Insurance reduces savings

By Fester:

Dependable insurance reduces private savings.  This is the point of almost all forms of legitimate insurance as it allows people to act closer to statistical personhood instead of a flesh and blood personhood.  This conversation started in response to Ezra Klein noting that the Chinese government is implementing a universal healthcare initiative as a stimulus measure:

The Chinese have a high savings rate — indeed, an absurdly high savings rate, between 30 percent and 40 percent of income — and one of the reasons is fear of medical expenses. China lacks a safety net, and so people spend less because they need to plan for catastrophe. And if catastrophe doesn't befall, then they've simply spent less. Which is a problem when you're facing down a potentially long recession. And so China is trying to make it safe for its citizens to spend, which means making future expenses more predictable, which means offering health care coverage.

Kevin Drum's response invites my post as he asks:

That's certainly a unique reason for backing national healthcare, isn't it? But that's indeed what the linked NYT article says. I wonder if it will work?

The theory behind universal healthcare insurance as a stimulus measure is simple.  It assumes that people are risk averse.  This means people are more fearful of loss than rewarded by an equivilant gain.  Most literature puts this effect at three or four times more gain is needed to pay for the possibility of a given loss.  So this risk aversion makes people very cautious and somewhat paranoid against big losses.  They oversave as they would rather have too many reserves than not enough reserves if faced with a catastrophe.  As Ezra notes, this is part of the reason why the Chinese save so much, individuals are trying to save and self-insure against catastrophes. 

The introduction of insurance changes the dynamic.  It allows people to become less risk averse as their catastrophe fears are assuaged.  This allows more current consumption and future catastrophic coverage at the same time.  How does this happen?

Let's deal with a hypothetical and three realities.  The first is in a no insurance world.  The second is in Econ 101 insurance world, and the last is the real world with universal insurance.  In all three, there is a 1% chance of a $100,000 catastrophe and that chance is completely random.  In each world there is 1,000 individuals. 

In the no-insurance world, each individual looks at the 1% chance of $100,000 loss and craps their pants.  Each individual then tries to start saving to insure against this loss.  Each individual saves $3,000 so there are global savings of $3,000,000 for $1,000,000 in catastrophic losses.  There is significant space for improvement here as the non-impacted individuals have a lot of money sitting on the sidelines and the impacted individuals are still crushed. 

In the Econ 101 world, the freshman figures out that the expected value of loss is $1,000 per person.  He then collects, without friction, transaction costs or reserves, $1,000 per person.  At the end of the year, he pays out $1,000,000 and collects $1,000,00 as well as a case of scurvy as he ate too many packages of Ramen noodles as he forgot to pay himself for his trouble.  In this scenario, everyone except the freshman is better off as each individual has $2,000 more current consumption available to them and the individuals who underwent the catastrophe are not wiped out.

In the real world, the insurance starts with the same basic calculation that the freshamn made. The pure risk cost is still $1,000 per person.  They then realize they are not dealing with the law of massive numbers so there will be some wiggle room in the expected risk costs.  So they add on a small expense chunk to cover the 11th or 12th person with a catastrophic loss this year.  And then they need to spend some money collecting and sending out the money,  Finally, they want to avoid the fate of the freshman beset by scurvy so they charge a salary.  In the US private group private health insurance market, this tacks on another $500 in fees per person , so $1,500,000 to pay off $1,000,000 in expected claims.  Medicare and other national systems will charge an extra $50 to $150 per person so they'll collect 1,050,000 to 1,150,000 to pay off the million dollars in claims. 

Individuals are better off, society is better is off, and a whole lot of new consumption is enabled by pricing and saving against risk more effectively.  That is why the Chinese government thinks universal healthcare will be a fairly high multiplier stimulus effort. 

Comments

[Enlightened Layperson]

Except that savings really are important too because they run the finance system and provide investment capital. One of the big problems that got us into this mess is that our banks somehow had to operate a finance system in a country with a savings rate of approximately zero.

[Dave Schuler]

Note that China is also essentially without social insurance. There's a perfectly reasonable, economic benefit, freedom-enhancing argument in favor of social insurance that I rarely hear made by anybody over here.