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Can’t repeal economics — health insurance

1 Mar

How does health insurance work? Individuals (or an organization on behalf of the individual) pay a premium to a company. If the individual falls sick the insurance company pays for health care. Sounds simple, but what is the insurance company’s business model here?

Healthy people pay premiums. That is the insurance companies revenue stream. When they fall sick the insurance company pays for healthcare — that is (along with administrative expenses) the insurance companies costs. Profits = Revenues – costs. The insurance company has an incentive to keep costs low and revenues high.

Notice that for the insurance business model to work healthy people are necessary as a revenue source. But what sort of person would prefer not to buy insurance? Well healthy people of course because they don’t think they need it. By the same token sick people would want insurance. This dynamic is not good for the insurance companies bottom line. That is why insurance companies would like to charge more for older people or sicker people (for example those with preexisting conditions) though ideally it would be best to not have these high risk categories on their rolls at all.

Older Americans are covered under government run Medicare since they add to insurance companies costs. Before ACA insurance companies could refuse coverage to people with preexisting conditions. Now they cant. Healthy people therefore cross subsidize people with preexisting conditions and as a result high risk people have a lower premium than they would otherwise have while healthy people have a higher premium. This is a risk pool and left alone it is not stable. Healthy people are paying more than they want to so they quit buying insurance. This reduces revenues and profits for insurance companies. So they raise premiums. This makes more healthy people leave. And the insurance company goes out of business. Healthy people are needed to cover expenses for sick people and a little bit more. But for everyone — both sick and healthy — to be covered healthy people have to be “incentivized” to buy insurance. In any case, any policy to add more people to insurance rolls implies that sicker people are more likely to apply while healthy people will not. This unraveling of the risk pool destroys the insurance business model. The only way to get around that is to “incentivize” healthy people to join the insured ranks.

The ACA does that by penalizing people who do not have health insurance. The various replacement plans floating around seem to want to give tax credits for those who join. They are essentially the same thing. Consider someone who has to pay a $1 penalty if she does not buy insurance. That $1 of her money she does not have — a penalty she can avoid by buying health care. Now consider the $1 tax credit. If she does not buy the insurance she loses $1 of her own money as taxes — a penalty she can avoid by buying insurance!

Can’t repeal economics. Sigh!

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Tenure: A meandering path to serfdom!

15 Mar

Tenure is part of the compensation package for college professors. However, college administrators view this as a privilege. In fact, the AAUP (effectively a professor’s union) tacitly agree because they make the case for tenure as an institution necessary for academic freedom with no connection to compensation.But let’s concentrate on the idea that tenure is about compensation. How should professors react when tenure is not part of a compensation package?

Consider what tenure does. It is part of a compensation package designed to reduce mobility. It is a barrier to exit in the college professor employment market. Thus it reduces bargaining power for the professoriate effectively by reducing any holdup costs. Professors cannot make a very credible threat to leave if they feel their working conditions are bad or wages are too low. This lack of credibility translates into reduced bargaining power when it comes to wages. This is, of course, a big reason behind the wage compression we see among professors relative to assistant professors. And if there is no way to bargain for higher wages or better working conditions why should the professoriate innovate? After all they cannot retain the fruits of their innovations. So what would happen if tenure went the way of Nineveh and Tyre?

The end of serfdom – similar to tenure insofar as it reduces the bargaining power of labor by restricting mobility – in medieval Europe may provide an object lesson. The reduction in the labor force wrought by the plague had differential impacts in Western and Eastern Europe. In Western Europe small institutional variations led to the end of serfdom as labor became more scarce. This jump started a secular increase in the share of output going to labor. Of course mobility and other institutional changes also promoted innovation and economic growth. In Eastern Europe, however, the problem of scarcity of labor was met with a strengthening of serfdom! The results are obvious and persist to this day.

In other words, removing tenure, like the end of serfdom, should increase the likelihood that the professoriate will innovate to keep themselves competitive and increase their wages. Of course there may be other problems based in agency theory. How will administrators gauge the productivity of the professoriate given the inherent information asymmetry that exists between the professoriate and college administrators? But that’s another post. Watch this space!

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