## A note on the difference between geometric and arithmetic averages

Question:  The table below has price data and daily return data for Vanguard fund VB.   Calculate the arithmetic and geometric averages of the daily return data.   Show that the geometric average accurately reflects the relationship between the initial and final stock price and the arithmetic average does not accurately explain this relationship.

 Daily Price and Returns For Vanguard  Fund VB Date Adjusted Close Daily Return 7/1/16 115.480674 7/5/16 113.99773 0.987158509 7/6/16 114.744179 1.006547929 7/7/16 114.913373 1.001474532 7/8/16 117.202487 1.019920345 7/11/16 118.128084 1.007897418 7/12/16 119.451781 1.011205608 7/13/16 119.10344 0.997083836 7/14/16 119.262686 1.001337039 7/15/16 119.402023 1.00116832 7/18/16 119.63093 1.001917112 7/19/16 119.202965 0.996422622 7/20/16 119.959369 1.006345513 7/21/16 119.481646 0.996017627 7/22/16 120.297763 1.00683048 7/25/16 120.019083 0.997683415 7/26/16 120.616248 1.004975584 7/27/16 120.347522 0.997772058 7/28/16 120.536625 1.001571308 7/29/16 120.894921 1.002972507 8/1/16 120.735675 0.998682773 8/2/16 119.12335 0.986645828

Analysis:   The table below presents calculation of the two averages and the count of return days.  The product of the initial value of the ETF, the pertinent average and the count of return days is the estimate of the final value.   Estimates of final ETF value are calculated for both the arithmetic average and the geometric average and these estimates are compared to the actual value of the stock on the final day in the period.

 Understanding The Difference Between Arithmetic Mean and Geometric Mean Returns Statistic Value Note Arithmetic Average of Daily Stock Change Ratio 1.001506208 Average function Geometric Average of Daily Stock Change Ratio 1.001479966 Geomean function Count of Return Days 21 Count Function Estimate of final value based on arithmetic average 119.1889153 Initial Value x Arithmetic Return Average x Count Days Estimate of final value based on geometric average 119.12335 Initial Value X Geometric Return Average x Count Days Ending Value 119.12335 Copy from data table

There is another way to show that the daily return should be modeled with the geometric mean rather than arithmetic mean.  The average daily return of the stock is (FV/IV)(1/n) – 1 where FV is final value and IV is initial value and n is the number of market days in the period, which for this problem is 21.

Using this formula we find the daily average holding period return is 0.001479966.  Note that 1 minus the geometric mean of the daily stock price ratio is also 0.001479966.

The geometric mean gives us the correct holding period return.

## How much house can a student borrower qualify for?

How much house can a student borrower qualify for?

This answer depends on the maturity of the student loan.

Situation:

Consider a person with a \$100,000 student debt.

• The person can either pay the debt back over a 10-year period or a 20-year period.
• The student loan is this person’s only consumer debt.
•  The person earns \$80,000 per year.
• The student loan interest rate is 7.0 percent.
• The mortgage interest rate is 4.0 percent.
• The mortgage term is 30 years.

Questions:

• How much mortgage can the person qualify for if the person keeps the student loan at 10 years?
• How much mortgage can the person qualify for if the person changes the student loan term to 20 years?
• What is the increased cost of the student loan payments involved by switching from a 10-year to 20-year student loan?

Answer:   I developed a spreadsheet that calculates the maximum allowable mortgage this person can qualify for.

In order to qualify for a mortgage two conditions must hold.

• Monthly mortgage payments must be less than 28% of income.
• Monthly mortgage and consumer loan payments must be less than 38% of income.

The procedure used to calculate the allowable mortgage is as follows:

• First, I calculate the maximum allowable mortgage payment based on zero consumer debt.   This value is 28 percent of monthly income.
• Second, I calculate the maximum allowable mortgage payment consistent with mortgage payments and consumer debt payments equal to 38 percent of income.   This is done by backing out the student loan and allocating the rest to mortgage debt.
• Third, I insert mortgage interest rate, term and payment info into the PV functions to get the mortgage amount
• Fourth, The allowable mortgage is the minimum of the mortgage totals consistent with the two constraints.

The calculations for the two situations presented in this problem are presented in the table below

 Mortgage Qualification Example for Borrower with Student Debt row # Student Loan Information Note 1 Student loan Amount \$100,000 \$100,000 Assumption 2 Interest Rate 0.07 0.07 Assumption 3 Number of Payments 120 240 Assumption 4 Student Loan Payment \$1,161 \$775 From  PMT Function Mortgage Information 5 Rate 0.035 0.035 6 Term 360 360 Income Assumption 7 Income \$80,000 \$80,000 Assumption 8 Constraint One:  Maximum monthly mortgage payment consistent with this income assumption \$1,867 \$1,867 28% of monthly income 9 Constraint Two:  Maximum monthly consumer and mortgage payments consistent with income \$2,533 \$2,533 38% of monthly income 10 Maximum mortgage consistent with constraint one. \$415,697 \$415,697 pv of mortgage rate number of periods, and pmt where mortgage rate and payments are assumptions baed on the market and product chosen and payment is max allowable given   income 11 Allowable mortgage payment consistent with constraint two given required student debt \$1,372 \$1,758 Row 9 minus Row 7 12 Max mortgage consistent with borrowing contraint two. \$305,593 \$391,505 Use PV function with rate and term set by market and product and payment the amount of mortgage payment after required consumer payments 13 Allowable mortgage debt \$305,593 \$391,505 Minimum of Row 10 and Row 12

An increase in the term of the student loan from 10 to 20 years increases the size of a mortgage a household can qualify for from \$305,000 to \$391,000.

Getting the extra mortgage is not cheap.  The increased student loan term causes total student loan payments to go from \$139.000 to \$186,000.

Concluding thoughts:  Most people who have \$100,000 in student debt will have to refinance the student loan if they are going to buy a house.

## Student debt and qualifying for a mortgage

Student debt and qualifying for a mortgage

Excel Topics:  PMT function and Spreadsheet design

Question:  A person graduates from college and graduate school with \$100,000 in student debt.   The interest rate on a 10-year student loan is 5% per year.   The person wants to buy a house that costs \$300,000 with a 90% LTV loan. The home mortgage interest rate is 4.5% on a 30 year FRM.

Assume that in order to qualify for the house the person must meet two conditions.

Constraint One:  The ratio of mortgage interest to income must be less than 0.28.

Constraint Two: The ratio of total interest (mortgage and non-mortgage) interest must be less than 0.38.

How much income does this person need to qualify for a loan on this house?

Why might student debt have a smaller impact on the purchase of a \$700,000 home than the purchase of a \$300,000 home.

Analysis:   The analysis for the \$300,000 home is laid out in the table below.

 Mortgage Qualification Example for Borrower with Student Debt Note Student loan Amount \$100,000 \$0 Assumption Interest Rate 0.05 0.05 Assumption Number of Payments 120 120 Assumption Student Loan Payment \$1,061 \$0 From  PMT Function House Amount \$300,000 \$300,000 Assumption LTV 0.9 0.9 Assumption Loan Amount \$270,000 \$270,000 LTV * House Amount Intrerest Rate 0.045 0.045 Assumption Number of Payments 360 360 Assumption Mortgage Payment \$1,368 \$1,368 From PMT Function Total Loan Payments \$2,429 \$1,368 Sum Payments Monthly Income Constraint One \$4,886 \$4,886 Student Loan Payment divided by 0.28 Monthly Income Constraint Two \$6,391 \$3,600 Mortgate Payment Divided by 0.38 Required Monthly Income \$6,391 \$4,886 Max of income over both constraints Required Annual Income \$76,696 \$58,631 12* Max Income

Observations Pertaining to the \$300,000 home for a person with and without student loans

A person with no student debt could qualify for this mortgage with an annual income of \$58,630.

The person with the student debt needs an annual income of \$71,585.

The impact of student debt on purchases of a larger home:   The allowable mortgage is determined by two constraints one involving mortgage debt only and the other involving the sum of mortgage and consumer debt.   When the mortgage debt is very large, constraint one (the mortgage debt constraint) will be the binding constraint.

Continue reading Student debt and qualifying for a mortgage

## Understanding the Four Percent Rule

Question:   Is the 4.0% rule an appropriate guideline for determining the amount of savings a retiree should spend each year?

Background on the 4.0% rule:  Under the four percent rule (as I understand it ) the retiree’s expenditure in her first year of retirement is four percent of wealth in certain accounts.  It is more difficult to apply the 4.0% rule to total household wealth because house equity, a major component of wealth is not liquid.  (The application of the 4.0% rule to total wealth including house equity would at some point require the sale of the home.)

Whether strict adherence to the 4.0% rule leads to a smooth, stable, and sustainable consumption pattern for the household does  not depend solely on average asset returns or average inflation.   The timing of returns and the timing of inflation are also important.

A sharp decrease in returns at  the beginning of retirement could lead to a relatively quick depletion of assets if not accompanied by a decrease in spending.  By contrast, a sharp increase in returns at the beginning of retirement could allow retirees to spend more than allowed or provide a bequest to heirs.

The four percent rule could prove inadequate for workers who are planning to retire in 2017 or 2018 for two reasons.   First, both nominal and real interest rates are very low.   Second, stock valuations are currently extremely high.  Portfolio returns will fall precipitously if interest rates rise and stock prices fall.

Illustrating the 4.0% rule:  The simulations of whether the four percent return will lead to a successful retirement rely on two assumptions — the rate of return on assets and the inflation rate. Our model assumes that the retiree starts spending four percent of assets at retirement and continues to spend at this level in real terms adjusted for inflation.   The output of the model is the number of years (if ever) before the retiree spends all retirement funds.

We consider four scenarios — (1) 2.00% returns and 3.0% inflation all years, (2) 4.0% returns and 3.0% inflation rate for all years, (3) a -20% return the first year followed by 2.0% returns and 3.0% inflation, and (4) -20% return the first year followed by 4.0% return and 3.0% inflation.

Note that scenario two is better than scenario one because returns are higher in the second scenario.

Scenario three is similar to scenario one except for the fact that the market collapses in the first year.

Similarly scenario four is similar to scenario two but for the first-year collapse in asset prices.

The table below presents the number of years it takes for the person to deplete all assets using the four percent rule.

 Adequacy of resource for 4% rule under four scenarios Shock Return Inflation Rate Year Balance goes to \$0 None 2.00% 3.00% 23 None 4.00% 3.00% 30 -20% first year 2.00% 3.00% 19 -20% first year 4.00% 3.00% 23

One bad year of returns in the first year of retirement resulted in a 7 year reduction of years with assets in the high return situation (simulation two minus simulation four) and a reduction of four years of assets in the low-return scenario (simulation one minus simulation three.)

The number of years prior to total depletion of assets among the four scenarios ranges from 19 years (scenario three) to 30 years (scenario two.)

Concluding Thoughts:

I suspect that these calculations understate the financial risk associated with adherence to the 4.0% rule, in general and in the current economic and financial situation.

The bad scenarios presented here involve a first year of retirement where the portfolio falls by 20 percent.   The collapse could be larger or more last more than one year.

President Trump believes that the the situation in Korea is the calm before the storm.   The same could be said for our financial markets and our economy.

The market is peaking.   The financial advisors and experts want to keep you fully invested argue that the market can run upwards for at least a few more years.   The more reputable analysts acknowledge that the valuations are high.   Long term interest rates remain low but when they rise (and they eventually will rise) bond prices fall.  The simultaneous collapse of bond prices and the reduction in stock valuations could will eventually lead to large losses at the beginning of retirement for a cohort of workers.

Some analysts suggest that investors who use the 4.0% rule should maintain a larger portion of their portfolio in equites.  I disagree.  The worse case scenario for the 4.0% rule involving poor stock and bond returns in a period of inflation actually occurred during the 1970s when inflation rose and stocks fell.   Luckily retirees in the 1970s had traditional pension plans that were not tied to the market.

President Trump believes that the the situation in Korea is the calm before the storm.   The same could be said for our financial markets and our economy.   I don’t believe the current calm before the storm will last.

## A House Equity and Mortgage Payoff Spreadsheet

A House Equity and Mortgage Payoff Spreadsheet:

Question:   A person buys a house and plans to either sell and move or pay off the mortgage in twelve years.

The person is considering taking out a 15-year or a 30-year fixed rate mortgage.

The assumptions on the home purchase, house equity growth, the cost of selling and moving, and the cost of funds for the payoff of the mortgage are presented in the table below.

Table One: Assumptions for 30-year vs 15-year FRM Comparison:

 Label 30-year FRM 15-year FRM Purchase Price of House \$500,000 \$500,000 Down payment percentage 0.9 0.9 Initial Loan Balance \$450,000 \$450,000 Mortgage Term 30 15 House appreciation rate 3.0% 3.0% Mortgage Interest Rate 4.0% 3.3% Years person owns house 12.00 12.00 Cost of selling and moving to a new home as % of house value 9.0% 9.0% Tax Rate on Disbursements from 401(K) Plan 30.0% 30.0%

Create a spreadsheet that provides estimates of house equity after the sale and move or mortgage payoff amounts after twelve years when the house buyer uses a 30-year FRM and when the house buyer uses a 15-year FRM

Base your mortgage payoff calculation on the assumption that the source of funds for the mortgage payoff are fully taxed funds from a 401(k) plan.

http://wp.me/a2WYXD-4i

Results:

The results for the comparison of the 15-year and 30-year FRM for the assumptions presented in table one are presented in Table 2.

Table Two: Results for the 30-year vs 15-year FRM Comparison:

 30-year FRM 15-year FRM House Equity after Selling and Moving Costs \$318,303 \$540,109 Forecasted Mortgage Payoff Amount -\$472,025 -\$155,160

Observations on the 30-year vs 15-year FRM comparison:

The person taking out the 15-year FRM mortgage has around \$222,000 more in house equity at the end of the 12-year holding period.

The mortgage payoff calculation when funds are disbursed from a 401(k) plan includes tax on the disbursements.   Inclusive of the tax bill, the mortgage payoff amount is \$317,000 higher for the buyer who uses the 30-year FRM than for the buyer who uses the 15-year FRM.

Other Applications for the House Equity or Mortgage Payoff Spreadsheet:

Modify the mortgage payoff calculation to allow for a situation where funds for the mortgage payoff are obtained from three sources – (1) a savings account, (2) sales of common stock, and (3) disbursements from a 401(k) plan.   Treat tax rates as an endogenous variable in the new model.

Compare results for both mortgage types under the 90% LTV assumption to results under an 80% LTV assumption.

Run the model on 15-year and 30-year FRMs for holding periods ranging from 1 to 15 years.   How does the advantage of the 15-year FRM vary with holding period?

Authors Note:   This problem was discussed further in the post below.

Essay Nine: Retire Mortgage Debt or Accumulate in Your 401(k) Plan:

https://financememos.com/2015/10/09/essay-nine-retire-mortgage-debt-or-accumulate-in-your-401k-plan/

Essay nine points out that many financial advisors stress accumulation of wealth in 401(k) plans rather than mortgage balance reductions even when their clients are nearing retirement.  The major banks employing the same financial advisors issue mortgages and sponsor 401(k) plans.   As a result, the interests of the financial advisors and the interests of their clients are not automatically aligned.

This approach can backfire when stock markets underperform nearing retirement.

During working years. the tax code favors people with large mortgages and people who are contributing to their 401(k) plan.  However, after retirement the person who must disburse funds from a 401(k) plan often has a hefty tax bill.

Interestingly, most financial analysts advise their clients to add more to their 401(k) plan rather than pay off their mortgage.  More discussion of this problem can be found below.

Increasingly, many Americans nearing the end of their work life find they have a large mortgage and must choose between paying off the mortgage or contributing more funds to their 401(k) plan. A large number of financial advisors advise their clients to increase 401(k) contributions rather than pay off their mortgage.

http://www.forbes.com/sites/nancyanderson/2014/01/03/7-reasons-not-to-pay-off-your-mortgage-before-you-retire/

http://www.kiplinger.com/article/real-estate/T040-C000-S002-should-you-pay-off-your-mortgage-before-you-retire.html

http://www.washingtonpost.com/news/get-there/wp/2015/03/26/the-case-for-not-paying-off-your-mortgage-by-retirement/

http://www.schwab.com/public/schwab/nn/articles/Should-You-Pay-Off-Your-Mortgage-Early-Before-You-Retire

http://www.principal.com/planningcenter/retirementplanning/nearingretirement/retirementnews/mortgagequestion.htm

My view is that it is essential for people nearing retirement to eliminate their mortgage debt even if this goal requires some reduction in 401(k) contributions.   I have two reasons for this view.   First, as noted and explained in the previous section 401(k) plans are not capable of mitigating the impact of market down turns at the end of a career or during retirement.   Intuitively, a person with no debt is much better able to withstand market downturns than a person with a mortgage.   The Wall Street analysts always say don’t sell on a panic the market will come back.   Well retirees with a large mortgage often have no choice but to sell.

Second, the financial risk considerations interact with another factor, the tax treatment of 401(k) plans. During working years mortgage interest and 401(k) contributions reduce income tax burdens.   During retirement a person with a large mortgage payment and most financial assets inside a 401(k) plan will pay more in tax than a person without a mortgage.

All disbursements from a 401(k) plan are fully taxed at the ordinary income tax rate.   A person with no mortgage disburses enough to cover discretionary expenses and taxes   A person with a mortgage must disburse enough to cover discretionary expenses, the mortgage and taxes.

The disbursement to cover the mortgage leads to additional taxes because all disbursement from the 401(k) plan is taxed. MOREOVER, THE DISBURSEMENT ON FUNDS USED TO COVER THE TAX ON THE 401(K) DISBURSEMENT IS ALSO TAXED.

Part of Social Security is taxed for people with income over a certain threshold. A quick way to find out if part of Social Security benefit is taxable is to compare your income to the threshold for your filing status — \$25,000 for filing status single and \$32,000 for filing status married.

http://www.irs.gov/uac/Newsroom/Are-Your-Social-Security-Benefits-Taxable

Higher disbursements from the 401(k) plan can increase your adjusted gross income beyond the threshold and increase the amount of the Social Security benefit subject to tax.   Of course any 401(k) disbursement used to pay the income tax is also taxed.

So let’s take a household with all financial assets in their 401(k) plan with a \$30,000 annual mortgage.   This monthly mortgage is \$2,500, not huge.   Let’s assume that the person has to pay around \$1,000 more in tax on Social Security benefits because of the additional disbursement to pay down the mortgage. A first order approximation of the amount of additional tax needed because of the additional \$31,000 disbursement is \$31,000 x the marginal tax rate for the taxpayer.   For most filers the marginal tax rate would be around 25 percent in 2014.

So the taxpayer with the mortgage and the additional tax burden because of the additional 401(k) disbursement will probably disburse \$39,000 more per year from their 401(k) plan.

This analysis puts a whole new wrinkle on the question how much money does one have to save in their 401(k) to have a secure retirement.   The answer is much more if you have not paid off your mortgage.

Note that the disbursement to cover the unpaid mortgage must occur whether the market falls or rises.

Many people who choose to add to their 401(k) plan rather than pay off their mortgage prior to retirement are going to have sell their home and downsize. Downsizing may make sense but most people don’t want to downsize until they are fairly old.

Some people who end up selling their home may choose to rent rather than buy a new home.   The main risk of choosing to rent throughout retirement is that home prices and rents may rise.   This exacerbates longevity risk.

Downsizing should be a choice not an outcome from a failed financial plan or worse the result of financial advisors putting their interests over your interests

Concluding thoughts on mortgage debt in retirement: An increasing number of households are retiring prior to their mortgage being entirely paid off. Surprisingly, the existence of a mortgage in retirement is often consistent with a financial plan developed by a financial planner.   Many financial analysts and planners advise their clients to increase savings in their 401(k) plan rather than retire their mortgage.

These financial planners are not being upfront with their clients.   Retirees with mortgage debt and all or most financial assets in a 401(k) plan are at the whim of the market and have a substantial tax obligation.   The advice that put people in this position is in my view a form of malpractice.

Appendix to Essay on Mortgage Debt and 401(k) Assets in Retirement

The issue of whether to pay off a mortgage or contribute to a 401(k) plan for an older worker is related to the issue of mortgage choice, especially for older homebuyers.   The following question addresses the interaction between mortgage choice and 401(k) investment strategy for an older worker.

Question:   A 50 year-old person is buying a house and must choose between a 15-year mortgage and a 30-year mortgage.   The mortgage choice will impact how much money the person can contribute to his or her 401(k) plan.

The person makes \$80,000 per year. The initial mortgage balance is \$400,000.   The person’s 401(k) balance at age 50 is \$200,000. The 30-year FRM rate is 3.9 percent and the 15-year FRM rate is 3.1 percent.

Discuss the advantages and disadvantages of two strategies (1) taking the 30-year FRM and investing 15% of salary in the 401(k) plan and (2) taking the 15-year FRM and investing 5% of salary in the 401(k) plan.

Analysis:

Let’s start with a reiteration of mortgage choice issues a subject previously broached in essay four.

Observations and Thoughts on Mortgage Choice Issues:

• The monthly payment on the 30-year FRM is nearly \$900 less than the monthly payment on the 15-year FRM. The higher mortgage payment on the 15-year FRM will all else equal require the person who chooses the 15-year FRM to make a smaller 401(k) contribution than the person who chooses the 30-year FRM.
• After 15 years the 15-year FRM is completely paid off.   The remaining loan balance on the 15-year FRM is around \$257,000.
• Note that gains from the quicker pay down on the 15-year mortgage are not dependent on market fluctuations.   The gain from debt reduction occurs regardless of whether the market is up or down and regardless of when bear or bull makers occur.
 Analysis of 15-Year Versus 30-Year FRM 30-Year 15-Year Mortgage 0.039 0.031 Term 360 180 Loan Balance 400000 400000 Payment -\$1,886 -\$2,781 Future Value \$256,799 \$0.00

Observations and Thoughts on Two 401(k) Contribution Strategies:

As noted in essay eight, the final 401(k) balance after 15 years depends on both the rate of return of the market and the sequence of the returns in the market.   Outcomes are presented for two market scenarios.   The first involves 7% returns for the entire 15-year period.   The second involves 7% returns for 10 years followed by -4% returns for 5 years.

• The difference in the final 401(k) balances (high contribution minus low contribution) under the 15-year bull market scenario is around \$211,000.
• The difference in the final 401(k) balance (high contribution minus low contribution) under the 10-year bull and 5-year bear scenario is around \$131,000
 Analysis of Different 401(K) Contribution Strategies 5% Contribution Rate 15% Contribution Rate Difference 7.0% Return for 15 Years \$675,442 \$886,752 \$211,309 7.0% Return for 10 years followed by -4.0% return for 5 years \$394,339 \$525,090 \$130,751

The initial balance in the 401(k) plan for both scenarios is \$200,000.

• The 30-year mortgage/high 401(k) contribution strategy results in major tax savings during working years compare to the 15-year mortgage/low 401(k) strategy.   All mortgage interest is tax deductible and the 401(k) contribution is not taxed.
• The 15-year mortgage/low 401(k) contribution strategy results in major tax savings during retirement compared to the 30-year mortgage/high 401(k) strategy.   The previous example in this section demonstrated exposures for the person with mortgage debt in retirement when the person is dependent on 401(k) disbursements.   Remember all disbursements from a conventional 401(k) plan including disbursement used to pay the mortgage and disbursements used to pay taxes are fully taxed at ordinary income rates.   By contrast, the money gained from paying off the mortgage and most capital gains on owner-occupied real estate is not taxed.
• Financial risks associated with a bull market persist through retirement as long as the saver allocates 401(k) assets into equity.

## Thoughts on the Health Care Reform Process

Thoughts on the Health Care Reform Process

David Bernstein

Bernstein.book1958@gmail.com

Republicans argue that the ACA has failed and want to repeal it and replace it with something different; although, there is little agreement among Republicans on what plan should replace the ACA.  Most Democrats appear to deny or minimize the existence of problems with the ACA.   Some sort of government option appears to be the only major ACA reform supported by Democrats.

My view of the situation is that while the Ryan plan would have left many Americans worse off it is possible to devise a plan that substantially improves upon the ACA.   The objective of this memo is to outline changes to the ACA that would reduce premiums and improve quality of health plans sold through the state exchanges created under the ACA.

This memo concentrates on four issues  — (1) the relative importance of employer-based insurance and state exchanges,   (2) rules and incentives concerning the impact of age on premiums and coverage on state exchanges,  (3) rules governing use of health savings accounts and high-deductible health plans, and (4) the treatment of extremely expensive catastrophic health care cases.

Analysis:

Issue One — Relative Importance of Employer-Based Insurance and State Exchanges:  Currently state exchanges are much smaller than the employer-based market.  There exists some evidence indicating that people who obtain their health insurance through state exchanges are less healthy than people with employer-based insurance.  Most people with employer-based insurance are better off than people with state exchange insurance because employers often pay a substantial share of premiums.  Policy makers need to consider subsidies and rules that encourage the growth of state-exchange marketplaces without making workers and families currently covered by employer-based insurance worse off.

Discussion:   Under current ACA rules, employers with more the 50 employees are required to offer health insurance to their employees or pay a fine.    The tax credit for people getting insurance on state exchanges is only available for people with household income less than 400 percent of the FPL.    The tax credit has led to some small firms dropping offers of employer-based insurance.  However, most working-age people and their dependents continue to obtain health insurance through their employer.

The Health Care plan offered by Paul Ryan and ultimately rejected by the Freedom caucus would have eliminated the employer mandate for large firms and would have expanded tax credits for the purchase of state exchange health insurance to people with income over 400 percent FPL.   These changes would have induced many firms to eliminate their offer of health insurance to their employees.

One could argue that health insurance should not be tied to employment and that independent state exchanges reduce burdens on businesses and expand state mobility.   Moreover, the expansion of state exchanges is needed to make these new markets financially viable.

However, employer-based insurance is financially attractive to many employees.   Employers typically pay 70 percent of the premiums on employer-based plans.   The employer contribution is not subject to income or Social Security tax.   The workers who lose employer coverage under the Ryan plan would become worse off financially.  Under the Ryan plan, many people currently obtaining health insurance through their employer would lose offers of employer-based coverage and some of these individuals would find coverage through state exchanges to be inadequate or unaffordable.

There is a need for financial and economic incentives that reduce employer-based insurance and increase the role of state exchange insurance.   However, it is important that this reform not make workers who currently have employer-based coverage worse off.

Suggestions:   There are several potential policies that might expand state exchanges and reduce the role of employer-based insurance.

• Employers should be allowed to contribute for the purchase of health insurance on state exchanges.   These contributions would be an expense for the business but would not be taxable income to the employee. These tax-favored contributions would replace the tax preference resulting from employer-based insurance.

• Subsidies for the purchase of health insurance on state exchanges would also be given to federal, state and city employees and retirees, people on COBRA plans and people on Trade Adjustment Assistance TAA plans.

• Employees at small firms that do not contribute to health insurance on state exchanges would be eligible for a tax credit.    The tax credit could be equal to the minimum or average contribution required by large employers.

Note One:  The tax credit proposed here is likely to be lower than current tax credits and the one proposed under the Ryan plan because of other subsidies and features of the plan.  First, the tax credit proposed here will be linked to the cost of a plan with high cost sharing, as described in issue three rather than the current silver plan.  Second, the proposal detailed in issue four for a government funded catastrophic health insurance plan also reduces premiums and the required subsidy.

Note Two: I am concerned that the availability of a tax credit could induce some firms to choose to not contribute funds for the purchase of health insurance on state exchanges.   Whether this is an actual problem depends on the design of the tax credit and the rules governing contributions from the employer.   I need to think about this issue a bit more.

Concluding thought on the need to increase size of state-exchange markets:  If the suggestions presented here were enacted, all working-age people not on Medicaid or government insurance would purchase their health insurance through state exchanges.   The mandate for an employer contribution would be needed in order to limit costs associated with the tax credit.  However, in my view the mandated employer contribution is less burdensome than pure employment-based health insurance.

Issue Two: There are too few young adults enrolled in state exchanges.    Policy makers need to create incentives for increasing the number of young adults who obtain their health insurance through state exchanges.

Discussion:   There are two reasons for the shortage of young people insured through state exchanges.    One involves a stipulation of the ACA requiring insurance companies to keep young adults on their parent’s policy up to including age 26.   The other involves the allowable age-rating ratios under the ACA.

The ACA rule keeping young adults on their parent’s policy up to the age of 26 is one of the most popular provisions of the ACA.  It has resulted in a substantial decrease in the number of young adults who lack health insurance.    Most parents of young adults get their health insurance from their employer.   As a result, most young adults also get their parent’s employer-based insurance policy rather than through state exchanges.

The ACA requires that insurance premiums be based on the age of the insured individual.    The maximum allowable ratio of premiums old people to young people allowed under the law is 3 to 1.    The Ryan plan increased the ratio to 5 to 1.   A 5 to 1 ratio would leave insurance unaffordable to low-income older households.  A 3 to 1 ratio is unfair to young adults. The issue of changes in the allowable age-rated premium ratio is in many respects a zero-sum game

Suggested Changes: A first step towards increasing the number of young adults with health insurance through state exchanges would involve changing the age-rated premium ratio.   I am recommending a modest initial change from the current ratio of 3 to 1 to a new ratio of 3.5 to 1.

Research has shown that a low old to young age premium ratio is especially problematic when the deductible on health plans is very high.  The paper linked below (which I authored) found that more than 80 percent of people between the age of 23 and 32 with a high-deductible health plan receive less than \$500 in payouts from their health plan.

Intergenerational Transfers and Insurance Policy Designs

http://www.tandfonline.com/doi/abs/10.1080/10920277.2008.10597522

This observation suggests that the issue of premium regulations is linked to the issue of the type of health care plan offered in the market.   Issue three below discusses questions involving differences in cost sharing arrangements.

There appears to be little support for changing the provision of the ACA that allows young adults to remain on their parents health plan because this change in health care law is responsible for a dramatic increase in the number of young adults with insurance coverage.   However, there may be some policy changes that could induce some young adults to move off their parent’s policy into one obtained in state exchanges.

It might be appropriate to apply a modest annual fee for young adults who remain on their parent’s policy.   Funds from this fee could be used to subsidize out-of-pocket expenses for low-income people covered by high cost-sharing plans.

Alternatively, it may be appropriate to give people who turn 24 an extra \$2,000 tax credit for a health savings account contribution if and only if they obtain a health plan from state exchanges.

Issue Three: The combination of high-deductible health plans and health savings accounts are unsuitable for many young households with high debt, limited income, and low levels of liquid assets.  Alternative cost sharing arrangements should be considered.

Discussion:   There are two main advantages of high-deductible health plans.  First,

High-deductible health plans result in a substantial reduction in health insurance premiums.   The reduction in health insurance premiums stems from the fact that the insurance company makes no payouts, except for some preventive services, until after the deductible is met.   Second, as long as the total health expenditures remain under the deductible the insured individual has a strong incentive to economize on health expenditures.

Most of the academic literature on the benefits of high-deductible health plans and health savings accounts involves a discussion of the extent to which these plans reduce the utilization of health services.

The following study by a group of economist found that the use of high deductible health plans reduced spending on out-patient care and on pharmaceuticals.   There was no evidence of increased use of in-patient services or emergency room services.

NBER study on impact of high-deductible health plans on utilization of health services.

http://www.nber.org/papers/w21031

There is also substantial concern that high-deductible health plans can cause people to forego needed procedures and not purchase needed medicines.

There are several potential problems and unresolved issues with the expanded use of high-deductible health plans.

First, the people who benefit the most from health savings accounts are high-income individuals with higher marginal tax rates.  Some conservatives including Rand Paul have argued that all people should be allowed to contribute to a health savings account regardless of the type of health insurance plan they use.    Conservatives also tend to want higher limits on the amount that people are allowed to contribute to health savings accounts.    This approach provides larger subsidies to people who already have comprehensive coverage.

Second, some households will only be able to fund health savings accounts by reducing contributions to their 401(k) plans. This change has little or no impact on savings and wealth accumulation.  It is similar to rearranging the deck chairs on the Titanic.

Third, as noted in my article intergenerational Transfers and Insurance Policy Design an estimated 80 percent of young adults will receive less than \$500 in benefits from health savings accounts.  The low potential payout for most young healthy adults will result in many young adults foregoing health insurance if a high deductible plan is the only affordable option.

Fourth, higher deductible health plans would be more effective to lower-income households if they were coupled with subsidies for out-of-pocket expenses.   The ACA does provide subsidies for out-of-pocket expenses for low-income households.   Congress did not appropriate funds specifically for this subsidy.   The Obama Administration reallocated funds for this program but House Republicans initiated a legal challenge to this subsidy.   Courts are still considering this issue.

Fifth, increased cost sharing creates an incentive to forego needed procedures and/or to not take certain medicines.   These decisions could have adverse health consequences.

Suggested Changes:  Two suggested changes to the rules governing health savings accounts and high-deductible health plans should be considered.

First, low-income holders of qualified high-cost sharing plans should be given subsidies for some out-of-pocket expenses.  It may be desirable to end the litigation on out-of-pocket subsidies by agreeing to fund subsidies only for people with high-deductible or high cost-sharing health plans.

Second, policymakers should allow people with a high coinsurance rate plan to contribute to a health savings account even if the plan has a modest deductible.

The low-deductible health plan with a high coinsurance rate may actually have a higher impact on health care utilization than a high deductible health plan.   Consider two plans both with a \$7,350 out-of-pocket limit.   The first plan has a \$7,350 deductible and no cost sharing once the deductible is met.   The second plan has a \$0 deductible and a 50 percent coinsurance rate until the \$7,350 maximum allowable out-of-pocket limit is met.  Under the first health plan there is not more cost sharing once total health expenditures reach \$7,350.   Under the second health plan cost sharing will continue until total health expenses reaches \$14,700.

I suspect that wealth accumulated in a health savings account linked to a high cost-sharing plan will be higher than wealth accumulated in a health savings account linked to a high-deductible plan.   (I believe I could provide evidence supporting this hypothesis using MEPS data and a simple simulation model.)

Issue Four: Around 5 percent of the United States Population accounts for roughly half of health care spending in the United States.

AHRQ Statistical Brief  497: Concentration of Health Expenditures in the U.S. Civilian Noninstitutionalized Population, 2014 https://meps.ahrq.gov/data_files/publications/st497/stat497.pdf

The share of health care expenditures in a relatively few expensive patients is even higher for children and the working-age population

Health care expenditures across age groups:

http://www.dailymathproblem.com/2017/02/health-care-expenditure-patterns-across.html

The government could provide catastrophic health care coverage for all expenditures or a proportion of expenditures above a specific limit.  A universal catastrophic health insurance plan would reduce premiums on private insurance.

Discussion:   Prior to the ACA many health insurance plans had annual or lifetime limits.   Often people with health expenditures that exceeded the limits on the health care plans were unable to obtain additional health services.  The recently withdrawn Ryan health care plan retained the ACA prohibitions on caps on health care expenditures.

A new Freedom caucus version of an ACA repeal bill may very well allow insurance companies to impose annual or lifetime caps on expenditures.   This bill is also likely to include high-risk pools that could cover some people denied coverage because of the expenditure caps.   Past versions of high-risk pools had limited funds and covered only a small share of the uninsured.

The ACA included a limited reinsurance option that was designed to reduce incentives for insurance companies to avoid high-risk options.  This option was stopped when Republicans refused to fund the program.   Some states including Minnesota have thought about including a reinsurance procedure in their state exchanges.

http://milawyersweekly.com/news/2017/03/22/how-reinsurance-may-help-health-insurers/

Suggested Changes:  Create a program where the government will pay or all part of catastrophic health expenses above a certain limit.  For example the new government funded catastrophic health plan might pay for 80 percent of all health care expenses over \$60,000 per year.  The individuals would continue to pay for all out-of-pocket expanses.   The private insurance company would no longer have to pay for expenses covered by the new catastrophic health plan.

Note One:  The new government funded reinsurance plan reduces premiums drastically for the new standard plan.   The higher deductibles or cost sharing also reduces premiums.  The lower premium allows the government to substantially reduce tax credits helping lower-income households afford premiums.   The cost of the reinsurance subsidy may be partially or even entirely offset by reductions in the tax subsidy depending on the details of the reinsurance program and the details of the new tax subsidy.

Note Two:  A replacement to the ACA that allows for insurance companies to impose caps on expenditures would lead to the death of some people once caps are reached.   It appears hard to fix this problem without some sort of government program.

Note Three:  One way to create a universal catastrophic health plan is to allow for automatic eligibility into Medicaid or Medicare for people with health expenditures that exceed a cap.   A second way might involve government purchasing a private catastrophic health plan with some private insurance company or consortium.   (This would be one huge contract.)

Note Four:  A universal catastrophic health plan would have a large impact on premiums and the reinsurer would only need to make payouts to a relatively few individuals.   I need to update my work on reinsurance, which was conducted prior to the passage of the ACA.

Geneva Paper on Reinsurance and Health Insurance in the United States:

https://www.jstor.org/stable/41953098?seq=1#page_scan_tab_contents

Concluding Remarks:

Here is the current situation.   The ACA has non-trivial flaws that need to be fixed.   The Republicans have done and continue to do everything they can to make sure the ACA fails. The Ryan bill would have led to the unraveling of employer-based health insurance and many people currently covered by employer-based polices or receiving tax credits on state exchanges would have been unable to afford health insurance under Ryan’s proposal.  The only Democratic plans put forward involve government options or single-payer plans, proposals that are not viable in the current political environment.   The Freedom caucus opposes any plan with a new entitlement even if the plan actually reduces the role of government in the health care system

Many of the recommendations discussed in this essay including the expansion of state exchanges, modification of age-rated premium formula, and changes rules governing health savings accounts are based on conservative principles.    The plan that I am outlining here  also contains a very large new government entitlement – universal catastrophic coverage for all U.S. citizens.   The new entitlement allows insurance companies to cap health annual expenditures.  This provision reduces premiums on private insurance and tax subsidies.

It is hard to see how issues related to the most expensive health care cases can be mitigated without some government involvement.   Even though this proposal contains a new entitlement this proposal should reduce total government involvement in the health care sector.  It is my hope a bipartisan group of Senators and Representatives will get behind a specific plan based on this analysis.

## Marian Hagler’s Health Care Plan

Marian Hagler, my wife, wrote this health care plan. Marian is an attorney who has worked on international transactions, energy, and start-ups.

Here is her proposal to reform our health care system.

Overview. I became inspired to put together a health care plan after listening to many critiques of ObamaCare coming without concrete proposals for improvement or replacement. I encourage others to go through this exercise. I have a new appreciation for the difficulty in finding something that works and incentivizes stakeholders in a positive way. I can now also read proposals for change with greater insight as to why they are good, even if imperfect, and whether there is a better option.

The following proposal is designed to simplify and improve the existing system, and hit all Republican and Democrat “must haves” (repeal/replace/improve ObamaCare, minimize government involvement and leverage the private sector, reduce premiums, keep increasing the number of people covered, maintain pre-existing conditions coverage, maintain coverage for persons 26 and under, reduce employer admin costs, incentivize people to buy affordable private insurance, guarantee equal rates for men and women, allow people to keep their doctors, and reduce prices of prescription drugs). In addition, it addresses other key problems..

The core of the proposal is to guarantee everyone at least some minimum of free medical insurance that covers them if their medical expenses reach a catastrophic level (“MajorCare”) and give 100% insurance to children (“YouthCare”). Taken together, the proposal essentially provides a safety net for retirees (by keeping Medicare), children and young adults (through YouthCare), the poor (by keeping Medicaid), and for major medical (by introducing MajorCare). It also turns over to broader private competitive market all plans supplemental to these (Private Supplemental Policies or “PSPs”), without the employer necessarily being in the middle and without state barriers.

How we pay for the plan and reduce drug prices is discussed last.

Disclaimer: I have no dog in this hunt other than to see us advance down a path towards a better system. If I have a tilt, it comes from the fact that I am a mother, a lawyer and a Democrat, but I am not a medical professional, nor do I work for a health insurance company, or pharmaceutical company, nor do I own such a company (unless a share or two is buried somewhere in my investment portfolio), although one of my clients is a medical device company. I am not on Medicare or Medicaid. Our family has private group health care insurance that is affordable for us. My sister is on ObamaCare and my parents are on Medicare.

I also work with a number of very inspiring entrepreneurs who sometimes walk the line between ObamaCare and Medicaid. Finally, my husband is a health care economist and has encouraged and helped me think through some of the issues here, together with my 13-year-old son.

Here is the proposal.

I. Medicare is maintained. This keeps retirees out of the private risk pool, which will keep premium and costs down for everyone else. This also keeps a political promise to “not touch Medicare”. We can think about whether to take the opportunity to tweak Medicare to improve it. Private Medicare supplements would still be available.

II. Medicaid is maintained. This keeps the poor covered and keeps them out of the private risk pool, which will keep private PSP premiums down for everyone else. A few key tweaks here: (1) Eliminate the month-to-month review, which is too frequent. Change to every six months. While this may lead to some temporary over coverage, there will be savings from reduced bureaucracy and reduced structural costs from people rolling on and off Medicaid. (2) We get everyone who is 26 and under off of Medicaid. They will be covered by YouthCare. This will help improve the health of the next generations, which should save costs down the road. (3) Develop incentives for the States to improve Medicaid. (4) Find ways to eliminate the problem of doctors who refuse to take Medicaid patients (or cap the number of Medicaid patients), so people can keep their same doctor as they roll on and off of Medicaid.

III. MajorCare and YouthCare are created as private insurance programs, with the premiums being paid by the US Government (USG):

A. General. MajorCare is a high-deductible policy designed to cover catastrophic/major medical expenses for everyone over 26 who is not covered by Medicaid or Medicare. YouthCare is a policy for anyone 26 and under, including children (because there is no income test, CHIP children would now be covered by YouthCare along with everyone else). Together, these policies ensure that the 20 million people picked up by ObamaCare will still have some minimum of health insurance at an affordable price (FREE), and we increase this 20 million dramatically by covering EVERYONE.

Also, with MajorCare in place, private policies won’t need to cover high, catastrophic costs, and this should lower significantly premiums paid under private policies. Further, unlike ObamaCare, no one would be required to sign up for MajorCare or YouthCare via a government website that does not work well or be limited by what is offered in their state. At its heart, MajorCare gives everyone peace of mind that they won’t be totally wiped out by medical expenses or incur high premiums because their private insurance company is covering catastrophic risk, and YouthCare ensures all of our children are covered (without the complications of Medicaid), and gets children and young adults in the good habit of going to see the doctor regularly. YouthCare picks up the ObamaCare coverage for people 26 and under and takes it a step further – young adults, and all our precious children, are fully covered, independent of Medicaid/CHIP or their parents’ insurance (or lack) and the limits of their parents’ policies.

B. Objectives. MajorCare and YouthCare should appeal to Republicans, Democrats and Independents. They follow the principle that a minimum amount of health care is a human right (regardless of income level) and our future depends on making children a priority. Importantly as well, these policies are provided and managed by the private sector with minimal USG involvement. USG negotiates the private insurer contract and pays the premiums. Since USG is paying the premiums, there is no higher premium charged to women or for pre-existing conditions and, so, this ObamaCare protection is maintained and even improved.

C. USG Contract Negotiation. The private MajorCare and YouthCare insurers would be selected by the USG in a negotiated process designed to yield USG an optimal policy and premium price. Here, we can take advantage of the Trump Administration’s skills in negotiating private sector contracts and ensure that MajorCare and YouthCare contracts are structured in a way that meets program goals and works within the private sector health insurance industry that will manage them. Also, retirees and non-youth poor, as well as everyday medical care for all non-youth, are all out of the risk pool. So, this lowers the premiums cost to USG. Also, these programs eliminate the problem of people electing to pay the ObamaCare tax penalty and then signing up for ObamaCare once they are really sick. Eliminating this problem helps to stabilize the risk pool, further optimizing the cost to USG.

The winning insurance company may team/reinsure so they can spread the risk/reward with other private insurance companies, so long as they don’t collude in the bidding process. If the YouthCare and MajorCare contracts are too big for a single winner, they may be divided into a series of regional contracts, so that a 25-year old who enters a hospital in Region A would be covered automatically by YouthCare in Region A. A 27-year-old resident in Region B would sign up for Region B MajorCare.

D. Required Bid Terms. Required bid terms for YouthCare and MajorCare would include: (1) pre-existing condition coverage (thus, keeping a key ObamaCare promise and making sure those who need it most are covered), (2) a max deductible (\$0 for YouthCare and, say, \$15,000 per year for MajorCare), (3) the costs that count towards the MajorCare deductible would include the usual medical expenses, as well as premiums and insured expenses paid by PSPs (see below) and perhaps even discretionary costs (vitamins, gym and sport fees, massages, discretionary therapies, etc.) as part of a “Make America Healthy Again” initiative, (4) seamless transitions between MajorCare/Youth Care and Medicare/Medicaid, so no one falls in a crack (in other words, MajorCare/YouthCare automatically picks up someone who is not on Medicaid/Medicare and, vice-versa, MajorCare/YouthCare continue to cover someone until their Medicaid/Medicare coverage actually commences, (5) MajorCare and YouthCare include prescription drugs and dental/orthodontia (and such expenses would count towards the MajorCare deductible), and (7) financial condition covenants on the winners and a USG guarantee, in case of insolvency/failure as well as other unusual events (epidemics, etc.) paid for by a reinsurance fee (the scope of the guarantee and amount of the fee to be bid by the private insurer) paid to the USG (and perhaps netted from the premium). USG premium payments would be biweekly or monthly (same as premiums currently paid by employers) to minimize exposure and misuse. How the premiums could be invested, and length of contracts would also be negotiated. There are clear risk trade-offs with longer contracts and investment freedom, versus the cost of the reinsurance/ guarantee.

E. Economic Experts. Health care economists can help USG and insurance companies determine the optimal levels (bang for the buck) for: (1) the MajorCare deductible (recognizing the inverse relationship between deductible level and premium cost), (2) the age for transition from YouthCare to MajorCare/Medicaid, (3) contract term, investment freedom and the USG guarantee/reinsurance fee. For example, data suggests that a \$15,000 deductible for MajorCare will alleviate higher costs for only 7% of the population but this will absorb about 80% of all working age medical costs nationwide, which should thus reduce individual PSP premiums for individuals dramatically. YouthCare would cover the approximately \$275 billion in annual medical expenses, and MajorCare (assuming a \$15,000 deductible) would cover about \$595 billion in annual medical costs.

The numbers on use and share of expenditures on expensive health care cases are from the 2014 MEPS survey. Some additional work on this topic can be found here.

http://www.dailymathproblem.com/2017/02/health-care-expenditure-patterns-across.html

IV. Private Supplemental Policies (“PSPs”): To eliminate the gaps in coverage from Medicare, Medicaid, MajorCare and YouthCare, PSPs will be offered in the open private market place, and not through employers or state limited exchanges.

A. Premium Affordability. PSPs should be more affordable than ObamaCare because while they contain the same restrictions (preexisting conditions, same rates for men/women), they exclude catastrophic costs, and all young people (who are covered by YouthCare). In addition, state exchanges and other barriers to national competition would be eliminated, something that has caused frustration due to limited choice. This also was a change that was proposed by Trump during the campaign. The vision is that access, information and competition would also be fostered by private brokers that allow people to compare policies meeting their criteria (similar to LendingTree and QuickenLoan for mortgages).

B. No Mandate. One of the most unpopular aspects of ObamaCare is the tax penalty, which was viewed as a necessity to ensure that healthy people join the risk pools. Under this proposal, because everyone is covered by MajorCare and YouthCare, this mandate can be eliminated and people would also be free to choose not to sign up for a PSP. To cover non-MajorCare/YouthCare costs, they can choose to rely on their own savings (see below re Health Cash) and, if they are healthy, the low probability that they will have unaffordable medical bills. My hope is that by offering everyone MajorCare and YouthCare, there is universal coverage and those risks pools are optimized (both sick and healthy are in) and therefore the adverse economic and societal effects from some (largely healthy) people choosing to not buy PSPs until they are really sick will be far less dramatic and, so, unlike the ObamaCare structure, there is less reason to force them to do so. This also eliminates a costly, economic inefficiency that arises from forcing people to buy plans that they just don’t want or feel they need. Individual discretion will also encourage insurance companies to offer healthy people attractive policies, by offering plans that are properly scoped and affordable.

C. Regulation. USG regulation of the private PSP market would be limited to (1) eliminating state barriers to competition, (2) requiring that pricing and coverage be blind to gender and pre-existing conditions (thus keeping two important ObamaCare benefits), and (3) creating incentives for purchasing PSPs (discussed next). Re pre-existing conditions and gender neutrality, insurers would be required to offer a premium pricing before they know the applicant’s identity (much like what is done now based on standardized pricing matrices depending on plan level and other factors). The cost to PSP insurance companies of covering pre-existing conditions and, as a result, premiums should be significantly reduced, because catastrophic costs are excluded and covered by MajorCare and children are covered by YouthCare.

Other means of regulating premiums in the PSP market would be considered and debated. The important point is that the existence of universal catastrophic coverage will reduce the incentive for insurance companies to cherry pick healthy customers.

D. Incentives.To help and incentivize people to buy PSPs, and stay with the same PSP (and doctors) if they change jobs, a few new rule changes would be introduced:

1) Low-income families would receive a tax credit equal to a certain percentage of the PSP premiums they pay for.

2) Employers would no longer be required to offer group plans and, instead, all individuals could reduce their taxable income by placing funds (“Health Cash”) into special accounts (“Health Care Accounts” or “HCAs”) maintained at a bank or other financial institution in the same way as current Flexible Savings Accounts (FSAs) and Health Savings Accounts (HSAs). Health Cash would reduce employer costs by eliminating the admin and other costs associated with maintaining mandatory group health plans. So, for example, say an employee is offered \$90k today plus a health plan. The employer is paying part of the group health plan premiums and has admin costs relating to managing the group plan. The employee pays taxes on the \$90k, including the amount he is paying for his share of the health plan (usually) and out-of-pocket medical and health-related expenses. With Health Cash, the employer can save an amount equal to its cost of old group health plan and the employee can reduce his income tax by reserving some of his income as Health Cash.

3) So that this proposal does unnecessarily disrupt the status quo, employers would still be free to organize and arrange group plans and supplement the cost by giving employees Health Cash as part of their compensation/benefits packages. This way, a large employer could still use its collective bargaining power to achieve premium discounts for its employees from PSP providers. The only changes would be that (1) group plans are no longer mandatory for any employer, (2) premiums would not fluctuate depending on how sick or well the group is (this cost/benefit is spread to the entire PSP pool), and (3) COBRA bureaucracy is eliminated and PSP contracts are individualized, so that individuals can keep their insurance (and doctors) if they lose or change their job.

4) Because contributions to HCAs are tax free, there is no longer a need for a limited deductibility of medical expenses, so this tax rule can be eliminated. This rule was not that useful for a great many families because of the high threshold.

5) The kinds of medical expenses could be paid from an HCA could be expanded to be the same as those that count towards the MajorCare deductible (medical expenses as well as health related expenses), as part of the “Make America Healthy Again” initiative. PSP premiums, for example, would be both payable from an HCA and count towards the MajorCare deductible, as well as gym/sport fees.

6) Unlike HSAs and FSAs, HCAs would never expire and anyone can have them. Importantly, these accounts could be passed on as part of an estate (although like the rest of the estate, an estate tax may apply), and they would be exempt from personal bankruptcy and not count as assets for purposes of Medicaid eligibility. These accounts would solve a few problems: (a) no more use-it-or-lose-it principle forcing people to guess how sick they will be in a calendar year, (b) we uncomplicate the administration of FSAs and HSAs by having one type of account with fewer rules/restrictions, and (c) by encouraging people to shelter and pass on cash in HCA lock-boxes, we build access to, and the affordability of, health care for current and future generations.

7) Contributions to HCAs (either by employer Health Cash or personal contributions) could have no cap or, if needed to control the fiscal hits to USG budgets, they could be subject to an annual cap to encourage good, regular savings habits. This is a point currently being reviewed and debated for HSAs.

8) Finally, people could use HCAs to pay themselves back for PSP premiums and medical costs not paid out of their HCA (e.g., because they did not have an HCA set up at the time or their HCA was depleted). Some cap or carry-forward time limit may need to apply here.

V. How to Pay For It. The cost of the plan needs to be evaluated in terms of how much more it will cost than current outlays under Medicaid, Medicare and ObamaCare, including the premiums to be paid by USG for the MajorCare and YouthCare plans, and the estimated fiscal losses from taxable income being diverted into HCAs, and where the new plan saves USG money (e.g., reducing internal USG admin costs, moving children out of Medicaid CHIP).

Ways to cover the added cost or reduce the cost:

A) negotiate prescription drug prices that will be paid by Medicaid, Medicare, YouthCare, and MajorCare. Reduced drug prices should help reduce costs of Medicaid and Medicare and reduce the premiums charged to USG for YouthCare and MajorCare. However, we need a way to prevent the drug companies from simply transferring the costs of this cap onto consumers who pay for drugs directly or through their PSP premiums.

B) include in the bid requirements for the YouthCare and MajorCare contracts, a requirement that the insurance company remit to USG 50% of any excess profits they make on the contracts. This may also reduce the incentive they have to improve profits by denying or fighting coverage. (Penalties in the contract for bad faith and private rights of action should also be added.)

C) reduce some of the employer tax savings on Health Cash. We still want employers to be incentivized to give Health Cash in lieu of wage income, but we may need to limit the tax savings. For example, FICA and Medicare taxes and may still need to apply to Health Cash payments, avoid fiscal hits to Social Security and Medicare.

D) float from MajorCare and YouthCare reinsurance fee: a current budget receipt v a long term contingent obligation. Note that this fee could be netted directly to reduce the USG premium outlay.

E) it might be possible to reduce USG premiums further and help pay for the plan through the sale of securities backed by the premium contracts for PSPs, YouthCare and MajorCare, which USG would purchase and, in the case of PSPs, guarantee. This would work much like Freddie Mac, Fannie Mae or SLABs (student loan asset backed securities). More analysis is needed to see if this would work and how much savings/leverage USG could achieve.

F) caps on tax deductions for HCA contributions, as discussed above

G) raising the MajorCare deductible to reduce the USG premium outlay, as discussed (we need to be careful here not to narrow the benefit too much)

H) develop incentives on health care industry and insurance companies to reduce costs without sacrificing quality or denying coverage.

I) other taxes

## A bi-partisan way to fix the ACA

A bi-partisan way to fix to the ACA

Background:   Current ACA state exchange market places are small, have relatively few young adults, and have a disproportionately large number of people with poor health status and lower income than the market for employer-based insurance.   As a result, many insurance firms eschew state exchange markets. Increasing the size of state exchange market places is a necessary condition to stabilizing these markets.

The most cost efficient way to cover people who cannot afford comprehensive health insurance is through a partnership between private insurance companies and a government fund covering health expenses over a certain threshold.   The private-public insurance partnership is Pareto superior to the high-risk pools proposed under Republican plans.

The plan presented here includes changes in rules and tax incentives that will allow and encourage more people to obtain health insurance through state exchanges and will provide an economical private-public health insurance option for all people that cannot afford a private health insurance plan and do not qualify for Medicaid.

Proposed Policy Changes:

• Abolish the current employer mandate, which requires firms with more than 50 full time employees to offer employer-based insurance.
• Replace the current employer mandate with a rule requiring employers with more than 50 full time employees contribute at least 60 percent of the cost of a gold plan on state exchanges for all employees. This new mandate would also require some contribution for part-time employees.
• Create a tax credit roughly equivalent to the above employer contribution for people who do not receive premium contributions from their employer.
• Require all federal, state, and local government employees to purchase their health insurance through state exchanges. The contribution level would be at least 60 percent of the cost of the gold plan.
• Premiums should be based on age; however, the age-rated formula should increase from its current level of 3 to 1 to around 3.5 to 1.
• Create a low-cost hybrid private-government health insurance option for people who cannot afford comprehensive health insurance because of affordability concerns. Under the private-government option, the private insurance plan would cover all insured expenditures under a cap and the government plan would pay most (maybe even all) expenditures above the cap.

Comment One:  State exchanges are the poor cousin of employer-based insurance and other venues.

Here are some statistics comparing the composition of the market for state exchange insurance to the composition of other venues, primarily employer-based coverage.

• Around 10 million people obtain their health insurance through state exchanges compared to around 150 million people obtaining their health insurance through employer-based insurance.
• Around 6.8 percent of state-exchange market place participants are between the age of 21 and 26 compared to 8.1 percent of people obtaining health insurance through other venues.
• Around 21.7 percent of people with state exchange coverage are over age 55 compared to 15.1 percent for other venues.

These difference between the composition of ACA exchanges and employer-based insurance and other venues will result in ACA insurance being either more expensive or less generous than employer-based coverage.

The post linked below has some interesting information on the age composition of state exchange market places compared to employer-based insurance.

https://healthcarememos.blogspot.com/2016/10/age-composition-of-state-exchange.html

Comment Two:   The disparity between state-exchange coverage and employer based coverage is the result of ACA rules and the extremely generous treatment of employer-based health insurance under the tax code.  ACA rule include the employer mandate and a rule that prevents people with offers of employer-based insurance from obtaining a tax credit for insurance on state exchanges. The ACA tax credit is also phased out for workers with household income over 400 percent of FPL. The preferential tax treatment of employer-based insurance results in many employers paying a large portion of their worker’s health insurance premiums.

Comment Three:   The health care plan offered by John McCain would have replaced the existing employer-based tax preference for health insurance with a universal tax credit for the purchase of health insurance.   The McCain plan offered a tax credit of \$5,000 for families and \$2,500 for individuals.  This plan would have placed everyone in a private market place similar to state exchanges. The proposal offered here would move us in the direction favored by John McCain.  Republican proposals of 2017 retain preferences for employer-based insurance over state exchanges.

Article on John McCain’s 2008 Health Plan

http://www.heritage.org/health-care-reform/report/the-mccain-health-care-plan-more-power-families

Comment Four:   There has been a long-term trend for small businesses to drop offers of employer-based coverage.  Many small business that are unwilling or unable to offer employer based insurance to their employees may be able to afford some employee contributions.

Comment Five:  Both the McCain plan offered in 2008 and the Republican plans offered in 2017 include funding for high-risk pools set up by states for people that cannot get coverage on state exchange or through their employer.  High-risk pools are not a cost-effective way to cover people with pre-existing conditions.

Many people have pre-existing conditions and people with pre-existing conditions are expensive to insure. The HHS estimated that around 61 million non-elderly people have pre-existing conditions that qualify them for high-risk pools under the eligibility requirement for high-risk pools that existed prior to the ACA.  Moreover, around 133 million non-elderly people would be viewed as having a pre-existing condition under the underwriting procedures generally employed by insurance companies.  Under some health care proposals, these people could be either denied coverage or charged higher premiums.

Around 18 million people with pre-existing conditions were uninsured in 2010 prior to the implementation of the ACA.  Over \$90 billion per year is required to insure these people.   Recent republican proposal for new high-risk pools allocated around \$10 billion per year.

HHS report on number of Americans with Pre-existing conditions:

https://aspe.hhs.gov/system/files/pdf/255396/Pre-ExistingConditions.pdf

The use of high-risk pools to cover people who cannot get insurance in a market place that allows insurance companies to either deny coverage for pre-existing conditions or base rates on insurance premiums would leave many people uninsured.

Comment Six:  The proposal for a private-public partnership offered in this paper will cover far more people at lower cost than high-risk pools.   Under the private-public partnership the private insurance company will cover all expenses over a certain threshold and the government will pay all or most expenses over the threshold.  The private-public partnership could substantially reduce the cost of private insurance depending upon the threshold limiting annual health expenditures by the private insurance firm and the share of expenses for the private firm over the threshold.   The cost sharing would also substantially reduce the variability of insurance expenditures, which could stabilize premiums.

One way to implement this program is to provide automatic enrollment into Medicaid for people who purchase a health insurance plan with an annual cap on expenditures (perhaps \$40,000).   This approach essentially turns Medicaid into a reinsurance program.   However, in contrast to some reinsurance schemes, government payments would be made directly to customers rather than insurance firms.  The cost of this approach would be borne by the government and would depend on the number of high-cost cases, which is not knowable in advance.   However, the cost sharing arrangement would be smaller than a high-risk pool, which insured the same number of people.

For more information on the costs and benefits of this approach see my previous blog on the topic

A proposed public-private health insurance hybrid:

https://healthcarememos.blogspot.com/2017/07/a-proposed-publicprivate-hybrid-health.html

Comment Seven:   The current proposal relies on age-rated premiums where age rating is set at 3.5 to 1.  As discussed in comment five above, the cost of unrestricted underwriting based on health status would be extremely high.   It would be useful to compare insurance premiums and costs of the partnership for the situation where premiums are purely determined by age to a rule where premiums are determined by both age and health status.  (For example, premiums would be allowed to vary 3.5 to 1 based on age with a 5 percent penalty for people with pre-existing conditions).

People would be allowed to purchase the public-private partnership based on some formula, like purchase the private partnership if premiums on the purely private plan were more than 9 percent of income.   I suspect, but cannot prove, that a rule allowing insurance companies to consider health status when setting premiums would substantially increase government subsidies compared to a rule where premiums are exclusively determined by age.  Clearly the most expensive government subsidy would occur when insurance companies could deny all applicants with pre-existing conditions and/or premiums were entirely determined by health status.

Comment Eight:  The primary reason why state exchange market places have disproportionately fewer enrollees between the age of 18 and 26 is that the ACA allows young adults to remain on their parent’s health insurance policy and most working-age people have employer-based policy. Polices could be implemented to encourage young adults to leave their parent’s policy in favor of a state exchange policy.   However, this may not be necessary.

Polices that move more working-age households to state exchange market places will automatically increase the number of young adults with state-exchange coverage. An empirical analysis based exclusively on people over 26 finds that in this truncated group participants in state exchange market places are younger than people with employer-based policies.

Concluding Remarks: The ACA created a separate health insurance market for working-age people without an offer employer-based insurance.  In this case, separate is not equal.  The ACA can only be fixed by creating incentives for people to move from employer-based insurance to independent market places.

## Proposal Seven: Providing Information to Consumers on University Value

Proposal Seven: Rank Universities on Basis of Costs Quality, Graduation Rate and Income of Alumni

Background:

In 2013, President Obama announced plans to create a federal rating system that would allow parents and students to easily compare colleges. He also planned to encourage Congress to pass legislation to link student aid to the rating system. President Obama’s proposal was bitterly opposed by college presidents.

On September 12, 2015, the Obama Administration abandoned its proposal to rank colleges let alone tie the ranking of the colleges to student aid and simultaneously introduced a web site providing raw statistics on university performance including

Readings on the Obama Era Efforts:

New York Times Article on Announcement by President Obama on plan to rank colleges on results and costs and link financial aid to the college rankings

New York Times Article on Reaction to College Rating Proposal by University Presidents:

Ner York Times article on Obama Abandoning Plan to Rank College

A Discussion of the College Score Card web site:

The web site

https://collegescorecard.ed.gov

introduced by the Obama Administration to provide information on the cost and value of colleges has some interesting raw data and a lot of limitations. The information on this web site for each school includes – average annual cost, graduation rate, salary 10 years after attending school, percent of students receiving guaranteed loans, typical loan amount for student borrowers who finished the program, percent of graduates who earn more than a high school graduate, SAT and ACT scores, demographics of students, and type of programs.

Limitations:

• The debt totals excluded private student loans and PLUS loans. The site also does not have separate information on percent of student using private loans and PLUS loans for each school.   These loans often are cause financial hardship for borrowers. The use of these loans is likely to widely vary across schools. The omission of information on private loans and PLUS loans will have a substantial impact on financial risk measures across schools.

• The ScoreCard software only reports median debt levels by student borrowers at a school.   It is likely the dispersion of debt levels is higher for some schools than for other schools.   It would be interesting to know the percent of borrowers with debt levels exceeding certain amounts (\$50,000 or \$75,000) at each school or debt levels at the 90th percentile for each school. These alternative statistics are a better measure of the likelihood a student attending a school borrows too much.

• The repayment statistic in the database — the share of students who paid back at least one dollar on their student loan three years after leaving school — is not particularly useful.  Initial repayment rates could be low at a school where many alumni go to graduate school.   The default rate, delinquency rate, and the proportion of students not in graduate school who are on target to finish payment on their student loans in 10 years are all more useful measures of repayment difficulty.

• The benchmarks in the database based on national averages are not particularly useful. Common sense suggests that the College Score Card cannot be used to compare the value of a state university to the value of an elite private institution.   The difference in post-graduate earnings is likely largely determined by the difference in the talent as measured by SAT score of the student body.  The difference in debt is likely determined by the price tag and the amount of available aid.  A ranking that found Harvard University graduates earned more than students from Ohio State but owed more at graduation would not provide new news. However, universities in the same category (highly selective, moderately selective, not selective) could and should be compared with universities in the same category.

Concluding Thoughts:  President Obama’s proposal to rank colleges based on their costs and the value they give their students was slammed by university presidents who proved they have a lot in common with executives running tobacco firms or leaders in the financial services industry opposing regulation after collapsing the financial system. Statistical analysis can and should be used to compare similarly situated universities and statistical information should also be used to guide the allocation of resources.