Sunday, May 30, 2010

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.

Friday, May 28, 2010

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.

Wednesday, May 26, 2010

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?

Saturday, May 22, 2010

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.

Monday, May 10, 2010

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.

Sunday, April 11, 2010

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.

Saturday, April 10, 2010

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.

Friday, April 09, 2010

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.

Sunday, March 28, 2010

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?

Saturday, March 27, 2010

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.

Wednesday, March 24, 2010

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.

Saturday, March 06, 2010

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.

Wednesday, March 03, 2010

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?

Monday, March 01, 2010

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.

Saturday, February 27, 2010

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.

Thursday, February 25, 2010

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.

Saturday, February 20, 2010

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.

Saturday, February 13, 2010

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.

Friday, February 12, 2010

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.

Thursday, February 11, 2010

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.

Sunday, January 31, 2010

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?

Wednesday, January 20, 2010

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.

Sunday, January 17, 2010

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.

Saturday, January 16, 2010

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.

Friday, January 15, 2010

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.

Saturday, December 12, 2009

Would You Buy a Used Car from James Hansen?

James Hansen recently had an editorial, "Cap and Fade," in the NYT.

In it, he argues against a cap and trade system in favor of a carbon fee (aka "tax").

I might actually agree with him on some matters of economics, but that is not the point.

This editorial is as full of errors in logic as almost anything I have seen. Even worse, it reveals the philosophical beliefs and political biases behind much of the climate change agenda.

As for some of the errors in logic: How about this one, early in the editorial:

Because cap and trade is enforced through the selling and trading of permits, it actually perpetuates the pollution it is supposed to eliminate. If every polluter’s emissions fell below the incrementally lowered cap, then the price of pollution credits would collapse and the economic rationale to keep reducing pollution would disappear.


To say that cap and trade "actually perpetuates the pollution it is supposed to eliminate" is either a naive attempt to influence complete idiots or a completely ignorant statement, take your pick. How putting a high price on something -- just as a carbon tax would, by the way -- helps perpetuate pollution rather than create incentives for its elimination is beyond me. (And also, with a cap and trade system, the beauty is that you will get in total whatever amount of pollution the political process decides upon. Contrast that with a tax based system, where the quantity of pollution reduction will be uncertain.) Hansen is correct that if for some other reason every polluters' emissions fell below the cap (well, almost correct -- it is the total of everyone's emissions that would have to fall below the total cap) then the price of credits would go to zero. But that should be celebrated, as the amount of pollution would now be under the level determined to be the socially optimal amount!! Hansen is showing his clear disdain for any kind of cost/benefit determined optimal pollution level and instead thinking that the socially optimal policy is to keep pushing to zero emissions -- while of course decreasing the demand for fossil fuels, lumber, minerals etc. The road to serfdom, in other words.

Here is another statement that just comes out of the blue and makes little sense:

Cap and trade (for sulfur dioxide emissions of power plants in the US) also did little to improve public health. Coal emissions are still significant contributing factors in four of the five leading causes of mortality in the United States — and mercury, arsenic and various coal pollutants also cause birth defects, asthma and other ailments.


Cap and trade did little to improve health...because coal emissions are still contributing factors?? This is the way we do science in the climate change community? Come on, now. What, the only improvement would have been if coal emissions were no longer a contributing factor to anything bad? Ah, right...the only test is if we get emissions down to zero...there we go again down the road to serfdom.

Here is an even better quote from Hansen, showing both a lack of economics understanding and his political biases:

The market for trading permits to emit carbon appears likely to be loosely regulated, to be open to speculators and to include derivatives. All the profits of this pollution trading system would be extracted from the public via increased energy prices.


Oh my god!! The market will be open to speculators and ....will include DERIVATIVES!!!! And of course the cost of all this high tech finance will be EXTRACTED from the public. Scary stuff. But if Hansen would think for a minute, he might not want the price of carbon credits to be $25 in one year and $250 the next...but eliminating those kind of price differences -- AND THEREBY CREATING SAVINGS -- will require trading and, most efficiently, derivatives contracts.

But the funniest quote from Hansen is this:

The fee would be uniform, a certain number of dollars per ton of carbon dioxide in the fuel. The public would not directly pay any fee, but the price of goods would rise in proportion to how much carbon-emitting fuel is used in their production.

All of the collected fees would then be distributed to the public. Prudent people would use their dividend wisely, adjusting their lifestyle, choice of vehicle and so on.


"All of the collected fees would then be distributed to the public. Prudent people..." Wow. Does anyone believe that if the US government collected hundreds of billions in new taxes, that these funds would then be distributed back to the public? And how would that redistribution occur, exactly? And prudent people would then use those dividends wisely? You have got to be kidding. It would be nice, if we got a carbon tax, that all such collected funds be used to reduce the deficit. But money, as we always say in economics, is fungible...our legislators and president could just say that the money they are spending is coming from somewhere else. Spending overall would increase, and the deficit would stay the same. The share of US GDP controlled by the government would increase.

Two conclusions are possible on the basis of Hansen's editorial. One, that he is incredibly ignorant and unwilling to learn when it comes to economics. Two, that he is willing to say almost anything in the pursuit of climate change goals. On the basis of other things he has written and said, and on the basis of many other writings of carbon control proponents, including the emails of ClimateGate, I put my weight on the second: Scarily, the ends justify the means.

Wednesday, December 02, 2009

In the Spirit of Famous Last Words

Frank Fabozzi, page 115 of his edited volume The Handbook of Mortgage Backed Securities, 2006 edition:

"Based on historical experience with financial guarantees by monoline insurers, capital market participants have a high degree of confidence in bond insurance because no investor in any bond-insured security failed to receive a single timely payment of principal or interest. Moreover, downgrade risk is viewed as minimal because no US financial guarantee company has been downgraded. Investors realize another benefit from bond inusrance. While rating agencies face reputational risk when assigning a rating to a security, monoline insurers are placing their won capital and credit at risk. Hence investors can correctly expect that the transactions structure is inherently safe and will remain so over the life of the securities guaranteed."

Joseph Stiglitz, Jonathan Orszag and Peter Orszag, "Implications of the New Fannie Mae and Freddie Mac Risk-Based Capital Standard," Fannie Mae Papers Vol. 1, Issue 2 March 2002:

"These results regarding the risk-based capital standard are striking: They suggest that on the basis of historical experience, the risk to the government from a potential default on GSE debt is effectively zero. Given this striking result, it may be worthwhile exploring three potential shortcomings in the standard. None of the potential shortcomings appears to be significant enough to alter the basic conclusion that the risk-based capital standard provides substantial protection against insolvency."

Dr. Michael Schlesinger, as quoted on Roger Pielke Sr.'s climate blog:

"As documented in the IPCC AR 4, it is not possible to replicate the observed warming due to natural causes -- the sun and volcanoes -- alone. Such replication can be done only by including the effects of the human-generated increase in the concentrations of greenhouse gases.

Thus the case of the causes of the observed climate change is closed, period -- RSP or any other climate skeptic notwithstanding."

Friday, November 13, 2009

More on Different Prices in Health Care

Some folks are still asking about the justification of different prices for health care services paid by different groups of people. The tone of the critiques is that the well-to-do are supporting a system that benefits them at the expense of the people who pay full prices for doctor and hospital services -- with those latter people being to a great extent the uninsured.

First, let's see if we can get some data to bear on the problem, rather than relying on my speculations and the media's love for heart-wrenching anecdotes. We can always find, for any system, some stories that make us want to cry, like the uninsured person who goes bankrupt because of a huge hospital bill based on full prices. I don't want to completely dismiss the exceptional cases, but I think when we are designing a social/economic policy we should focus on the total picture.

So I had speculated that not too many people pay full price at hospitals, and I claimed that many hospitals treat the destitute for free. In fact, most hospitals have formal sliding scales of prices, giving LOWER prices to lower income people. I found a good blog posting by Uwe Reinhardt at Princeton on this subject, and he referenced a paper, Melnick and Fonkych, "Hospital Pricing and the Uninsured: Do the Uninsured Pay Higher Prices?" in Health Affairs, Feb. 5 2008. The Reinhardt piece is very good; he actually argues for a law that would restrict pricing to the uninsured at more than 115% of Medicare rates -- although he also admits that for most hospitals this would be nonbinding, as they already do so.

But on to the main article and their findings. They looked at California hospitals in 2005-2007. Below is the chart of their main findings:



So what does this show? Well, the four solid lines show the percent of full price paid by four groups of patients: The commercially insured; the uninsured; Medicare; and MediCal (low income California Medicaid system). You can see a few things. First, who pays the most? The insured. Of course. Who pays the least? MediCal, followed closely by Medicare. Just for the record, Medicare patients in 2005 paid on average about 27% of full price!!! Even the insured, who pay the most, only pay about 38% of full price.

Point number one: my claim that not many people pay full price is correct. Given how low all of these percentages are, there is no statistical way that many people can be paying full price. Some in the sample will be, no doubt, but to get an average of 27% I am sure that the vast majority are paying closer to 27% than to 100%.

Point number two: Who pays on average the most? The insured population. Again, of course. If anything, the insured patients should be screaming about the lower prices being given to the Medicare, Medicaid, and uninsured populations. (But be careful here: it is probably profitable for the hospitals to charge lower prices to those groups -- that is what price discrimination is all about. Prices to the insured would be even higher if the hospitals had to cover all their costs just from the insured population.)

Point number three: Who pays the least? Those insured through government programs, that is, Medicare and Medicaid. So those of you out there who want "one price to all" better realize that the biggest effect of that will be to raise Medicare costs substantially. Essentially what we have here is a hidden tax: the government uses their negotiating clout with doctors and hospitals to get lower rates, which the rest of us then pay for. If you mandate one price, then Medicare will have to raise funds somehow else -- an increase in the income tax, most likely.

Point number four: This pricing is pretty crazy, with list prices being so high. Why not just cut them down across the board? I could go into that, but it is not crucial right here and now.

Beyond this paper, another main point of mine about price differences for health care is that they serve a very important purpose. If the government mandates one price for all, how is that one price ever going to be determined in anything that would approach a competitive fashion? It is the ability for one buyer to negotiate and get a better rate for themselves that benefits all of us by helping to set prices at a reasonable level and keep the escalation of health care costs to a lower level.

Also, people have this idea that pricing is kind of a zero sum game. If one group gets a lower price, someone else has to get a higher price. That logic is tempting but not correct. Hospitals have huge fixed costs they need to cover, from all groups. If you don't let the commercial insurance group get a lower price, you won't get their business. Then all of the fixed costs need to be covered by the remaining groups -- the self insured, for example. The price they will have to pay to cover the hospital's costs is likely to be much, much higher. The zero sum logic applies if we always have all the customers and we are just trying to spread costs around, but this is not the real situation we face.

Tuesday, November 10, 2009

No Generalized Villains, But Many Squandered Opportunities for Heroes

The title of this post is my summary of the credit crisis.

News today that the managers of two Bear Stearns hedge funds were found not guilty of fraud and insider trading supports the "no villains" idea.

This was a trial by jury, with normal everyday people on the jury. That they found the two not guilty is significant.

These two Bear funds that went bankrupt heralded the beginning of our credit crisis, but not enough people saw the meaning of their downfall at the time. Why? Because it simply wasn't clear that the world as we knew it was about to end...

More on Different Prices for Different Folks

Here is a good story from the Wall Street Journal that I found in my search for good information on who pays the "rack rate" or "list price" for health care.

I agree that it is bothersome that some of the most needy end up paying the highest prices for health care.

But at the same time, there are some good reasons for those price differences and some lessons to be learned.

How many of us ask when we go to the doctor what the price of the service will be (and how many doctors even know)? Why are we willing to accept such ignorance of prices from docs and hospitals when we will haggle to the final penny with a car dealer or a bank on a mortgage? This is just one example of the inconsistencies in people's behavior when it comes to health care vs. other products and services. Another one is that many people think regular exams and preventive maintenance should obviously be covered by insurance. I bet I could find people who would argue that, on their way to the car dealership to pay hundreds of dollars for their 50,000 mile checkup on their three year old Chevy. We accept that we have to maintain our cars, houses, and other property, but not our own bodies? Go figure.

At least larger insurance plans do some negotiating for us. It is too bad that not everybody gets the benefit of those negotiated rates -- if self employed people buy individual insurance plans and then have to pay full list prices. But again, if we take away the incentives for anyone to negotiate, what will that do to the pricing power of the suppliers and to the overall level of prices? I predict we would see even higher prices.

I believe it is also true that the great price differences we observe today in health care (list price vs. negotiated health plan rates) began when Medicare got into the market. Just an observation...

Sunday, November 08, 2009

Different Prices for Different Folks

"Reefnetter" asked a question about the justice/injustice of charging different people different prices for an important service like health care, or even basic products like food.

This does raise some interesting questions. Right now in health care, there are at least four levels of price, in order of high to low: The "rack" or "list" price; the negotiated price for insurance plans; the government/Medicare rate; and a price of zero. Who pays the rack price? Not too many people, would be my guess, but I am not sure. If you are self employed and buy health insurance in the marketplace, that policy could still have a negotiated rate with suppliers. Some people who pay the full price are actually the rich uninsured; others would be medical tourists. Who pays the "zero" price -- well, that would be the destitute who get care and cannot pay. This might also end up being a negotiated rate, greater than zero but less than maybe even the Medicare rate.

Do these price differences concern me, especially given that the well-to-do will generally receive the negotiated rates rather than the list prices? Not, not really.

One of the benefits of these price differences is that they serve to put pressure on the service providers. Suppose we had a law saying that health care providers had to charge everyone the same price. Do we think that would result in higher or lower prices overall? I am sure it would result in higher prices, because it would prevent any one insurance plan from being able to ask for and receive a lower price. It is that process of insurance plans going to service providers (e.g., large hospitals, doctors' clinics) and negotiating lower prices that gives us some relief from unmitigated price escalation. Does this process of competition mean that some plans will negotiate lower prices than other plans? Yes -- and that is exactly what we need to give the plans incentives to put pressure on the service providers. In the new world of health care about to emerge, this will be one of the main ways for different insurance plans to get a competitive advantage. We should celebrate it -- how else will we get the health care providers to put a lid on their prices?

Note also that generally the larger plans will be able to negotiate the best prices. Why? Because they will be able to promise (or withhold) large amounts of business from the providers. Bulk purchases generally do get better prices. This is true for electricity, food, cars, ....you name it. Reefnetter, I bet you give your largest customers some kind of volume discount, right? In health care, it is valuable for a hospital to be able to count on business from a large pool of insured people. This gives the hospital enough confidence in its volume to expand facilities, invest, etc.

Another side benefit of the high list prices is that it induces people into the ranks of the insured. There is a real problem in health insurance caused by people "gaming" the system: being uninsured when healthy, then getting into insurance just when you need it. This is one of the problems that the health care reform is dealing with, this time with penalties for not being insured. If the uninsured can get the same low rates as the insured, then there is even more incentive to game the system.

Interestingly, I have always thought that the lack of price differences for some goods and services has created some distortions in our society. For instance, the postal service charges the same rate for rural service as for urban service, even though the cost of rural service must be higher. Similarly, AT&T always charged the same rate for home service, no matter how few people were in an area. These prices entailed low-cost, urban customers subsidizing high-cost, rural customers -- was that fair, or good?

Wednesday, October 28, 2009

Health Care Question

I recently moderated a panel on health care for the Dartmouth Minneapolis Club. It was very good. Minnesota companies are doing some interesting things, including some vertically integrated health care delivery models that are very intriguing.

But a point came up about end of life expenses, with a president of a hospital lamenting on how much can be spent to maintain a few extra months of someone's life -- we all know the stories on this. And yes, the question arose from someone who was concerned about death panels. The hospital president was pitching living wills to deal with this problem.

I responded with this question: If I create a living will for myself that will limit the medical options to be used for me in certain end-of-life situations, should I get a lower price for my health insurance?

Note that the Senate Finance Committee bill will allow health insurance policies offered through their exchanges to differentiate prices based only on age, family size, and tobacco use -- and with maximum increases that can be applied for any of these situations.

Someone else on the panel wanted policy prices to be lower for folks who use seat belts.

If we recognize lower cost of health maintenance for people who don't smoke or use seatbelts, why not for people who voluntarily limit their access to some of the most costly medical technology?

I have always thought that the free market solution to the health insurance problem would give people choice in their coverage to a much greater extent than the policies available today. Such choices would have to limit a person's ability to access certain kinds of care in certain situations, such as my end-of-life example. Other ways to do this would be to accept a process for determining what procedures, devices, drugs are deemed to be cost effective. That sounds like death panels -- let a panel decide whether a procedure will be authorized -- but the difference is that individuals would be making the choices themselves and getting the benefit of lower prices.

Sunday, September 27, 2009

Europe tilts right while US spins left?

Angela Merkel is celebrating --sort of -- in Germany. Her party, the CDU, did not do all that well, but the Free Democrats upped their percentage to 15% from 10% in 2005. The Free Democrats are more pro-market even than the CDU. See the NYT's coverage.

The left-leaning Social Democrats (SPD), with whom Merkel had to have a grand coalition with over the past four years, reached its post-War low in election percentage.

Merkel can now govern with a partner that is more in line with her own more conservative philosophy.

Interesting. After the biggest economic disaster since the Depression, with all the press blaming markets, Germany of all countries doubles down and bets even more on a free (r) market economy? Or am I misinterpreting this?

Saturday, September 26, 2009

AIDS Vaccine Success (Funded by NIH)

Good news this week on the AIDS front, with mild success reported from a vaccine trial. See David Brown's reporting on it in the Washington Post.

The trial involved more than 16,000 men and women in Thailand, and it cost $105 million. Most of that came from the United States' National Institutes of Health, through the National Institute of Allergy and Infectious Disease.

Just for the record, the entire NIH budget is counted as health care spending by US residents when those tabulations are made of the percent of GDP that we spend on health care.

Wednesday, September 16, 2009

The Baucus/Senate Health Plan

Senator Max Baucus released the Senate version of a health care proposal today, and the New York Times said it "meets many of the requirements that President Obama laid out in his address to Congress last week."

What shocks me about the Baucus bill is the 35% tax on health coverage over certain amounts -- $21,000 for a family. The Times reports this, misleadingly of course, as follows:
"...the proposal would impose a new, 35 percent excise tax on the most expensive group insurance plans, those costing more than $8,000 for individuals and $21,000 for families."


Actually, the language of the proposal makes it abundantly clear that the total amount to be considered as the "limit" includes the total cost of health insurance provided to employees, whether they pay for it directly or the employer does, PLUS any dental, vision or other health coverage, PLUS the amount that an employee or the employer deposits into a Flexible Spending Account.

This year at Dartmouth the most expensive family health coverage costs $18,300. Add to that $1850 for dental coverage and the maximum $5,000 flexible spending employee contribution and you get $25,154. With a 35% surtax on the excess over $21,000, that means someone (look in the mirror) will end up paying about $1450 in additional tax (or change their health coverage). So now we know what the folks in DC consider to be a "gold-plated" insurance plan -- look no further than your own.

The President and others have been very vocal on how their proposals will not require those with insurance to change anything. In the President's words to Congress the other night: "Let me repeat this: nothing in our plan requires you to change what you have."

OK, so if someone holds a gun to my head and says, give me $1500 -- does that mean they aren't requiring me to change anything I do?

One might think that since health care benefits are provided taxfree right now, that starting to tax them is perfectly fine. In principle, yes. But not in this piecemeal, add-on, excise tax fashion!! If you want to really improve the health care insurance situation, sever the cord binding employees to get their insurance from their employer by giving the employee a tax credit for insurance no matter who they get it from. In the process, if we limit the tax deduction to a certain amount, I could live with that.

And I have just begun to read the Baucus plan. No doubt new gems lie to be discovered.