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  • President's Proposal Introduces "AIG Risk" in Federal Insurance Rate Regulation

    White House

    The White House has just issued an 11 page concept paper (PDF) for yet another health care bill that, among other items, includes a proposed new Federal “Health Insurance Rate Authority.”  The Administration has yet to provide any legislative language on how this new Federal regulatory regime would operate, but based on statements by the President and other officials, as well as similar provisions included in the bills already passed by the House and Senate, there is good reason for concern as to whether the President and Congress really know what they are doing in this regard.

    The President and the Congressional leadership assert that health insurer rate increases are unjustified and point to some cases of recent double-digit increases announced by certain insurers.  But so far they have offered no explanation of what portion of those increases they think are unjustified or their reasons for taking such a position.

    In reality, there are a number of reasons why health insurers raise their rates, and so-called “insurer price-gouging” is one of the least likely causes.  The biggest reason is growth in the price and volume of medical care that the plans pay for.  If policyholders consume more medical care and/or if doctors and hospitals charge higher fees, then insurers must—obviously—raise their premiums to cover the added costs.

    Another reason, and one that is particularly relevant this year, is that during recessionary periods some individuals in good health figure that they can save money by temporarily dropping health insurance coverage.  They are betting that they will stay healthy and that, once the economy and their personal situation improve, they can buy coverage again.  Of course, that means that insurers face a drop in premium income and need to raise rates on their remaining policyholders to cover the difference.

    What is most disturbing about the President’s latest proposal, and similar ones in Congress, is the apparent lack of understanding that one of the most basic purposes of insurer financial regulation is not to prevent “price-gouging,” but rather to prevent the problems that occur if insurers under-price their products.  Specifically, if an insurer fails to charge enough in premiums to cover its expected claims costs, then it is at risk of being unable to make good on the promises made to its customers.  That can leave policyholders with worthless coverage or spark demands for government bailouts that impose on taxpayers the cost of covering the losses.

    It was precisely such problems that led states more than a century ago to start regulating insurance.  As in any other market, competing insurers try to attract customers by offering lower—not higher—prices (premiums).  But “consumer protection” in insurance rate regulation means ensuring that insurers are financially sound enough to make good on the promises made to their customers.  Thus, a primary objective of insurance law and regulation is to ensure that insurance companies charge enough in premiums, and set aside enough in reserves, to be able to pay the claims that they have promised to pay.

    The whole AIG debacle is a good illustration of what can go wrong if an insurer is allowed to under-price coverage.  What AIG essentially did was to sell banks insurance against their loans going bad.  But because it structured what were really insurance policies as financing instruments, AIG was able to avoid insurance regulator oversight and instead have the products regulated by banking regulators who weren’t experts in insurance.

    The result was that AIG underestimated the size of its potential liabilities, under-priced the coverage (which made banks even more willing to buy it, since the “premiums” were cheap), and failed to set aside sufficient reserves against claims.  When the banks’ loans went bad, AIG was faced with tens of billions of dollars in claims that it simply couldn’t pay.  Congress had a choice of either telling the banks, “Sorry, you bought worthless insurance,” or sticking the taxpayers with the tab to bailout AIG so that it could payoff the banks’ claims.  In the end, Congress, worried about the collapse of the banking sector, stuck taxpayers with the bill and bailed out AIG so that it could pay off the banks.

    A President and Congress that want to regulate health insurance rates, but either don’t understand or don’t care about the potential costs and damage of allowing—or even forcing—insures to under-price their coverage, and who seem to have learned nothing from the AIG experience, is something that all Americans should be very worried about.

    Posted in Obamacare [slideshow_deploy]

    5 Responses to President's Proposal Introduces "AIG Risk" in Federal Insurance Rate Regulation

    1. Brian Flanagan, Guil says:

      You could also have included that when healthy people drop their insurance, all that is left is the sick people, who use more than a normal share of medical services. Therefore, to cover those people remaining who kept their coverage premiums will have to go up — no longer are the healthy people subsidizing the group. Now it's only the sick, and premiums skyrocket. That makes semi-healthy people drop the coverage, leaving only the really sick.

      The Democrat's health care proposal will allow people to buy insurance AFTER they get sick, and they cannot be discriminated against, cannot have pre-existing conditions tonight, and cannot be charged more than the healthy.

      Why, in God's name, would anyone buy insurance BEFORE they got sick? Just call them from the ambulance or your hospital room.

    2. rimaye says:

      This is a hatchet-job if I ever saw one. It starts with a reasonable enough premise (I.e., the legislation proposed by the President could in some circumstances force insurers to underprice products), and then proceeds to make a number of assumptions and unsubstantiated claims – that the health insurance markets are in a state of perfect competition, rather than monopoly or oligopoly; that for some reason, we shouldn"t expect insurance companies to behave like corporations and charge as much as they can get away with, but only what's necessary to cover expenses (does that include bloated executive compensation packages?); that there is any sort of similarity between insurance markets for asset-backed securities and far more straightforward health care.

      Obviously, I represent the politically opposite end of the political spectrum vis-a-vis the Heritage Foundation, but I at least attempt to state my assumptions and provide some evidence to back up my position. This probably will not make it past the moderators, but I hope it will, because I think we as a country need more reasoned debate between people with disagreements, rather than platitudes with little substance.

    3. Pingback: Fausta’s Blog » Blog Archive » The President’s $1 trillion health bill

    4. Lloyd Welch Valdese, says:

      I come to the Foundry, read almost all the articles and comments, then I post sometimes the moderators tell me I post too quickly and tell me to slow down. Which I do, or try to anyway. Something I would like to say is I am old enough that I lived through all this. When Bush Sr. was in office I had a good job and made adequate money to have a good life. I had good insurance through a group policy at work and life for the most part was good. Bill Clinton was elected President. I didn't vote for him because I am a republican and politics was not one of my main concerns. I had heard of NAFTA but didn't know much about it. I was honestly too busy living the good life to care a lot about it, but it didn't take long for me learn at lot about NAFTA. The company I worked for opened a plant in Brazil and we started working three weeks out of four. I went to college changed jobs and a few years later the company closed all their manfacturing facilities in America. The plant I worked at is now a hugh warehouse. I think Wal Mart bought the property and will soon open a Super Wal Mart there. I have watched plants close all over Western NC. I have moved to a different county but the county I grew up in has the third highest unemployment in NC. We do not have a health care crisis in America. We have the best health care in the world. Unemployment and underemployment is the crisis. Not being able to afford insurance is the crisis.

    5. Tyler Smith says:

      I generally agree with Heritage, but this article seems a little too much like an opportunistic play on fear of Wall St. to debunk Obama's plan. I don't agree with Obama, but I don't agree with fear-mongering either. Comparing credit default swaps by AIG to health insurance policies is quite a stretch. In AIG's case these were basically bets by an opportunistic financial products division that an overvalued real estate market would not go sour. I sincerely doubt that most insurance companies would ever bet that everyone in their risk pool would stay completely healthy. But if they ever did, then your comparison would be sound.

      "AIG seems to have thought CDS were just an extension of the insurance business. But they're not. When you insure homes or cars or lives, you can expect steady, actuarially predictable trends. If you sell enough and price things right, you know that you'll always have more premiums coming in than payments going out. That's because there is low correlation between insurance triggering events. My death doesn't, generally, hasten your death. My house burning down doesn't increase the likelihood of your house burning down.

      Not so with bonds. Once some bonds start defaulting, other bonds are more likely to default. The risk increases exponentially."

      from Adam Davidson "How AIG Fell Apart" http://www.reuters.com/article/idUSMAR85972720080… Reuters 9/8/2008.

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