Insurance Explained

The barista, explaining Obamacare to the cook:

...so if you get sick you get your money back and more.    The company is betting you will not get sick and they get to keep the money.  It's just like being a bookie.

On the (admittedly scanty) evidence, I'd have to give her an A plus.  Once you understand that insurance is a subset of bookmaking, the rest is easy.   Afterthought: with analysis like this, she just raised the average level of public dialog on the subject.

TPM on Paul on Deductibles

TPM is having a merry old time with Rand Paul for insisting on the idea of a $2,000 Medicare deductible.  I suppose they are right that it's bad politics (though perhaps not quite as bad as they seem to perceive?).  But I'd like to know is how many self-conceived left-leaning economists also support the idea, or some close variant thereof.  Economists like incentives and deductibles are one way of marrying incentives to an insurance scheme.  Needless to say I'm not going to do the work myself, but if someone were to comb through all the high-priced textbooks of high-priced econ profs, I bet they'd find a lot of support for deductible-type incentives and very little opposition thereto.

The Gold Star Mothers: A Second Look

Remember those Gold Star mothers, getting ripped off (or so it seemed) by the insurance company?  I.e., the case where the insuresters were  investing the money at 4 percent and paying the policy holders at 1 percent, using them for a sort of carry trade?   My friend Ignoto weighs in:

Excuse me but in the late 1960s in NYC I noted that TIAA CREF presented ALL surviving benes with a very complex package and at the very end in very tiny print they said, in essence, if you insist we'll give you the money. so, in 2010 I am shocked shocked.

Er--well, right.  But TIAA CREF would have said they were doing you a favor, protecting you from yourself, trying to make sure you used the money for a proper annuity payout, rather than blowing it all on one great gaudy night. Maybe they were required to do it this way: in any event, the chances are we can count them as an instance of the Sunstein/Thaler Nudge,  where the packaging of the benefit can help to predetermine the result.

He's got a point; in the same vein, the California lottery (others too, I assume) gives you the choice of a cash prize or a time payout.  You take a huge haircut if you opt for cash.  The point is clearly to protect you from yourself.   I'm vague on the details, but I've got the impression that there are similar limitations on "structured settlement" payouts in lawsuits.  And that's the point of all those hawkers who pestiferate the web with offers to turn your payment streams into cash.

Still, I'm not sure the "Gold Star Mothers" comparison is apt.  So far as I can tell, there was no limit on how fast the beneficiary could draw out the proceeds.  And it seems like no disclosure of the fact that the insurer was making a packet on retention.    On the other hand, the recipient was very likely better off not taking the money in cash, and the insurer might have been doing her a back handed favor in spite of it self.   Like I said before, this really looks like a case where the insurer needed a good spin doctor.  Too bad they didn't call me.  Or Ignoto: I have his phone number, I can put you in touch.

Japanese Saving: An Economics Puzzle

Here's an observation on Japan that perhaps represents my best attempt ever to win a Nobel Prize in economics. It's about risk, and savings, and "economic man."

Start with a question: why do people buy casualty insurance? It can't save you any money. Suppose a loss will cost $1 and that the chance of loss is one in four. Then the premium must be 25 cents plus the cost of administration. Granted, people do self-insure some risks, particularly small ones (lots of people turn down the "extended warranty" coverage, for example). But consider bigger risks--fire, theft and casualty on the family jalopy, for example; or trip insurance on your vacation: lots of people could cover these losses on their own, but they'll pay out good money to pass them on.

Why? The conventional wisdom among economists is that people are "risk averse"--that they value certainty more than uncertainty, and will pay a positive sum just to smooth out their flow of wealth. This isn't an "explanation," of course; just an "observation"--at best an empirical observation, either true or not true as the evidence may disclose, just like the assertion that "all bachelors wear bow ties."

But in standard economic discourse, people tend to ignore the empirical part. They tend to treat it as an analytical, definitional ("all bachelors are single men"). I've done it myself, and I forgive myself: as a matter evidence, I think the statement is pretty wellsupported, and it is easy just to treat it as a universal.

Okay, jump cut to Japan--famous for having one of the highest savings rates in the world--down from its peak of a few years back, but still perhaps 10-11 percent of income, which is astronomic, at least by comparison with the US. Traditionally they've also received lousy returns. Why do they accept so much for so little? My friend Kagawachi-san explains:

Japanese face many risks. You may lose your home to an earthquake, for example, or a typhoon. You need to have money on hand for an emergency.

So, why don't they buy insurance? Kagawachi-san continues:

So, why don't they buy insurance? Well, they could buy insurance. But then what if they paid premiums all their life than never had a loss? They would have nothing to show for it. Japanese would rather save and hope to avoid the loss, and and enjoy the opportunity of having something to show for their efforts at the end.

In other words, the Japanese attitude to risk seems to be just the opposite of the American: they'd rather not trade uncertainty for certainty: they'd rather bear the risk of a downside loss to keep the upside opportunity. Fine so far; but recall, risk aversion is built into standard economic thinking as a quasi-analytic proposition. If Kagawachi-san is right, then it is just another empirical hypothesis, leaving the underlying issue--why do people (ever) buy casualty insurance?--unanswered.

Afterthought: As I write, I can think of a couple of complications. One, I can think of one area where Americans tend to think like Japanese. That is pension planning: most folks figure out sooner or later that they need to provide for their old age. They could buy annuities, and some few people do. Burt most do not; why not? One possible reason: returns on annuities always strike me as unrealistically low, which might be reason enough to look for another choice. But another reason is that people seem to find it unbearable that they might have to give up all "their" money: no matter how much they need, they want to be able to leave some kind of estate for their survivors.

Another complication: traditional life insurance. Traditionally, life insurance has usually come packaged with some kind of "investment/savings" paackage. For many potential customers, this never did make any sense: insurance is one thing, savings another, and no need to mix them. People who do want to mix insurance and savings are probably saying something just like the Japanese.