Date of Award

Spring 5-16-2011

Degree Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Graduate Group

Managerial Science and Applied Economics

First Advisor

Mark V Pauly

Abstract

I examine the problem of writing guaranteed renewable health insurance in the presence of medical spending growth. Prior research suggests that the growth and difficulty in forecasting future medical costs is an impediment to multiperiod health insurance, where contract reserves are used to pay a portion of the benefits in later years of the contract. Medical spending growth is an input to calculating the magnitude of premiums and reserves, so setting up reserves to pay future claims involves forecasting spending growth. Hedging assets can ameliorate the investment problem by providing assets that automatically adjust to unexpected shocks in spending growth.

I expand an existing model of guaranteed renewability in an economy with risk to show the specific ways that medical spending growth enters the premium and reserve functions. I treat stochastic trend as a factor the insurance company can predict with error. I utilize aggregate and individual level insurance spending data and financial returns data to analyze whether medical trend can be hedged with existing assets. I separate trend into predictable and error components and analyze the correlation between the error component and return on assets. I find that medical spending growth is predictable with error over short and medium time horizons. I find that there is no significant correlation between asset returns and forecast errors across several broad asset classes.

The combination of partially predictable spending growth and the absence of a hedging asset imply that insurers should be using reserves to manage the macroeconomic risk of spending growth. The load for reserving for trend is an up-front cost in addition to the up-front expense of guaranteed renewability. Insurers should use a diversified investment strategy for reserves rather than one targeted at trying to match spending growth. I conclude by noting the positive and negative effects of the newly passed health reform law (PPACA) on guaranteed renewable health insurance and other health insurance arrangements that require contract reserves and policies that shift health care spending onto public plans.

Included in

Economics Commons

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