Comments on: Conditional probabilities and evil insurers http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/ A slice of lime in the soda Sun, 26 Oct 2014 19:05:02 +0000 hourly 1 http://wordpress.org/?v=4.2.5 By: Brad Ford http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/comment-page-1/#comment-4872 Fri, 31 Jul 2009 17:26:45 +0000 http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/#comment-4872 The problem with the analysis is that it pretends almost 100% of the policy rescissions occur because applicants do not know they are not telling the truth.

Simply put, the individual insurance market is difficult because of adverse selection. Typically, people seeking coverage realize they have risk and are seeking to pass it off to the insurer. Furthermore, they understand rates will go up (or coverage will not be available) if they disclose medical conditions on their applications. Unfortunately, many outright lie and most will bend (forget) the truth to minimize their premiums.

If we put the burden on the carriers to spend the time and money to track down the applicants medical records before they accept a policy, I would expect doing so would easily cost hundreds of dollars for each application. Since rejected applicants would not pay any premiums, the millions of dollars in investigative costs would need to be passed on to actual customers.

While there certainly have been cases of abuse of rescission, the current system relies on information provided by the lowest cost source of information on the health of the applicant – the applicant.

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By: tomrus http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/comment-page-1/#comment-4828 Thu, 30 Jul 2009 22:41:25 +0000 http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/#comment-4828 With respect to counterparty risks in cat insurance, presumably one can put on the same hedge GS did for AIG with respect to their CDS counterparty risk, as in http://www.felixsalmon.com/004158.html

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By: Sandrew http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/comment-page-1/#comment-4823 Thu, 30 Jul 2009 21:33:50 +0000 http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/#comment-4823 The analogy to CDS is inapt. While both issues relate to conditional probabilities, health insurer rescission is far more troublesome (and sinister) than counterparty risk. A CDS counterparty can’t refuse payment because you filled out the paperwork wrong (unless you actually filled out the paperwork wrong, which in the case of a CDS contract seems unlikely). Rescission is more akin to a conditional put option. If you filled out the paperwork wrong, the insurer can choose to tear-up the contract. Obviously the insurer wants to collect as many of these options as it can, so it makes it’s no surprise (though certainly not forgivable) that they do everything they can to make it likely that you’ll inadvertently make a mistake on the application.

There is however an good analogy to be made between counterparty risk in CDS and counterparty risk (by which I mean inability to pay, rather than unwillingness to pay) in insurance contracts. When you buy insurance (health/life/property), a good chunk of what you are insuring against are idiosyncratic risks: the risk that YOU will need healthcare or that YOUR family will need coverage in case you cease to be or that YOUR property will be damaged. These idiosyncratic risks are pretty much uncorrelated with the insurer’s wherewithal to pay.

But there are also systematic risks that impact both your need of coverage and the wherewithal of the insurer to provide it. In property insurance, this is the (implicit) part of your insurance that covers you for damage incurred in a large, widespread catastrophe. If you live along the I95 corridor, this might be a 1,000-year hurricane or winter storm. In the west, it might be that 8.5 earthquake that comes around once in a very blue moon. For life and health insurance, the key systemic risk is the next pandemic flu. And of course, there are systemic risks that impact all of these: major geopolitical unrest, nuclear war, another Dinosaur-killing comet, alien invasion, etc.

I throw in these latter examples to illustrate a point. For major systemic risks, no one expects their counterparty to perform. They expect their government to. Which basically means we’re all self-insured against systemic risks.

And counterparty risk on a CDS contract works pretty much the same way. You’re paying for protection against idiosyncratic risk, but you better not be counting on too much systematic risk protection. Which is why it’s so puzzling that anyone was ever willing to pay even a couple bps for super senior protection on a well diversified basket of credits. This smells very much like buying a end-of-the-world insurance from someone of this world.

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By: Don the libertarian Democrat http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/comment-page-1/#comment-4815 Thu, 30 Jul 2009 19:04:26 +0000 http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/#comment-4815 The point is that Insurance is a contract. There is no reason that the following conditions couldn’t be included in such contracts:

http://yglesias.thinkprogress.org/archiv es/2009/07/the-public-plan-you-wont-have -access-to.php

“The most important part of the bills that actually exist—the part that will impact the lives of most Americans—are the new regulations on insurers.

The administration is proposing:

— A ban on discriminating against people with pre-existing conditions.

— Caps on out-of-pocket spending.

— No cost-sharing for preventive care.

— No “rescission” of coverage for people who get seriously ill.

— No gender discrimination.

— No caps on coverage, either lifetime or annual.

— Extension of family coverage for kids up to the age of 26.

— Guaranteed insurance renewal.”

The thing is to have a third party with enough clout to negotiate such a deal, say the Federal Govt. The govt could even propose its own competing plan if it couldn’t get the deal that it wants. In the end, the govt will step in where the private market of insurance doesn’t cover enough. In some cases, the govt itself offers insurance where it tends to often get stuck with the tab. So, there’s nothing new about that discovery.

The only reason that you would favor my idea as opposed to employer insurance and a total govt plan is if:
1) You think that the employer based option doesn’t have the clout to get the best deal, and it hides the cost of health care from the recipients of it, causing expenses to be less than efficient.
2) The single payer plan will save money over the current mess, but will end up costing us quite a bit more than its advocates claim as politicians will be loathe to increase taxes or cut services. Its better to have a market make those type of decisions, especially if the govt can negotiate effectively the basic conditions.

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By: quantacide http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/comment-page-1/#comment-4813 Thu, 30 Jul 2009 18:30:23 +0000 http://blogs.reuters.com/felix-salmon/2009/07/30/conditional-probabilities-and-evil-insurers/#comment-4813 I can’t speak for health insurance, but I know Life Insurance has a 2 year statute of limitations. Once you are through that window, it doesn’t matter if you’ve lied through your teeth on your app.

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