History teaches us things that we could not learn otherwise. Only in retrospect does the mode, meaning and intent become clear.
Without much ado, let us go back to the most defining moments in the recent
past dating back a few decades.
Liability is an all-encompassing word that deals with every
nuance of human behavior. The morality of escorting this behavior into the
domain of risk managers is Odysseus’ siren song of the mantic truths of Social
Responsibility. Here “some” (insurer) take the risk of “others’ (principle) behaviors.
The moral of the story (I will give it to you right up front), however is cushioning ‘others’ bad behavior encourages
more bad behavior due to information asymmetry. While “Less is More” is a
product of the lessons learned from such moral hazard, applying it
appropriately is a nuance of judgement. Both Welfare and Disability are the
current norms in a society filled to the gills with moral hazards. Welfare
incentivizes poverty while disability payments empower people to look for
compensations. Although some (Pauly 1968) have tried to remove the “Morality”
out of the moral hazard to make it less appetizing to the sensitive souls, it
remains an issue of perverted incentives based on well-intentioned efforts.
Similar efforts are being espoused daily under the premise of financial
redistribution. Those receiving the redistributive wealth are incentivized to
do less as ultimately those that are doing more to create wealth, reach the point
of diminishing incentives (Margaret Thatcher would simplify by saying “When you
run out of other people’s money).
Many years earlier there was a President who envisioned in
his heart and mind with a well-intentioned view that everyone in the country
deserved a picket fence to realize his or her dream. And so, began a race to foster
such a provision. Another President echoed those sentiments and continued the compassionate
policy.
The policy was to make money available to everyone at cheap
rates so that people of all stripes could afford a home. Soon people with
meager means realized that they could use the cheap money to buy and sell and
reap the appreciating reward. This was euphemistically termed “flipping.”
Flipping continued and many a person with meager means grew to amass a
reasonable sum of money. But that did not stop the wheel from tumbling. The
people started to make bigger and bigger bets with larger and larger sums of
money that they could ill afford to pay off should the counterparty not be
available to purchase. Meanwhile the banks realizing the benefits of cheap
money scaling into a larger sum of money started writing larger number of
mortgages to anyone who would ask. In so doing and not holding the mortgage bag
for long the banks decided to package good mortgages and those that potentially
might default into baskets or (Hi + Lo Risks) tranches and sold them to other
investment houses based on Moody’s Risk Ratings (And Moody was paid by the
Investment Banks to rate). Given the complexity of the risky nature of these
tranches, the banks worldwide got into this easy money-making machine and went
to the Insurers to insure their mortgages in case of default. The Insurers
realizing a nice size premium from the insured expanded their reach to
underwrite any bank that was willing to follow. Essentially trillion dollar
bets were made and hidden in open sight for the willing blind to see. What
happened was when the music stopped, (bubble burst in slang parlance) and
mortgage default rates started to rise, the banker, insurer and the politician,
all saw blood on the street. Wall Street panicked and huge wealth
dematerialized. But the Policy-makers were not done, they decided that the
banks had to lend to “unfreeze” the bank loans to the consumer (the little
people). Congress under pressure from the then Treasury Secretary (Hank
Paulson) and the Federal Bank Chairman (Ben Bernanke) agreed to print up $700
Billion as a “toxic asset relief program” or TARP. The funny thing about the
$125 Billion of loans forced on the banks to unfreeze the lending market were
never paid out as loans. Those assets were used by the banks to shore up their
balance sheets. Since those heady days of looking at the financial abyss, the
government has issued $4.5 Trillion in paper money to bail out the U.S.
Streets. Most of the money has trickled into the banker’s, Insurers and their
CEO’s portfolios and not too much into the worker, consumer or the little
people. Hence the steep rise of the wealth inequality) Moral Hazard, you say.
Um yes, totally. A policy of cheap money for picket fences lead people to
hazard bets they could ill afford and when they couldn’t anymore they allowed
foreclosures on property. The market value of Real estate plunged, leading
JPMorgan to buy out Bears Sterns at pennies on the dollar US government bailed
out AIG to protect its tentacles into risk management that AIG could not manage
and Freddie and Fannie Macs. Only Lehman filed insolvency.
"A top-down policy of good intention by giving every household in a dilapidated aging housing project with corroded gas pipes, a large candle, in case the lights go out."
Free markets resolve issues by entrepreneurs and market
forces. The slack is removed in time, the errors are corrected, the faults are
masked over, innovations blossom and paradigms get shifted in scope and scale. A
form of Taleb’s Antifragility exists when free market forces are at play. A top
down policy is a petri dish cultivating a dangerous pathogen that ultimately
destroys the laboratory, its creator and the people that come in contact. A top-down policy of good intention by giving every household in a dilapidated aging housing project with corroded gas pipes, a large candle, in case the lights go out.
As hazards go, moral hazard, that is, after the debacle that
pushed a lot of people through greed or innocence into a financial abyss, 9 US
Banks held up and now control 77-80% of the U.S. Assets. These institutions are
now considered “Too Big To Fail,” you see the moral hazard there, don’t you? As
things go, being that these behemoth banks, large and clever, with financial
wizardry they also became big policy maker’s hand-shakers to effect policies in
their favor. Morality has been buried in plain sight. Now, there are High
Speed Computerized Algorithmic Trading and Dark-Pool market-places where only a
few participate. Flash crash hazards will become all too common as incentives to catch the microsecond information asymmetry, overwhelm morals. A new moral hazard is brewing before our eyes.
Not to be outdone, the policymakers looked at the medical
industry and there too, under the guise of “greater good” or “public good” they
jumped into the medical industry with both feet. To weed out the wicked and not tempt the good people from doing bad things, they were determined to
exorcise the whims of immortality.
Seeing a potential windfall, a few insurance intellectuals
decided to move into the medical industry to carve out a niche for themselves.
With well-informed lobbyists inhabiting the various nooks and crannies in the
Capital Building in DC. They decided on underwriting the health risks of
individuals with a slow ever-escalating premium scheme. The asymmetry of human
behavior manifested as people started utilizing these cards for even the most
minor of complaints, jamming into emergency rooms and doctor offices (Moral
Hazard). The business of medicine went into overdrive. Seeing the payouts
skyrocket, the Insurance executives put constraints on physicians with
preauthorization requirements and then used their patient population reach to
contract prices with the physicians for services rendered. The private and
public insurance party was in full swing. The public sector was similarly
enmeshed with overuse of services, physician offices and the hospitals were
brimming with Medicare and Medicaid patients. Various acronyms PQRS, AHRQ,
PCORI etc. were floated and they finally rested on the term “value” as the
arbiter of physician payments under the MACRA program. The experts from the
private sector and the academic circles had jumped into the public sector to
regale their opinions. Soon the public sector was living the dream of the
academics and scholars who had never worked a day in their lives except for
pontificating. As technology blossomed so did the need to incorporate it into
the medical sector. It was professed that every encounter between the patient
and physicians would be digitized and yield benefits to the healthcare of
individuals through data gathering. A policy was enacted between the U.S. Chief
Executive and HITECH was portrayed as the next coming of sliced bread.
Within the technology industry a few well-placed cronies found the niche to market their Electronic Medical Records and soon
millionaires became billionaires with the fortune of knowing the right people
in the right place at the right time. Meanwhile the hazard of caring increased
and physician time became an expensive commodity. Soon the patient-physician relationship collapsed because the eyeballs were focused on the flickering screen and not on the patient and as per queue, the blame was laid at the physician's feet. The policy-makers ratcheted
that up by demanding x-numbers of minutes or hours spent would receive
y-amounts of reimbursement for the services. The gaming had begun. Prosecutions
erupted like dormant volcanoes all over the country as lawyers looked at
numbers of patients serviced and hours in a day and deemed the impossibility of
such encounters did not deserve the invoiced amount therefore the payments were
considered a fraud crime. The policy rope kept growing in length and soon to
circumvent further payouts, the noose tightened and the wonks decreed readmissions into the
hospitals within 30 days was a non-reimbursable event. The hospitals found
themselves on the wrong end of the deal and made it the physician
responsibility to the detriment of the patients many of whom died at home from
lack of hospital care. If you were a hospital employee as a physician and your
“activity” did not make money for the hospital, then you were looking at a pink
slip. Those physicians, adept at the game, survived and thrived. Others simply
decided to call it a day and retired prematurely.
What we find is the institutionalization of the moral hazard
by top-down policies that have clearly and dearly hurt (and continues to hurt) the country in wealth and health. A
policy decreed by academics with no “skin in the game” leads to unintended
consequences that they can never foresee in the real world. Enacting policies
that are thrust from “high on up” who decide reality based on a few variables
end up exacting real burden on people. Insurance then is a means to guard
against loss. Yet it falls prey to both Moral Hazard and if provoked through
policy, Adverse Selection. To decide healthcare premiums, based on the
information asymmetry, high risk and low risk individuals are pooled together
to create the actuarial data of low and high premium averages for a given
individual’ risk of contracting illness or disease. Not having the low risk
individuals in the pool to offset those premiums, forces the premiums for high
risk individuals to sky rocket and become unaffordable as evidenced in the
Obamacare disaster - where both moral hazard and adverse selection are in play.
The moral hazard here was excess use by the high-risk-covered entities and the low
risk decided to pay the penalty and not play the game of chance. The penalties
were not enough to offset the insurance costs. Everyone suffered.
All models ultimately show that insurers face larger
increases in occurrences, magnitude and costs against what is insured. The society
rests on the prevailing doctrine that insurance shields us from disasters thus
modifying behavior. Further adding subsidies for the
greater good leads to even greater losses due to adverse selection and more risky behavior:
Ultimately the Free Market principles and entrepreneur led
innovations result in the best outcome for all. The old-adage of “skin in the
game” teaches us all a valuable lesson in moderation and self-responsibility. Subsidies and entitlements, enable.
Now to convince the Regulators…Oh but that is a wonderful pipe
dream. Isn't it?
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