McCain: Inarticulate on Health Care

So by now I realize that the presidential election is all but over and my preferred (and I use that term loosely) candidate is not going to win, but I do want to comment on the health care issue at stake in this election.

In my view, the issue of how to reform health insurance is the most important domestic issue that will be decided in the next several years. Either we grant the state a bigger role health care or we allow individuals more freedom. We really cannot have both and I would certainly choose the later.

Unfortunately, as evidenced by my friend Rob's recent post, which compared and contrasted the candidates views on health care, McCain is doing a terrible job of articulating what increasing health care freedom means for Americans. So as it becomes less and less likely that anything that I want to happen is actually going to happen let me try to explain what McCain should have said.

The government creates two big problems with health care: Employer based insurance and minimum coverage requirements. Lets take a look at each of these problems and how the government can solve them.

Problem 1: Employer Based Health Insurance

Most Americans receive their health insurance as a benefit from their employer due to federal government tax policy. The policy states that if a business purchases health insurance for its employees, it can deduct the money it spends on health insurance from its taxes just like it deducts the money spent on employee salaries. The federal government does not allow individuals to deduct money spent on health insurance from their taxes. So when most companies and their employees do the math it works best for businesses to buy health insurance for their employees. However at least three problems with this situation have become apparent:

1. Companies have insurance options, but employees do not: If the company is the one purchasing the health insurance, they are the ones that choose which insurance to buy. They may choose to give their employees some limited options, but at the end of the day the business with likely look out for its own interests not necessarily those of its employees. Likewise, the insurance company looks at the business as their customer, not the employees. So when it comes down to making the business happy or making the employees happy the insurance company will try to please it the business, its customer. This contributes to frustration with "insurance".
2. No portability of care: When people get their health insurance through their employer, by definition if they change jobs, they have to change insurance. This creates a problem if someone needs to change jobs when that person or a family member is going through an illness. So the person is left with either not changing jobs or potentially dealing with denial of coverage due to the preexisting condition. Just like it does not make sense to change property, auto, or life insurance when changing jobs, it does not make sense to change health insurance when changing jobs either.
3. The Part-Time Cracks: The previous two problems make health insurance less convenient for the majority of people with a single steady job. However a significant percentage of people lack health insurance all together because they work at a part time job, or perhaps multiple part time jobs. When a business can amortize the cost of an employee's over 40 hours a week for 52 weeks per year, most times they can make the math work out in favor of supplying health insurance for their employees. When they look at an employee who works less than that, either per week or seasonal employment, they may likely conclude that the costs of health care is not worth it relative the employee's total annual salary. People in these situations fall through the cracks of the employer sponsored health insurance.
   

So what is the solution to all three of these problems? Easy, just shift the incidence of the tax deduction from employers to employees and make employer sponsored health insurance a taxable benefit. It takes both things not just one. The net result, at least via the back of the envelope calculations on McCain's website, is at least a push financially with the current system and has the added benefit of giving individuals increased control over their health care, which solves the three problems mentioned above.

The big open issue with this proposal is what happens if individuals choose to leave their employer sponsored insurance plan for a plan that they buy individually. The key assumption to this plan is that by taxing an employer provided health insurance benefit, employees will understand exactly what their employer is paying for health insurance and consider it an explicit part of their salary instead of a difficult to value benefit. So, an employee chooses to leave their employer sponsored plan, they should demand the full value benefit in extra salary, which would give them the extra money to buy that insurance privately.

Problem 2: State Mandated Minimum Coverage

The second government created problem with health insurance is not created in Washington D.C. but finds it genesis in each of the 50 state capitals where legislatures make rules about what types of procedures health insurance has to cover. The classic example is chiropractic care, which many states mandate health insurance cover, but few people actually have any desire to obtain. This is basically a special interest give away by making the majority of people pay higher premiums so that a minority of people can get their specialty care subsidized. Or so that the providers of that specialty care can make more money.

The simple policy change that this country needs is to allow people to purchase health insurance from a company in another state that may have fewer minimum coverages and lower costs. Personally I will never choose to visit a chiropractor, so I would prefer not to hold insurance coverage that covers chiropractic care because it is marginally more expensive and I neither need nor want it.

What is the concern with this? It is not like we are outsourcing health insurance decisions to some third world country. Health insurance would still be regulated by some state and states and insurance companies would have an incentive to make insurance policies more relevant to the individual's needs. That is a good thing as far as I can tell.

Unfortunately we will not get get it because McCain cannot articulate it.

Things I Didn't Know About Subprime

Yesterday I read a fascinating paper, The Panic of 2007, by Gary Gorton (via Tyler Cowen) that describes the factors that contributed to the problems in the financial sector. I learned a bunch of interesting things about subprime mortgages, RMBS (the securities used to fund subprime mortgages), and the more arcane financial structures (CDO's and CDS's) that have contributed to this crisis. The following is a list of the interesting things that I didn't previously know:

1. Subprime mortgages short term loans - This was a little surprising because I had always thought about mortgages as long term investments that could possibly expire early i.e. refinancing or prepaying principle on a 3o year fixed rate mortgage. It seems that when banks made subprime mortgages, they intended force the borrower to refinance after two or three years. Page 12 starts an interesing discussion of subprime mortgage design. In short the banks intended to make a mortgage loan that would need to be refinanced in just a few years, which they assumed would be possible due appreciation on the home value. Gorton argues that this is tantamount to holding a call option on home prices.
2. Subprime backed Residential Mortgage Backed Securities (RMBS) were meant to be short term investments - Again I had usually thought about these bonds as long term investments that might expire early and hence carried prepayment risk. Pages 32 and 33 show a comparison of two subprime backed RMBSs, one issued in 2005 and another issued in 2006. The first thing to strike me about these two deals is that the 2005 deal has already seen prepayments of $836 m on the original $1.2 B of mortgages (70%). In fact the vast majority of the original highest rated (AAA) bonds had been paid off. I would not have thought that less than two years after issuance the so much of this debt would be paid off.
3. The problems with RMBS may have more to do with increased duration than market illiquidity - In contrast to the 2005 deal, the bonds associated with the 2006 deal are not seeing anywhere near the amount of prepayments - $518 m on the original $1.3B (40%). So investors and banks are now apparently stuck with bonds on their books that they originally expected to prepay. So it may not be so much the lack of trading as the lack of prepayment that is hurting the credit markets.
4. The highest rated bonds (AAA) are still highly rated - My initial impression of the subprime mortgage crisis was that the underlying mortgages were performing so poorly that even the highest rated bonds were losing their AAA ratings. Looking at these two deals, that does not seem to be the case. Only the A4 tranche of the 2006 deal has been downgraded and even that bond still gets a AAA from Moody's. I also took a brief look at an subprime RMBS index mentioned in the paper, the ABX.HE index. Just browsing through the various AAA rated indices shows that many of the original AAA rated bonds still held their rating and many of the ones that didn't still held investment grade ratings. The real carnage appears to be in the mezzanine tranches.
5. CDO complexity exposed - I guess that I pretty much understood what was going on with RMBS's being restructured into CDO's but this paper really illustrates how complex the payoff structure is. With multiple checks and tests per layer trying to model the cash flow from these investments is basically impossible. Of course if your expectation is that housing prices will keep rising and that you will get your money back in just a few years it may make sense to invest in something that you do not really understand. I guess that is the thought process.

I may have a few more thoughts in a subsequent post.