RiskProf

The One about "Research"

Florida Insurance Commissioner Kevin McCarty talks about "research" ...

It is always interesting, and frequently amusing, to read various “research” pieces on the Florida property insurance market. While I, like every other insurance regulator, industry professional and observer in the world, agree that the Florida property insurance market provides a challenging, to say the least, economic environment, I must also finally break down and respond to some of the more recent articles.

Here is an abstract and a link to a recent and hopefully amusing article on Florida written by a couple of real comedians (at least our friends think so).  Actually, I am not sure if he is even responding to our riotous prose because Mr. McCarty does not refer to any particular piece of research and does not cite any studies or commentary in his protest regarding the amusing research.  As the "regulator" he should point fingers and cite his sources of amusement for the rest of us aspiring humorists. 

Here is a direct but extremely short rebuttal from the CEI. I didn't notice any belly busters or guffaw worthy bon mots in the CEI's response, but I did note (with a couple of well placed chuckles) that the CEI recently ranked Florida regulators at the bottom of a 50 state list.  I suppose it probably was not for the lack of a sense of humor.

 

ABSTRACT (gated link, but appears to be free for now)

The Perfect Storm: Hurricanes, Insurance, and Regulation

by Martin Grace and Robert Klein

The intense hurricane seasons of 2004 and 2005 caused considerable instability in property insurance markets in coastal states with the greatest problems occurring in Florida and the Southeast. Insurers have substantially raised rates and decreased their exposures. While no severe hurricanes struck the United States in 2006 and 2007, market pressures remain strong given the high risk still facing coastal states. These developments generate considerable concern and controversy among various stakeholder groups. Government responses have varied. In Florida, political pressures prompted a wave of legislation and regulations to expand government underwriting and subsidization of hurricane risk and constrain insurers' rates and market adjustments. Other states' actions seem more moderate. In this context, it is important to understand how property insurance markets have been changing and governments have been responding to increased catastrophe risk. This article examines important market developments and evaluates associated government policies. We comment on how regulation is affecting the equilibration of insurance markets and offer opinions on policies that are helpful and harmful.

Florida is Full of Good Ideas

According to the Miami Herald a law maker is thinking of taking reserves away from Citizens (the state owned insurer of last resort) to capitalize new insurers. 

Two things to note here.  First, Citizens is still under capitalized in a big way. So taking away some of its reserves to put into the private market seems crazy. Essentially, the state would be taking money from an under-capitalized company to subsidize a private market company. This isn't any different than subsidizing Citizen's customers by keeping prices artificially low. Second, Florida is terrible about picking companies to give money to.  A major Florida player, POE, was essentially  started by the state through the institution of Citizen's previous take out program.  POE is, ironically, never more......

Risk and Race

One of the major criticisms of credit scoring is the alleged link between a person's race and poor credit score.  On the surface, the credit score does not know a person's race as it is just based on a set of behavioral indicators (do you pay your bills on time and things like that) which depending on whom you believe might suggest credit scores are a proxy for membership in racial and ethnic groups.  The FTC's recent report (see p 4) says there might be some relatively small relationship while other studies do not find it (see III's list of industry funded, but scientifically not objectionable studies).

Given this background, I'd like to pose another question.  Let's suppose that a certain racial group has a higher percentage of people with a propensity to do X.  [Let's let X be undefined for a moment and let it be under a person's control and not be something like a gene which causes a higher risk of disease or death.]  So, should public policy prohibit the use of race merely because of a disparate impact?

Under the Civil Rights Acts (which do not apply to insurance coverage), the prima facie disparate impact test would be something like:  if the decision to insure is facially neutral to one's race, but there is higher proportion or statistical adverse impact based on race, then there is evidence of discrimination.  Again, this is not the rule as applied to insurance underwriting decisions, but just in case it was, it would be theoretically possible to void credit scoring if one could show a link between race and low scores.

Now suppose that an insurer desired to charge people who smoked a higher rate than non-smokers.  Could one argue based on the disparate impact theory that if relatively more smokers were of race Z, then then there would be a disparate impact on people of race Z and that would be enough to prohibit the risk classification?

It is a slippery slope to use this disparate impact test for insurance when we are talking about risk classifications.  If people see a higher price for riskier behavior they will change higher behavior over time.  Thus, smokers should be charged a higher rate even if it impacts whites as class (as it actually appears to do) more than other races.  (see the following chart for a racial breakdown of smoking incidence.)

(click to enlarge).

The insurance market provides incentives to high risk people to modify their behavior.  If people have poor credit scores their cost of risk is higher.  Won't this knowledge lead people to make better decisions about their financial health leading to a lower cost of risk in the future?

Mr. Hunter Tries a New Tactic

Consumer advocates have generally suffered losses in the war against the use of credit scores and other rating methods that they deem unfair.  Fairness in the risk-rating business is generally defined to be having a legitimate link between risk and the rating category.  Smokers, for example, have higher risk of lung cancer and so they get a higher life insurance premium.  No one really disputes this rating classification because everyone knows smoking is bad for one's health.  However, the consumer advocates believe that insurers should not charge poor people more for their insurance just because they are poor. I concur.  However, I do not think that is the case at all and most states have agreed with this position.

Now, the consumer dis-advocate argument is becoming slightly different.  Mr. Hunter and his associates are claiming that an ethical consumer should not deal with a company which gives them a price discount if they are going to raise the poor person's insurance as a result.

Hunter cautions that some companies seem to harbor biases against minorities and low-income people. He objects, for instance, to auto insurance giant GEICO's use of education and occupation as factors to determine a driver's risk. Through a formula, he says, domestic workers and high school dropouts pay higher premiums to GEICO than do their better-educated counterparts who have identical driving records. His tip for ethical consumers: Beware when an insurer starts asking about your schooling and your job. Even though you might get a good rate, your less-educated neighbor may be paying an exorbitant fee due to an unfair process.

"A lot of people don't think about how this classification system works," Hunter says. "I think most people say, 'Oh, the rate is $50 less, I'll take it.' They don't [realize], 'The reason I'm paying $50 less is because some poor people over there have to pay $100 more.'  (Christian Science Monitor)

So now the consumer with a good record (or low- risk) becomes complicit with the evil insurer for the risk classification system.  So, non-smokers should not take the lower life insurance premium as the lower educated poor person will have to pay more as a result.  The low-risk consumer is now as evil as the invidious insurer.

The wacky thing here is that there is no causation and every actuary should know this.  Risk rating classes are designed not to subsidize or tax others. The price for the risk class of non-smokers (or good credit risk) has nothing to do with the price for the other risks the insurer provides protection.  If there were subsidization, then we'd have too many high risks taking a low risk policy.  This causes a loss to the company.  If we tax a policy we end up selling too few of that type of policy and the company would not make as much money as possible.

OUCH! But not surprising.

Frederick Sachs writes in the

The Scientist

Complaints by scientists about the flat NIH budget have grown louder in recent years. For scientists to effectively lobby Congress for increased funding, however, we need to show that increased funding increases productivity. Given this need, I decided to examine scientific productivity as a function of the budget. Since the NIH budget doubled from $15 billion to $26.4 billion from 1999 to 2003, I reasoned that there should have been a corresponding jump in productivity. The test was the simplest measure of productivity: the number of publications.

Here's what I found: The number of biomedical publications from US labs did in fact increase from 1999-2004. However, so did the number of publications from labs outside the US where the research budget did not double. ... There is no upward jump that you would expect to see with a sudden increase in productivity.

[emphasis added]

via FuturePundit

While this is a unidimensional look at productivity (it does not take into account any potential impact of the research), it is pretty discouraging, but not surprising that the government can not efficiently purchase R&D.  In addition, it imposes a tremendous amount of overhead on universities (to prevent fraud).  Our overhead rates on federal contracts are in the 40-50 percent range.  Historically this funded utilities, the upkeep of research labs and the like, but now it funds auditors, contract administrators, and an entire university bureaucracy devoted to obtaining and administering even more grants.  Just look at your alumni magazines.  They are now almost 100 percent glossy descriptions of all the cool research going on at the old U.

A Little Research Report on Tort Reform

One of the major themes of the tort anti-reform movement has been the assertion  insurance premiums have not fallen after tort reform.  Ty and I are doing some research on this (which we will post after it is finished).  However, one of the things I was reading was the paper put out by the Center for Justice & Democracy entitled Premium Deceits.  In it, they count the number of major tort reforms in a state and then they look at whether the change in premiums over the period 1985-1998 is related to the number of major reforms.  They find that price changes over the period are not related to the number of reforms.  The report then makes the claim, that tort reform is deceptive and that it will not have an effect on lowering premiums.

I thought I'd talk about two things I noticed in the report.  While the report was carefully done in terms of enumerating the states' reforms, it doesn't necessarily make sense just to add the reforms up into an index of tort reform.  For example, one state may have a collateral source rule change and a damage cap enactment.  Another state may have a damage cap enactment and a change in joint and several liability . ... both would count as a '2', but they may or may not have similar impacts.  So, I thought this is a problem and is generally treated in academic papers by using a dummy variable for each significant tort reform.

So what if I disaggregated the Center's tort reform index and made a dummy variable for those states with two tort reforms and those with three tort reforms?  To see the effect of this minor change in defining the index, I estimated two regressions. (If your eyes are glazing over just skip down to the § symbol below.)

I estimated a simple regression (something the Center did not do in the report) of the form:  percentage change in products liability premiums = a + b*Number of Major Tort Reforms Enacted.

I obtained the following results:

*** significant at the 0.001 level.

This is essentially the conclusion that the authors made.  Tort reform was not statistically related to reductions in the change in prices over the period.

However, if I were to break out the number of reforms into two dummy variables (TR2 =1 if state has enacted 2 tort reforms, and 0 otherwise, TR3 =1 if the state has enacted 3 tort reforms and 0 otherwise) I get a slightly different result:

***significant at the 0.001 level and ** significant at the 0.05 level.

§This result suggests the tort reform does have an effect on lowering prices, but the number of reforms that accomplished this goal is 2.  This result refutes the Center's conclusion (at least for products liability) as the coefficient on TR2 is significant at the 0.05 level.  In simple terms, two tort reforms were associated with a 26 percent reduction in the percentage change in product liability premiums over the period in question.

This is still unsatisfactory, though, as one can not really add the state's tort reforms up to get a simple additive index of tort reform.  I don't even believe that two reforms make a difference but three do not.  So as all good academics are wont to claim, more study is needed.

FYI:  The data used are all available in the appendix of the Center for Justice and Democracy's paper which I linked to above.

Again: Med Mal Rates

NC Trial Lawyers say mutual med mal insurer charges too much.

Again:  It is a mutual insurance company.  Any surplus belongs to the policy holder physicians.  If the insurer has too much surplus, eventually the consumers (physicians) get it back with interest.  If an insurer has too much surplus, it may imply that the insurer is worried about being able to cover its eventual liabilities. 

I also can see a legitimate suit against the directors of a mutual company for not being prudent if they did not carry the necessary surplus for a med mal insurer.

Again, if you can do  better (as Ted Frank suggests)  form your own company. 

Again:  It is Jay Angoff saying this.

I think it is interesting to see that the trial bar is interested in insurance prices.  Perhaps it is feeling guilty?

An Interesting Juxtaposition

Lisa Fairfax at the Conglomerate summarizes a recent Washington Post article (reg req'd) by Jeff Brown discussing the profitability of socially responsible investing.  According to Brown, The research suggests that investors give up profits  to do so.

At the same time, the University of Nottingham is introducing an MBA in corporate social responsibility.  Here's an MBA for people who choose to under perform!

via Marginal Revolution

Moral Hazard II

If the Swedes are some of the healthiest people on the planet, why do they have the highest disability rate?

This can all be explained by moral hazard.  See Mike Feehan at Insureblog.

 

Moral Hazard I

Moral hazard is everywhere even at Universities.  Academic tenure allegedly causes shirking.  Today’s VC has an interesting discussion of this phenomena.  I have a slightly different take.  It is not just tenure, but the retirement systems which may cause future problems in academia.

Opponents of tenure (including me) claim professors obtain job security through tenure and and then supposedly stop working.  I don’t see it everyday, but I know it happens.  Dead wood likely abounds at US universities and it likely to get worse.  This is, in part, due to the change in the universities’ retirement systems. Most younger professors (50 and below) have been switched to, or voluntarily chose, defined contribution plans.  This is a common trend across universities and the private sector.  In contrast, most older professors (50+) are on defined benefit plans.  The DB-ers retire at 30 years of service because they get a “formula benefit” based on the highest three years of salary and the number of years of service.  At some point it pays to quit as the pension approximates some relatively large percentage of full time pay.

In contrast, the each year the DC crowd keeps putting money into a retirement plan like a 401k.  Some years the returns on the retirement portfolio are positive and in some years they are negative. If there is any economic uncertainty, the individual professor bears all of the risk of a market down turn.  Thus, it makes sense to keep working if the market is in turmoil.  Well, just about everyone thinks the market is in turmoil (even if it has had a couple of goods years).  Further, one never knows, but the next crash could be just around the corner.  So, the risk averse tenured professor decides to keep working even into his or her dotage. To compound the tenure problem there is no mandatory retirement age to “force” retirements.  In Georgia (where I live) unlike other states like California, it is probably illegal or unconstitutional to offer buy out plans to faculty.  I suspect we will be seeing in the future a large number of older professors like me graying at the vine. 

I don’t really want to “force” professors to retire with a mandatory rule, but there is likely to be an optimal retirement age for many of us and we need to design a proper incentive system.  Right now the individual’s incentive might be to go beyond that optimal retirement age.  As people age they become more risk averse and are likely to stay employed (assuming they can handle the work) taking a guaranteed income rather then retire and face a potential variable income.  In addition, each year of work provides an additional contribution to the retirement portfolio.  However, each year of work beyond the optimal retirement age costs the university in terms of lower productivity (even if the professor is not “dead wood”).  I can see private universities being able to have a greater ability to craft buy- out packages for their faculty.  They will be able to compete by saying “Our faculty are young  and dynamic and are in the prime of their research lives.  Come to our school to study!”  This places Georgia public universities at a disadvantage.

See also TIAA CREF Study, Marginal Revolution and links therein.