Still Laboring

SUMMARY

Too Many Choices

The e-mail announced cheerfully: it’s time to enroll! The phrase evoked the beginning of school days, with new supplies, new outfits and (at least initially) no bad grades on the report card.

Alas, I’m too old to be going back to school. Instead, the message referred to annual enrollment in our corporate benefits program, a process that can make astrophysics seem easy by comparison. The good news is that there is a substantial amount of information available to help workers make decisions on health care coverage, but the bad news is that it is terribly difficult to understand it all. And there is a lot of economics involved, which is a scary prospect.

Most corporate providers will offer their employees a menu of alternatives for health care coverage. They typically differ by the range of coverage offered, the range of providers that can be used, and the split of payments between patients and insurance. On this latter front, there are a couple of key variables to consider, each of which involves important tradeoffs.

1. Co-Payments. Asking patients to pay a modest amount for an office visit might lead them to think a bit more carefully about whether the visit is essential, which can help reduce the cost of unnecessary appointments. But if the co-payment is too high, a patient might defer a checkup or a treatment, raising the risk of health problems (and health expenses) later on.

2. Deductibles. High-deductible plans have become increasingly popular. They provide coverage for more significant situations, but require patients to pay out-of-pocket for more routine things. Again in this case, people might choose to save money and defer medical maintenance. Low-deductible plans initiate coverage earlier, and thereby shift more of the risk for high medical expenses to the carrier.

High deductible plans are often paired with Health Savings Accounts (HSAs), which can be used to cover out-of-pocket medical expenses. HSAs can be funded with pre-tax dollars, and employers will sometimes kick in money to help endow them.

Of course, plans that require less of patients when they get sick carry higher premiums. If you had perfect knowledge of your family’s care needs for the coming year (and good spreadsheet skills), you could simulate how much you would pay under each of the alternatives, and then select one that is the cheapest overall. But no one can predict how their health might evolve with a high level of precision. Accidents happen, and benign conditions can unexpectedly become chronic. The consequences of decisions taken today (in the arenas of wellness and insurance coverage) could take many years to fully manifest, adding to the intricacy of the exercise.



Behavioral economics plays a big role in the process. As we discussed earlier this year, people have a tendency to turn complicated problems into simple ones they think they can solve, with potentially dangerous consequences. Or they avoid the problem altogether; quite a few people simply roll over the coverage they had the year prior, even if their personal circumstances have changed or if a new alternative has been added to the menu.

Finally, people seem to dislike paying deductibles, even if doing so lowers their overall costs. This may be a reflection of risk aversion; we don’t know if we’ll get sick, but if we do, we don’t want to add the insult of having to pay for the privilege. Premiums are collected through payroll deduction, which is relatively painless; deductibles and copayments come more directly out of our pockets.

There are websites that can help you through the analysis, but the cold calculus they use fails to account for our innate irrationalities. Just thinking about enrollment is giving me a migraine … I wonder if my insurance will cover it?

False Flattening

I’ve been getting a lot of questions about the yield curve lately. Specifically, clients ask whether the diminishing spread between long-term rates and short-term rates is warning that a recession is coming. A recession will certainly come again someday, but the yield curve may not be the best leading indicator for that event.

Yield curves normally have an upward slope, for two reasons. First, during good economic times, inflation is likely to be rising and central banks are more likely to be raising interest rates. And second, investors require compensation (called a term premium) for extending their durations, since they risk seeing short-term rates rise during the term of their investments.

When a yield curve is flat (or on those rare occasions when it inverts), it could reflect an expectation of lower inflation and lower interest rates in the future, which would result from slower economic times. History (below) shows that flat yield curves have been observed around the last several U.S. recession periods.



But the current the current yield curve is not unusually flat, and the history shows that the yield curve can be flat for a long time without a recession occurring (as was the case in the 1990s). Further, the shape of the yield curve is influenced by patterns of government borrowing, which currently skews heavily to the short-term. This week, Treasury Secretary Steven Mnuchin announced a further shift toward short-term debt issuance.

Perhaps the biggest damage to the yield curve’s utility as a forecasting tool has been the massive participation of foreign investors in long-term Treasury auctions. As we discussed earlier this year, global pools of capital have grown substantially over the last 20 years; the U.S. Treasury markets offer strong liquidity, a relatively strong currency and high credit quality. Given their wish for portfolio diversification, some international investors may not be basing their choices exclusively on the outlook for the U.S. economy.

In sum, the yield curve is certainly worth watching. But its current position is no cause for alarm.

© Northern Trust

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