Notes from Recent Travels

Before I begin this evening, I would like to comment on my absence for the last week.  I gave a talk on Friday to the Southeastern Actuaries Conference.  I found myself behind the eight-ball, because of my many other projects, and so I had to block out the time to write and prepare the talk.

I’m going to turn the talk into a post, or a series of posts.  If you want to view the presentation before then, you can download it here (PPT PDF).  I needed more time; I wanted to do more with it – but you reach the end of your time, and you have to make your speech.  I didn’t feel well on the day I presented it; my throat was sore.  So, my apologies to any at SEAC who felt my talk was marginal.


One thing that came out of the SEAC meetings was an actuarial analysis of the health bill.  The presenter tried to be as neutral as possible, but the more he said, the more the actuaries I talked with said, “This bill doesn’t make sense.”  Now, I’m not a health actuary; I am a life and investments actuary by training.  Roughly 1/3rd of the audience were health actuaries, and 2/3rds were life actuaries.  The response was not, “This will hurt the industry.”  The response was more like, “This won’t work.  The costs are underestimated, and the taxes are overestimated.  This has real potential to mess up the good parts of the system, and be a very costly fix to the less generous parts of the system.  Taxes are front-ended, and costs are back-ended.  The analyses that show savings over ten years will show significant losses in the long run.

Among my pet peeves is that the bills are likely to do away with HSAs, which more than most health plan designs, gives real incentives to keep health care costs down.  If anything, moving away from first dollar coverage to catastrophic coverage would be a real incentive to keep down health costs.

I genuinely hope this does not pass Congress, and that nothing is done.  Then again, perhaps the Democrats want to commit political suicide.  Not that I like the Republicans much, but cramming through an ill-thought-out plan not favored by most Americans, can’t do much for their chances in 2010.


Secretary Geithner changed his view on why the AIG bailout was done.  He now says it was not over the derivatives counterparty, AIG Financial Products.  He probably says that because the government could have cut a better deal with creditors and did not, leaving the taxpayers on the hook.  Having thus bailed out Goldman, and other US and foreign investment banks that were due payments from AIG, the malodor of aiding investment banks in an opaque way is something the Treasury wants to lose.

So, now he claims it was to prevent systemic risk from failure of AIG’s operating insurance companies.  Now, I know that the life and mortgage insurance companies would have died, because of research I did in March and April of 2009.  But in September of 2008, no one was arguing about the insurance subsidiaries; it was all about AIG Financial Products.  No one was focusing on the weird losses from securities lending at the life subsidiaries of AIG.

Taking a step back, Insurance companies don’t produce systemic risk to the same degree that banks do.  First, the insurance industry is only one-third the size of the banking industry.  Second, insurance asset investment regulations are stricter for insurers than the bank regulations.  Third, the leverage isn’t as high, and the sources of profit are more diversified.  Finally, the liability structure is longer for most insurers, making “runs” less likely.

So, what would have happened if the Fed hadn’t come in and rescued AIG?

  • I recommended at the time that the government wall off the derivatives counterparty, and then analyze what the risks would be to the system as a whole if AIG did not pay on its derivative agreements in full.
  • The life and mortgage companies would have failed.  The mortgage companies would have added to the losses of Fannie and Freddie.  No state guaranty funds there.  The life companies might have passed $1-3 billion of losses to the state guaranty funds, hitting the life insurance industry when it was weak, but it would have killed few companies.
  • There were support clauses in many of AIG’s main P&C companies for some of the Life companies.  The P&C companies could have made good on those, and perhaps the state guaranty funds would have been clear.
  • Perhaps International Lease Finance or American General Finance would have been weak, but they would not have died immediately… and there would have been little systematic risk from any failure.
  • Common and preferred shareholders would have been wiped out, and maybe junior bondholders.  Senior bondholders might have been forced to compromise.

This isn’t good, but it is also not systematic risk.  After walling off AIGFP, there was no systemic risk from letting AIG fail.

Holding companies should never be bailed out.  There is no case for protecting them.  Operating subsidiaries are another thing; they are regulated for the good of consumers, ostensibly.

Ergo, I find the logic of the Treasury and Secretary Geithner wanting if he is claiming he was trying to avoid systemic risk in bailing out AIG, outside of AIGFP.  These arguments were not made in 2008, and in general, it is really difficult for an insurance company to generate systemic risk.  Systemic risk stems from short-funded financials, and in general, insurance companies do not fit that description.


This is just another reason why average Americans don’t trust the Fed.  But there are many reasons:

  • The Fed will not submit to full transparency of its actions.
  • They will not comply with legitimate FOIA requests.
  • They can’t be replaced by the people, but they have a big impact on the lives of the people.
  • Congress does a lousy job regulating them.
  • They acted high-handedly in bailing out entities like Bear Stearns and AIG that should have been put into bankruptcy.  Bailouts violate the sense of fairness that most Americans have.  Systemic risk could have been avoided without bailing them out in entire.

Is it any surprise then, the Congress, having done a lousy job of regulating the Fed and the Treasury, points the finger and blames those that they have been appointed to rule?  Alas, I see a lot of room for blame to go around, but few are willing to take it in DC.  There is no equivalent of Truman’s “The Buck Stops Here.”

In a bad environment like this, many governmental entities worry for their survival.  Good.  They should worry.  There is the outside possibility that things could change dramatically after the next election.  Perhaps ending the Fed won’t be a pipe dream then.  After all, the US did quite well without a central bank for most of its existence.


  • Terry says:

    “The presenter tried to be as neutral as possible, but the more he said, the more the actuaries I talked with said, “This bill doesn’t make sense.” ”

    Whoa, David! How can you suggest that the presenter, a spokesperson for the health insurance insurance (specifically, Blue Cross/Blue Shield), “tried to be as neutral as possible”? The health insurance industry’s ox will be badly gored by almost any of the variants of health care reform that are being considered. They are trying to prevent that from happening in every forum possible–from hundreds of millions spent on lobbying Congress to TV and other advertising to presentations at professional conferences.

    I’m sure that if you took a close look at the assumptions and methodologies used to arrive at the conclusions of this presentation, you would be more critical of its conclusions.

    That said, I believe we need massive health care reform that is as inclusive as economically feasible. I’m not sure that any of the bills or ideas under consideration do that cost-effectively–and certainly not with the addition of $300M to Louisiana’s Medicare coverage to buy Sen. Landrieu’s vote.

    • Look Terry, how many actuaries do you know? They are bright and tend to shoot straight. They told me that he tried to be even handed about the bill, but when they heard about the limitations on how premiums would be set, many said that’s not enough variability, there will be antiselection.

      I personally did not hear the presentation; my plane got held up in Atlanta. The bills as currently configured will benefit the health insurers. Healthy people will migrate to private plans; the public option will be more costly than expected, because the subsidies will attract older and sicker people. The cost estimates done by the CBO will not hold up.

  • David,

    I can’t speak to the health care particulars other than say that these days it seems that ANY legislative action is geared solely to give me another compulsory proctological exam. Regarding the AIG deal, there’s a relevent opinion within this interview here:

    maybe halfway in….

    Frequent visitor, 1st time commentator – thanks for all the hard work!

  • AllanF says:

    I don’t think Congress will do anything to shutdown the Fed. Like declaring war, most Congress-critters don’t really want the accountability that necessarily follows the responsibility.

  • matt says:

    “…cramming through an ill-thought-out plan not favored by most Americans, can’t do much for their chances in 2010.”

    Voting for an unpopular bailout of the financial holding companies didn’t hurt their chances in 2008. Why is 2010 different?

    “Finally, the liability structure is longer for most insurers, making “runs” less likely.”

    Absolutely. And, in a low rate environment like this, it’s unlikely that masses would take loans against their policies (creating an unexpected liquidity need).

    “Perhaps ending the Fed won’t be a pipe dream then.”

    Sorry, but I don’t see the international banking cartel loosening grip over politics or privilege to print profits.

  • CrocodileChuck says:

    a v interesting piece. I choked on the last sentence, however: how can you say the US did ‘very well’ without ea central bank for most of its history? in the 19th C, it veered from boom to bust continually, including some severe depressions, eg 1873 (this one lasted ca. 20 yr, from memory). I’m a big fan of the Aleph Blog, David.

    • CC — booms and busts are unavoidable. You get them with or without central banks. But with central banks, you run into bigger busts like the Great Depression, and the current Not So Great Depression. Because bad loans are not cleared away, the marginal efficiency of capital falls, and the rate of growth of GDP falls.

      Yes, we had some severe booms and busts in the absence of central banks, but in aggregate the economy grew a lot faster, because we cleared up bad debts, making up for the volatility. We reduce volatility with central banks for a time, but in the end, we get the volatility in bigger doses. Can’t cheat the system. Can’t end booms and busts.

      PS — the bust in 1873 lasted six years, I think.

  • RN says:

    “I genuinely hope this does not pass Congress, and that nothing is done.”

    Spoken like a true American, who doesn’t give a damn about anyone but himself. Lowest of the low.

    I wonder how the dozens of millions without health care feel.

    • RN — I don’t know you, and I hope you mean well. I believe in Charity, not coercion, and I back that up with my own money. Unless you are one in a hundred, you don’t give more than me to charity as a percentage of your income.

      Health care is a privilege, not a right, and most of those that don’t have health care did a number of things early in their lives to sabotage their chances. They didn’t study. They didn’t seek counsel. They put pleasure ahead of the long term. They didn’t ask, “What do I have to do by age 18, 22, 30, in order to maximize my odds of success?”

      Call me what you like, I write this because I love people, and want to give something back out of my experiences. What I write certainly does not compensate for my time. I write because I love my lousy nation, and do not want it to fail. Passing a health care bill is one more step on the road to national death. Health care doesn’t matter if the nation dies.

  • Terry says:

    “Look Terry, how many actuaries do you know? They are bright and tend to shoot straight.”

    I don’t know any actuaries. I believe they must be bright. Whether they “shoot straight,” however, depends on their aim (pun intended).

    Having lived around Washington, DC, for more than 3 decades and worked some political issues with various Administrations and Congress, I find it difficult to give much credibility to a health industry actuary on a health industry issue–especially one as critical and controversial as this. He may be right, but I would much more trust such an assessment from a non-industry source.

    As for the CBO, it is independent (in my view), but its projections (like almost everyone else’s) over a decade are more often wrong than right. In this case, they probably don’t have the actuarial capabilities they need to make a better projection. In general, my experience with CBO projections is that they overstate the positive effects of prospective policies while understating the negatives (in this case, health insurance cost). (See the CBO’s assessment of the ARRA as another example.)

  • Michael says:

    DM: “Health care is a privilege, not a right”

    I find this to be a fairly silly view, and mostly irrelevant. It’s trivially true that some minimum level of care greater than zero would be a great benefit to the nation as a whole. The marginal value to the whole of increasing that minimum if it is already at high levels is certainly debatable, but the value of going from zero to non-zero is obviously high. You need to get over the fact that some people who made stupid choices earlier in their life might get a free ride someplace. People already get free rides / things they don’t deserve all over the place, you shouldn’t let that get in the way of being able to see what would ultimately be best for the whole.

    Also, the fact that 99/100 people give less to charity than you illustrates the problem with charity. It can _never_ have the same level of impact as a well funded gov’t program. If you felt that the problems you hope to solve through your charity were really worth solving, you’d help create the political will to solve those problems in a real and sustainable way.

    • Sorry you feel that way, Michael. The US can’t afford what it is doing now; that’s fine that you want to add to the burden — it will make for a bigger bust, and sooner. Just hope that what typically happens to empires when they fail does not happen here.

  • Michael says:

    I agree that we’re outspending our capabilities, some things are worthwhile, others are not. A defense budget that outstrips the rest of the world combined _plus_ two wars is where I think we ought to start looking to make things more sustainable. Providing some minimal guarantees around citizen and workforce health seems like a no-brainer in comparison.

    • And I would agree with you on Defense, even though it would unemploy many of my friends. We are involved in two wars where we have no direct interest, and many bases that we don’t need to have, unless we feel we need to dominate the world in order to get our way.

      I have commented before that if we wanted to create a simpler and cheaper system that covers everyone, there are ways to do so that reduce health care costs more effectively. Funding a National Mutual Healthcare company would be one, as would expanding HSAs, with subsidies for the poor. I think pragmatically as well as ideally, because I know my ideals are a minority position.

      But, there is no great interest for shrinking the US Government or its actions. There are many competing for a little more from the weakening body of the US Government. I live near DC, and am aware through friends of some actions in the bureaucracy, both high and low, and from Congressmen also, a few of which deign to send me tidbits.

      Michael, I appreciate your response. Write anytime. As it is, it is time for me to write tonight’s post.