposition (well, postponed until some time well in the future). To reduce demand to a more natural level, we need to remove the 25% - 40% subsidy given to purchasers of insurance through the exclusion of health benefits from taxation. I suspect that this tax will get moved up in time as the costs of the new bill become obvious. Get ready, but it actually is a good thing (maybe next they will remove the interest deduction for first and second homes as well?).

I have to look through the bill to see what provisions there are on the supply of doctors. I really worry what is going to happen with another 20 million or so people putting unlimited demands on an already-stretched health care system. This is not the time to be without a physician, for sure -- line one up now. And, I suspect that in the future, because there is going to be more nonprice rationing, WHERE you live will become almost as important as what company you work for, in regard to having access to medical care. I suspect that health care is going to become very similar to public schools, with location being very important and with a two tiered system emerging as well.

So, we are off to a brave new world. At least Americans can now walk through Europe without being thought of as monsters who don't provide health insurance to their neediest of citizens. And there will be some interesting possibilities for innovation and efficiency in this new system.

Is This How History Will View Bush?

Interesting editorial by Richard Grenell in Al Jazeera on the current Iraqi elections.

On January 10, 2007, George W Bush, the then US president, defied critics and ignored popular opinion and political polls in the US by committing more than 20,000 additional American troops to the war in Iraq.

"The Surge," as it is commonly called, has since been credited with bringing the Iraqi people more security, less violence and greater freedoms. By July 2008, the surge was heralded as a success from Baghdad to Boston.

Grenell also has some choice quotes from Obama, Biden and H. Clinton on their view of The Surge.

There is no doubt that the war was costly and the planning and handling of the immediate post-war situation was pretty well botched. Also, the rhetoric for the war was unfortunately focused too much on WMD instead of the facts of S. Hussein's greater non-WMD threats to peace, security, and freedom.

Run the counterfactual for me, please. What if the US had not invaded Iraq back in 2003? Quick bottom line: would the Middle East and the rest of the world be more or less secure than we are now? Would the prospect for longterm peace, security and freedom in the Middle East be more or less than now?

Obama's Unrelenting Rhetoric Against Insurance Companies

Obama today steps up again to rail against insurance companies "arbitrarily and massively raising premiums."

This is so deceitful, and the President and his advisers know it. Larry Summers ought to be ashamed to have this kind of rhetoric being used for purely political purposes.

Insurance companies are not the reason for the rising cost of health insurance any more than the local grocery store is the reason for the high price of orange juice after a freeze in Florida.

Folks might want to explore the situation in Massachusetts, a state that passed a mandatory health insurance law a few years back. The Boston Globe reports today about health insurance price increases in that state that range from 8 to 32 percent (in the text, one individual reports an increase of 40%). The Globe even notes that

Even as businesses and individuals feel the pinch of surging health costs, three of the four largest state health insurers last week posted financial reports showing operating losses for 2009.

It appears that consumers in Massachusetts got a gift last year from their rapacious insurance companies -- health insurance at below cost prices. That, of course, cannot continue.

Even more scary about all this is that the spectre of price controls has risen. The Administration added language to their insurance proposal that would allow the Federal government to review price increases by insurance companies. Massachusetts is reviewing all increases that exceed 4.8%. Real price controls are not far behind.

I suggest that if Obama cannot get a straight answer from the insurance company CEOs he listen a bit more carefully, with an open mind. Or maybe he can start by reading the several page letter that Wellpoint put out after the Californica fiasco (linked to in one of my earlier posts on the topic).

Even better, I suggest that Obama and his advisers go talk to some health care providers -- docs and hospitals -- and ask them what their price increases are. I guarantee you that they will be closer to the source of health care price inflation at the hospital than at the insurance company office.

And Another Person in Favor of Consumer Health Responsibility

This article by Barbara Kiviat discusses the importance of knowing price when we buy things, including health services.

I am about to go on a rampage to get my local hospital and clinic to clearly post prices. As I know some folks on the Board of Trustees and other high places, it should be fun. I wonder how many of the Directors of the hospital know what things cost at the institution they are responsible for?

More on the Case for High Deductible Policies

Two fresh editorials out today, suggesting a wave (!) of positive sentiment for high deductible health insurance policies.

One from the governor of Indiana, describing the Indiana experiment with Health Savings Accounts in combination with high deductible, high copay policies: "Hoosiers and Health Savings Accounts."

The second is titled "The Case for High Deductible Health Insurance."

If the Obama administration is reading these things, I hope they take them seriously. Such policies will be one critical part of a health care system that delivers care efficiently.

Designing a High Deductible Plan

I am increasingly gratified to see more economists and politicians coming out in favor of high deductible health insurance. The positive effects of such plans would be both direct and indirect. I am actually more excited by some of the indirect, subtle effects that I think would happen as more people moved into high deductible plans, especially in regard to demanding more price information.

Here are my thoughts on how one would go about thinking about designing a high deductible plan for a self-insuring employer. There are lots of details that I won't get into, and most important, to make real progress I would need historical data on the distribution of health expenses in the employee base. But I think I can illustrate some of the key ideas.

The data that I would start with would be the percentage of employees with yearly expenses falling in different ranges, like this:

Health Care Expenses, % of Employees

0 - 2500, 10%

2500- 5000, 15%

5000 - 7500, 25%

7500 - 10000, 20%

10000 - 12500, 10%

Greater than 12500, 20%

If I had this data for an employer, I would start with it to get a feel for where a reasonable initial deductible might be. I want a deductible high enough so that I capture a reasonable number of employees with total expenses under that amount. At the same time, I don't want a deductible that is going to be unreasonably high. What's reasonable? Well, for the number of employees, I think we would want to catch something like 25%-50% of the base with total expenses under the deductible, at least. My thinking here is that the deductible is set to capture expenses for which true insurance makes sense, and if something is occurring more than 75% of the time, or even up to 50% of the time, it sounds too common to be reasonably covered by insurance. But on the other hand, I don't think a deductible that is too high is going to be acceptable to people who are used to "insurance" paying the bills.

Since I don't have that detailed of data at hand right now, let me proceed by assuming that what I do know is that 1/2 of the employees have total yearly expenses under $7500, and that the overall average expenses are $18,000 per year. For a family, that is a reasonable number. Given these two assumptions, we can infer that the other 1/2 of the people have expenses that are on average $32,250 per year (with some no doubt having very high expenses!)

With average expenses of $18,000 per year over all employees, we know that "fair" insurance would be priced at $18,000. (Apologies again to Sec. Sebelius for using such a blasphemous phrase as "fair insurance. What I mean by fair here is just that if the employer charged $18,000 for the insurance, with no deductible, it would come out, on average, just even.) I do recognize that the data we observe will be influenced by the deductible in place during the data collection period.

Now what would happen if we put a $7500 deductible in place? Well, everyone with expenses less than $7500 would pay all their health expenses themselves. That is 1/2 of the people. The other half would pay their deductible, and the employer would pick up the rest.

If expenses in the upper half of the distribution (greater than $7500) stayed the same -- I will return to this point -- then the employer's expected expenses look like this:

Employer's Expected Expense = .5(0) + .5($32,250 - $7500)
= $12,375

That would be the "fair" price of the insurance plan with a $7500 deductible. Note that the fair price of the plan with a deductible is not just the average expenses less the deductible -- that is, the fair price is not $18,000 less $7500 = $11,500.

So, there is our comparison: Insurance that covers everything for $18,000, or a $7500 deductible policy that would cost only $12,375.

Importantly, as a consumer, I could buy the cheaper policy and put the difference in prices, $18,000- $12,375 = $5625 into an account, which we might as well call a Medical Savings Account. On average, that amount of money will cover my out-of-pocket medical expenses (1/2 of the time my expenses will be less than $7500, or $3750 on average; and half of the time my expenses will be the deductible, $7500.) I am not dealing with taxes here, but if that MSA better be tax deductible if the cost of insurance is, or this will never work. Also, the MSA cannot be "use it or lose it."

That gives an idea of some of the thinking that would go into the design of high deductible plan. Next would come some more subtle, yet important, issues. One, what would happen to the expenses of those folks who used to have expenses greater than $7500. I would expect them to come down, for several reasons: One, the employees would simply not incur as many expenses, partly because they would decide to forego some expensive but optional services. Two, because they would be more careful about their health to begin with. Three, because they would put some pressure on health care providers to cut their prices. These effects would be the cost-control measures that we so desperately need, and they would allow for a DECREASE in the price of insurance as time went on. Can you imagine that??

Another subtle issue would be self-selection if we made two plans, the high deductible and the no deductible, both available. Then we would get folks taking the no deductible plan who expected to incur large expenses, and vice versa for the low deductible plan. That would allow the high deductible plan to be priced even lower, and would force a higher price on the no deductible plan. This is essentially what we see happening to individual insurance prices in the California market, and it should not be viewed as a bad thing.

Other Economists Supporting Reasonable Health Care Proposals

Two editorials by some very smart people that are very similar to my proposals for health care changes -- a focus on incentives for individuals, and changes in the tax treatment of health care.

First, one by Cliff Asness: "Don't Ask" is No Way to Run Health Care" The basic message here is that we are "insuring" way too much -- small health care expenses instead of focusing on catastrophic expenses. Large events are what insurance was created for. I like to ask people if they have insurance for new tires on their car every couple years?

Second good editorial is by three economists, John Cogan, Glenn Hubbard and Daniel Kessler, "A Better Way to Reform Health Care." These guys also stress the need to make individuals bear the true cost of their health care. High deductible policies and elimination of tax deductions for health spending would effect that.

Nice to see a little press on these very common sense changes to our messed up system.

Price Increases on Individual Health Plans: Deductible Leveraging

I was intrigued by the mention of "deductible leveraging" in Wellpoint's response to criticisms of their on-average 25% premium increases for individual customers in the California market.

How important an effect might this leveraging idea be? Well, pretty significant. The basic idea is that as underlying expenses increase, the company bears a larger portion of the total expense, so long as the deductible remains fixed. This increase in cost is going to be reflected in premiums. Here's the simple math.

Let x, a random variable, be an individual's actual health care expenses for a year. Let the deductible be D and we will call the premium P. All these will be annual amounts.

Then the expected value of the individual's insurance expenses are E(x) and the insurance company's portion of that would be:

I = insurance company's costs = E(x) - D

since the individual pays the deductible first. I am ignoring any coinsurance.

With fair insurance (I wonder if Sec. Sebelius can imagine such a concept!) the premium would be set at:

P = I = E(x) - D

Now let's just see what happens to P when we experience inflation at the rate of "i" in underlying insurance expenses.

Expenses will become (1+i)x, and therefore the insurance company's costs become (1+i)E(x) - D. This means that the premium increases to

P' = (1+i)E(x) - D

Then the percentage increase in the premium is

P'/P = {(1+i)E(x) - D}/{E(x) - D}

= {E(x)-D}/{E(x)-D} + {iE(x)/(E(x)-D)}

= 1 + i{E(x)/(E(x)-D)}

Note that the term multiplying the inflation rate is greater than 1, since the denominator is smaller than the numerator. There is the basic leveraging effect.

Let's use some numbers to see how it might work out. Suppose underlying inflation in health costs to be 10%, and let's take a policy with a $2500 deductible with a premium of $3600 per year. This implies, from the above equation, that total expected costs must be $6100.

Using that last equation up above, it follows that the rate of increase in the premium will not be 10% but instead 16.9%. Using the kind of rhetoric that Sec. Sebelius (fast becoming my least favorite person in Washington), the premium increases 1.69 times faster than the underlying rate of inflation.

As will be obvious from the last equation, this leveraging effect is greater for higher deductible policies.

Note that while the individual feels a 16.9% increase in their premium, their total expected cost still only increases by the rate of inflation, that is, 10%. This is a trivial point, but one that not a single reporter or story has made.

There are many problems in the individual health insurance market that need fixing and that can be fixed. I just wish that Obama, and the Republicans too, would hold true to their pledges to stop the rhetoric and focus on the real issues. Blaming the insurance companies and their "excess profits" as dear Sec. Sebelius has been doing, is shameful.

High Deductible Health Plans: Difficulties With

Like at many other institutions, I expect to see significant increases in my health insurance costs purchased through my employer in 2011. I have often advocated for high deductible plans -- catastrophic coverage, essentially -- as a good direction to go in health insurance. Such plans would potentially:

-- Make consumers internalize the true cost of health care and make efficient decisions concerning purchases
-- Create conditions for more price transparency. I expect that more consumers would start asking their providers what procedures will cost.
-- Make consumers realize that much of the problem with health care cost is not with the insurance companies but with high prices from providers.

Unfortunately the path to high deductible plans that would lead to such effects is not easy. There are a lot of behavioral and institutional issues that need to be corrected, and at least one major tax issue. Let me elaborate a bit by using Dartmouth's prices for insurance as an example.

My choices in health insurance are three-fold: a "high" deductible indemnity plan, a "zero" deductible PPO (preferred provider organization) plan, and a "zero" deductible POS (point of service) plan. I put quotes around the deductible amounts since they are fuzzy -- depending on what kind of provider you use, the deductible might or might not apply.

But let's try to keep it easy and focus on the two plans I paid attention to. The indemnity plan has a $3000 per year family deductible, while the PPO plan has a $750 family deductible so long as I stay in the network of preferred providers, which I normally would do. The PPO deductible only applies to some things, like hospital stays, outpatient services, physician services. Routine exams and things like xrays are either covered in full or for a nominal amount ($15).

The high deductible indemnity plan would cost $19,800 per year while the low deductible PPO costs $18,635. Thanks to misguided tax policy, all of this is paid for with pre-tax dollars.

Already you can see how tough this choice is going to be. This is not like comparing what kind of beer to buy, for sure. Not even like auto or home insurance.

But let's try to cut to the chase. If I buy the high deductible plan, I save $1165 per year. For that, I risk paying an additional $2250 or even $3000 in my own health costs. If I can put money into a health savings account, then I can keep the comparison in pretax dollars, but the problem with our health savings account is that if I don't use all the money in a year, I lose it. So I have to estimate what I will spend, and put only that much in. If I underestimate, then I will end up paying the deductible with post-tax dollars, which really hurts.

So if I expect my health care costs to be less than $1165 for the year, I would be better off with the high deductible plan -- the savings in plan price exceeds what I will pay out of pocket for costs. (I am assuming here that the effective deductible on the PPO plan is zero, as most of my expenses are in the zero deductible category.) More than $1165, and I should take the low deductible plan. And in doing these calculations, I should anticipate that my pattern of health care consumption should be different depending on what plan I have (since in one plan I pay for each service and in the other plan I do not).

This is a tough call. The biggest problem for me is that there is simply not much to be gained one way or the other. The dollar amounts are just not that large. And then there are other differences that our dear benefits providers have thrown in to make the choice even more complicated: the plans differ in mental health services, eye care, drug coverage, and even reimbursement for health care membership.

Faced with the choice, most people, I believe, opt for the PPO plan. Yes, it costs a bit more, but it is easy to understand. I think the College probably feels this is good, that most people opt for the PPO, as it discriminates against out-of-network providers. So employees use the low-cost preferred providers.

The problem of course is that now I have a zero deductible on all kinds of services and a low deductible on a lot of other things. So many consumers get into a situation where the marginal price of health care for them is zero. That causes consumption of services to be too high, and creates a situation where consumers don't know what things cost. Not even doctors and hospitals know what things cost, because nobody has an incentive to ask. And, consumers, when they see increases each year in their health care plans, blame the only entity for which they see a meaningful price that they pay -- in this case, Anthem. (Interesting, the payment for a doctor visit under the PPO plan is $15, probably leading many consumers to think that doctor's can't be charging too much!)

In my opinion, the design and pricing of these plans is very poor. If they are designed to get folks into a PPO so they select in-network providers, that can be accomplished another way. What they plans are not doing is getting people to take high deductible plans and have proper incentives.

Could better plans be designed? Of course. In my next post, I will work out some more details. However, the key elements are going to be: First, there has to be a really high deductible plan, something in the $5,000 range. Otherwise there just won't be enough potential savings to play around with. Second, with such a high deductible, the medical reimbursement account will have to have a corresponding high limit, and, CRITICALLY, the "use it or lose it" aspect will have to disappear. If you put $5,000 into an account for medical costs, and use only $1,000, then next year you should be able to roll that entire amount forward. Essentially we should be able to self-insure our medical expenses with pretax dollars over time.

Next post will take some imaginary data and play around with a couple plans that could get a larger portion of employees into a high-deductible plan.

More on the Health Insurance Price Hikes in CA

Both the facts and the reporting of the facts interest me in this story about Anthem/Wellpoint's price increases for individual health insurance in California.

After some searching I found the five-page response letter from Wellpoint -- why don't virtually any of the stories reporting on the increases link to Wellpoint's response, which is available here?

The letter gives some information, but it is not perfect. Brian Sassi, CEO of the Wellpoint Consumer Business Unit makes some good points. He notes that the 39% increase reported is one of the largest increases, not the average. He points out that many increases are related to insured consumers getting older and moving into higher priced tiers. He makes an interesting argument, which is that if insurance has a fixed deductible, and health care costs increase, then there is a phenomenon that he calls "deductible leveraging." This is true; with a fixed deductible and an x% increase in underlying health care costs, the premium will have to increase by more than x% to maintain fair insurance. Why deductibles are not indexed is an interesting question.

He also argues that adverse selection is working powerfully in the individual market. This is probably true.

He argues that many individuals can and do move into lower cost policies (with higher deductible) both before and after price increases. He cited one fact, that a 40 year old woman in LA can obtain a $1500 deductible policy for as low as $156 a month.

What he doesn't do, unfortunately, is give us data on the actual age-constant policy premium increases. Why beat around the bush so badly? Come on, 'fess up and spit it out for crying out loud!

So, a big question here is: Why would Anthem institute rather large price increases in the individual market at a time when such an announcement is sure to cause a huge ruckus?

Theories, with my probabilities:

1. A lower level manager made the moves without thinking about the effect and without alerting upper management. Now the company is in defensive mode. (10%)

2. Upper management made the decision on the basis of sound business analysis, understood the implications, and decided that business trumps politics and they would just deal with the outrage. (35%)

3. Upper management made the decision on the basis of sound business analysis, understood the implications, and decided that it would actually be good to stimulate some debate, since much of the increase follows from the bad state of current policy. (50%)

4. The price changes were not entirely based on sound business analysis, but upper management decided to announce them purposely to stimulate debate. (5%)

Note that the letter from Wellpoint does devote a fair amount to current policy problems, and why the proposals in Congress will not solve these problems:

Unfortunately, the proposed personal coverage requirements in the health care reform legislation passed by both houses of Congress failed all three requirements by (1) exempting tens of millions of Americans from the requirement, (2) using the tax filing process as the only checkpoint which misses tens of millions of Americans who do not file taxes, and (3) including penalties that are a small fraction of the cost of coverage. Under this framework, it is only logical that many individuals— primarily those who are healthy—would have not been captured by the mandate or would have made the logical choice to pay the penalty unless services were needed.

And Now for Some GOOD Republican Ideas

George Will, in a column titled Charting a Simple Road to Government Solvency lays out the proposals of Paul Ryan, Congressman from Wisconsin (with help, it seems, from Republican representatives Devin Nunes of CA and Jeb Hensarling of TX). The full proposals are available here.

First, on health care: refundable tax credits for purchasing portable coverage in any state, with the link to employment clearly severed. Quoting from Ryan's proposal:

Yet health coverage is currently linked to employment by the individual income tax exclusion for employer-sponsored health care. This tax treatment effectively discriminates against workers and families who do not have employer-sponsored health insurance. Compounding the problem, the number of employers providing health insurance has dropped 69 percent since 2000; and this alarming trend is continuing.

Equalizing the tax treatment of health care and coverage will give workers and families much more freedom to acquire a plan that best suits their needs. Making health insurance portable means an individual no longer will live in fear of losing his or her health care along with a job. As the marketplace begins to respond to this new patient-centered control, the resulting increase in competition will improve the quality of services and provide more options to meet the diverse needs of Americans, while lowering costs.

In addition, Medical Savings Accounts would be strengthened. Medicare would be grandfathered in for older people but younger people would enter a new program that would give them vouchers to buy insurance.

These are significant changes. Intellectually exciting, with the potential to really change the system as we know it (which makes any scoring by the CBO virtually meaningless, as they cannot take account of behavioral changes.)

But Ryan doesn't stop at health care -- he has changes for the tax code and Social Security as well.

As for taxes, he opts for simplicity and incentives: a broad base (no deductions other than the health care credit) and two rates, 10% up to $100,000 and 25% beyond that. Beautiful. (It also solves a problem that a colleague was really harping on the other day to me: that the majority of Americans now pay NO income taxes. What kind of "skin in the game" is that?)

And Social Security, like Medicare, gets grandfathered in for older people but younger people get the option of Personal Retirement Accounts for up to 1/3 of their Social Security taxes.

Nobody can say that the Republicans do not have any ideas. This set of ideas is radical, but based on sound economics and conservative principles (as in, individual responsibility and small government). They could ensure that the US economy would be the most dynamic wealth-producing economy in the world for decades to come.

In fact, these ideas are enough to make me want to join Mr. Ryan and his colleagues.

Gingrich and Goodman's Semi-Lame Ideas

The Republicans have some pressure now to show that they are skilled at more than just blocking the Democrats. They need to come up with some ideas of their own. In two posts, I give two examples: First, a set of ideas for health care reform that don't really excite me, from Newt Gingrich and John Goodman, as they wrote in an editorial in the WSJ.

Gingrich and Goodman start out with a couple OK ideas. Give consumers the choice of either a tax credit or a deduction for health insurance, and have it be a fixed dollar amount regardless of how much insurance one purchases. Make insurance portable they say. (But they don't say clearly if they mean to sever the link of tax credits/deductions to employment. Just saying that "Employers should be encouraged to provide employees with insurance that travels with them from job to job..." Why not take the big step and make the tax credit/deduction separate from employment?)

After the first couple points that could have some effect if they were made a little more powerful, the two Republicans end up with a list of rather minor and vague points: "Allow doctors and patients to control costs." "Don't cut Medicare." "Inform consumers."

I almost fell asleep reading it. Zero intellectual excitement.

On to a better version in the next post.

Individual Health Insurance Prices/Adverse Selection Spiral?

Many are reporting on Anthem of California's large price increases in the individual health insurance market -- see here for instance.

Be careful, of course, because all we really know is that

Anthem Blue Cross has unveiled rate increases of up to 39 percent for its 800,000 individual policyholders in California.

And of course there are the stories of individuals reporting their own personal increases.

What we don't know from the stories is what the average increase for the entire pool is.

However, some of the explanations are reasonable -- that some insured people are dropping out of the pool, leaving only the most costly remaining. As prices go up, this will of course only get worse: those who think they are healthy will take their chances, and drop out. This is the adverse selection death spiral.

I am, however, skeptical -- as usual. Skeptical that the anecdotes don't represent the average. And, if indeed the average is going up anything close to 39%, skeptical on why Anthem would be stimulating the debate on health care in such an aggravated fashion.

I will be keeping my eyes open for more information on this important development.

Yale University Announces: We'll Eat our Seed Corn

In a letter to the faculty and staff of Yale, President Richard Levin announced that he was seeking $150 million of savings in order to balance their budget. Among other cost reductions, he said that the number of new students admitted into the Graduate School will be reduced by 10-15%.

No detail was given on what schools would see the reductions, but this is depressing. In my world at least, great PhDs are in extremely short supply, and we should be increasing the numbers.

Levin attempts to temper the news by saying that the number of graduate students will be no lower than a decade ago.

So...a decade of no growth in Yale graduate students. Did the population of the world not grow in the last decade? Did the world's demands for doctorates stay level?

This cut in graduate school admissions needs to be put into the context of flat undergraduate admissions at the nation's top colleges, especially the Ivy League. When these schools were flush with cash, instead of admitting more students, they gave away more financial aid to the existing students and put up nice new buildings. The choke point at the top of the pyramid just got tighter and tighter: a larger US population, more global applicants, yet the same number of students being let through the doors of opportunity.

Trying to Understand the Pre-existing Conditions Issue

One of the bigger talking points for health care reform was the idea that greedy insurance companies turn away people with pre-existing conditions.

The confusion over these kind of claims is amazing. As I dig into issues like this even a little bit, I get more and more worried that we were being sold a pig in a poke and/or that many legislators and advocates did not really understand what our current health care system really is like. If they don't understand the true nature of what we have, how can we trust them to design something new?

(I have already pointed out in this blog two other major areas of confusion, one being that most folks who get insurance through their employer are actually part of a self-insurance program; and the other being the large extent of miscounting in the percent-of-GDP calculations for health care.)

So a friend and I were wondering why Dartmouth College had dropped its pre-existing conditions clauses several years ago. I remember having to deal with such issues when hiring faculty, but we no longer have such clauses for new employees. The most likely explanation (I wish I could say enlightenment on the College's part but I don't think I can) was a new Federal law: HIPAA, or Health Insurance Portability and Accountability Act of 1996. I recommend this site to get an overview. Here is a brief description:

HIPAA is a federal law that:

Limits the ability of a new employer plan to exclude coverage for preexisting conditions;

Provides additional opportunities to enroll in a group health plan if you lose other coverage or experience certain life events;

Prohibits discrimination against employees and their dependent family members based on any health factors they may have, including prior medical conditions, previous claims experience, and genetic information;

and

Guarantees that certain individuals will have access to, and can renew, individual health insurance policies.

Now this law does not solve perfectly a key issue involving health insurance, that being the ability of individuals who have not had group-based health insurance to continue with individual insurance (at reasonable prices). But, I note that it did solve many problems that could have affected the vast majority of people with health insurance, that being the difficulty in even switching jobs if you have health issues. (I think that many people still think that they can be denied coverage by a new employer for pre-existing conditions. Probably many of those folks support health care reform on the basis of that faulty assumption!) I also think that HIPAA points the way to MODEST reforms that could be made to the individual insurance market that would help alleviate the issues that remain in that market (even short of the policy change that would really help that market, that being severing of the tie between one's employer and one's health insurance).

Lake Skating

For anyone interested in a real new winter adventure, I highly recommend lake skating. Check out these pictures of Goose Pond in NH yesterday. The entire lake, all 550 acres, was like a hockey rink. Snap a pair of nordic skates onto your cross country ski boots, buck the North wind up to the head of the lake (avoiding frostbite), then turn around and scream down to the other end.

I was a little afraid yesterday to go across the wide part of the lake to get to the other side, but today I am going to do it. As they say, it's not a sport if you can't get killed doing it.

Getting Intimate with the iPad?

It was well below zero yesterday morning, and the fire in my woodstove had burned down to only glowing coals. The temperature was probably about 45 degrees in the house. So, with a cup of coffee in one hand and my iPhone in the other, I stayed in bed and cruised the web and got all the Saturday morning news. All my favorite sites...Fox, Drudge, RealClear Politics, Roger Pielke Sr. ...

The interesting thing is that I had my laptop with me as well, and could have been using that. I would get a bigger image, but I would not really be as comfortable. With the iPhone, I could move around at will, and of course the image orientation followed me.

Two eureka thoughts. The first one was, hey, wouldn't a slightly larger version of the iPhone make this picture even sweeter? Yes indeed it would. A nice light device, with a large screen, and one that would allow me to multitask easily from a website to maybe a book that I had been reading? Thank you Steve Jobs -- I can see an iPad on my wishlist.

Second, I had jumped around to myriad news sites, including the WSJ, BBC News, Washington Post, Washington TImes -- :), New York Times, but I had not paid anyone a single dime for all that good reading. Sure, a few advertisements were somewhere in my screen occasionally, but on an iPhone one hardly notices them.

I am still waiting for Steve Jobs to figure out some way to package news content with the iPad, and charge me a monthly fee for it. Yes, that will be painful, but I am willing to do it. How much? Let's see...if you gave me the Economist, WSJ, New York Times, Shooting Illustrated, Washington Post and maybe one or two others...I already pay a hundred dollars per year each for the first two...how about $50 per month?

A Bad New Beginning

Obama has conceded that goals for a health care reform package need to be revisited in light of the Massachusetts Surprise.

But he gets off to a very bad start with this line:

We know that we need insurance reform, that the health insurance companies are taking advantage of people.

How about stopping the blame game and the populist rhetoric for a better beginning? If we want to eliminate the pre-existing conditions clause, how about we start by honestly recognizing the basic and real problem faced by self insuring employers and insurance companies of individuals who stay uninsured but as soon as they get seriously sick opt into the insurance pool? Pre-existing conditions clauses prevent that.

I suggest a small commission of smart, unbiased, action-oriented individuals who would come up with a nice clean set of changes to our health care system that would meet a small number of clear objectives. And then have Congress vote up or down with no option for bribes and payoffs.

Hope Springs Eternal

There is a ton of writing out there on the election of Scott Brown by the voters of Massachusetts, and much of it is very good.

I will just add a couple thoughts. One is that I derive a LOT of hope and optimism from this result. The electorate does matter, that is very clear. A seat that anyone would have thought was tenured to the Democrats long ago was taken away by a Republican in a blue, blue state. Wow.

Two, I think this puts the country back on its trend line of an electorate slightly more conservative on at least economic and defense issues. The election of Obama and the Democratic Congress was the bigger aberration. But how could that not have happened, with two wars, an unpopular Republican President, an economy on the brink of a second depression, and a lackluster Republican candidate and his somewhat problematic running mate? And Obama did not exactly win a landslide.

But three, I would be cautious in interpreting this as a massive turn to the Republican Party. This was an expression of outrage at government, ie., the incumbents broadly speaking and the Democrats in particular who are in charge and who are spewing out trash like the exemption of union workers from the cadillac health care tax. The Republicans can capitalize on this by actually coming up with some constructive ideas on, for instance, health care. And taxation -- and more than just "cut taxes." How about a serious review of the income tax code. I for one will volunteer a slight increase in my total tax payment if part of the deal was a broadening of the base, a lowering of marginal rates, and a general elimination of complexities like the AMT.

Venezuela Appropriates a French Chain of Stores

Will the French invade in response?

More realistically, how long will this Chavez fiasco in a once-great country continue?

Story on the expropriation here and here.

Betting Markets Predict a Scott Brown Victory!

One of my colleagues alerted me to the recent trading activity on InTrade. The runup in price for the Scott Brown contract, and the corresponding decline in the M. Coakley contract, is just amazing. Not a lot of volume in the market, and I still think it is too good to be true.

The AM radio station 1030 WBZ must be enjoying a tremendous revenue windfall, as is the NECN news channel. Ads for Brown and Coakley are running almost continuously. I do think that the Coakley ads, at least some of them that I have seen, are markedly negative -- dark, nasty images and pictures of (horrors!) George W. and Dick Cheney.

On NECN right now, a Coakley ad is running. It claims that Brown would deny rape victims immediate contraception. I heard Brown on the radio earlier denying that explicitly. In fact, here is news that Brown is claiming defamation against the Massachusetts Democratic Party for such a claim in a mailing it sent out.

The Stench of Health Care Deals

I just cannot believe that the Democrats and Obama have stooped so low as to give the unions five years more than the rest of us, in regard to when a tax on "cadillac" health care plans kicks in. Is that sad or what? In order to get the support of the unions, Pelosi, Reid and Obama have to pay them off with petty cash. See here for a description of the story.

Why would any rational policy exempt workers who are identical in all ways except they are covered by a collective bargaining agreement, i.e., they belong to a union?

This comes on top of the buyout of Ben Nelson and Nebraska, and a few other groups as well. It's been a while since I read the Senate bill, and I suppose I should get out a bottle of wine and PeptoBismol and do it again. (Note that reports today had Nelson asking for removal of Nebraska's special status, but I will believe equal treatment of states when I see it.)

The other thing is that they are really gutting the cadillac tax, by raising the limit, excluding "high cost states" (what is the point of reform anyway?) and by now excluding vision and dental. I wonder when people will realize that the current version still includes reimbursement accounts. The cadillac tax is not such a bad idea, in a world of second-best, but if unions and longshoremen and others get breaks I drop my limited-to-begin-with support.

Too Good to Be True

If Scott Brown were to win the Massachusetts US Senate seat held by the late Teddy Kennedy, what would that qualify as?

Definitely a political heads-up to any Democrat who wants to keep their job.

Tuesday night is going to be a late one. I hope I don't have any meetings Wednesday morning scheduled.