I give an example of buying tangerines at a grocery store and tie it together with one of the biggest conversation in politics right now: health insurance.
Consider this typical grocery shopping exercise. You go to the grocery store and want to buy tangerines. You have two choices:
- Buy a bag of ten
- Buy ten individual tangerines
Ceterus paribus, for the consumer, from a cost perspective, it is better to buy ten individual tangerines than to buy them in bulk as a bag of ten. We can add some complexity to this decision-making by changing the per tangerine cost when buying in bulk or buying them individually.
From the standpoint of the tangerine seller, it is better to sell in bags of ten rather than individually. Why?
When a consumer can purchase individual tangerines, what will happen? If there is a stand of 100 tangerines, the first ten to go will presumably be the best tangerines. Then the next ten to go will be the next best and so on. However, at some point, either due to aging (shelf-life) or other factors, the tangerine seller will be left with tangerines that have gone bad or are otherwise undesirable. As such, this represents a loss of inventory and a loss of profit.
To alleviate this, it’s more efficient for the tangerine seller to sell tangerines in bundles — perhaps with a distribution of nine good tangerines for every one bad tangerine. This way, the seller is still moving all inventory. The consumer now picks up the risk that some bundle that they purchase will contain one or more bad tangerines. For that risk, a conscientious seller may give competitive pricing against buy tangerines individually. That is, if one wants to buy an individual tangerine, it would cost more on a per tangerine basis than buying ten at a time. The price trade-off captures the risk that some of the tangerines bought in bulk will be bad and the overall value to the seller for moving product in bulk. If there were a guarantee that all ten tangerines were good, then the price differential between the bulk purchase and the individual purchase is the seller’s value in moving products in bulk.
In a nutshell this is how securitization works. There is some collection of goods that some owner (or owners) is (are) looking to sell. Selling off pieces individually will leave the undesirable goods unsold. However, if there were a way to collect these goods and sell them as one product, then we have full inventory turnover and presumably a better profit margin.
And some times this can happen …
Complexities arise in financial products, for example, when what is actually being sold is a cash flow stream from loans (housing, eg). As time goes on, the “good cash flow” may have already paid off the loan, and the “bad cash flow” (lower rated) may have defaulted. What ends up happening is portfolio of loans that at time of sale looked good, but after \(T\) units of time have passed are now no longer good.
In the case of health insurance and despite the unsavory example of tangerines going bad, we can try to understand the notion of spreading risk of premium increases by grouping people with an optimal mix of healthy and unhealthy so that across all groups, the variance in pay is minimized. That is, one person is not paying $4000 per month for health insurance because of their specific health, while another person is pay $40 per month because they are in good health. Rather, we would want that all people are paying roughly the same amount.
An obvious way to have everyone pay the same amount is to lump everyone into one pool. Done. But for a country like the US with numerous laws surrounding insurance and the like, if there is a desire to have multiple plans and offerings from the many providers that exist, then the trickiness is in deciding how these “risk pools” are created.
Putting people with (expensive) health problems into their own category, or excluding certain ailments from coverage, does not help with this variance minimization problem. And unlike tangerines or financial instruments, health insurance should be first and foremost about people.
It’s a thorny subject because of the many divergent views, but at the least from a “securitization” viewpoint, we can understand why it is necessary to group a diverse set of health conditions into one pool. Optimally, what happens is everyone is covered at a reasonable price. There is no such thing as “my health insurance dollars paying for someone else’s health insurance”. If we want to think about it this way, then I would point back to the example of tangerines or financial products and remind us that we all will age and at some point “someone else’s health insurance dollars” will have to pay for our health insurance.
In the cases where some price stability cannot be met, and because this is unlike financial products [which, remember, got banks bailouts], government subsidies can be brought into place to keep things affordable. To my knowledge, similar subsidies already exist to keep food prices stable, so that a large proportion of the population can purchase food. [And yes, that is a whole ‘nother topic.]
Final comment, the discussion above is done in broad strokes. There are many nuanced details, so save the vitriol of “big government” and “corporatism”, etc for a different blog.