Sunday, October 15, 2006

Business mathematics

Thanks to Jennifer Young for this one.

What should you do when your boss wants you to give 100%, or even more than 100%?

Here is the math behind this concept.

Represent A, B, C, . . . , Z by the numbers 1, 2, 3, . . ., 26.

Then:

KNOWLEDGE = 96%

HARD WORK = 98%

ATTITUDE = 100%

BULLSHIT = 103%

ASS KISSING = 118%

So, it is mathematically certain that while knowledge, hard work, and attitude will get you there, bullshit and ass kissing will put you over the top.

Sunday, October 08, 2006

The Palm Beach Post’s editor wants to make the insurance problem worse

Randy Schultz, the Palm Beach Post’s Editor of the Editorial Page, has an editorial titled “On insurance, will the state get fooled again?”. However, it is Mr. Schultz that is being fooled, and by his own faulty understanding of arithmetic and economics, not by the insurance companies.

Mr. Schultz’s article is an excellent example of the kind of mistaken thinking that I often used in my MBA classes to illustrate that even VIPs spread dumbth.

Here are some excerpts from Mr. Schultz’s editorial, along with my comments.

However the Foley scandal plays out in the race for his congressional seat and other U.S. House races around the country, Floridians will be dealing with the same insurance crisis once the election is over. There's no chance that the Legislature will hold a special session on property insurance before the Nov. 7 election, since there's no consensus on what to do. Also, Gov. Bush would have to call it, and a special session would remind voters how little he and the Republican-led Legislature did this year and last year.

Given the proposed solutions that typically come from government and the Mr. Schultz’s of the world, doing nothing is preferable to making things worse by doing something.

Ideally, the next Congress would deal with the problem by creating a federal disaster fund similar to the National Flood Insurance Program. Both candidates for governor favor such a program, and why wouldn't they? It would solve the problem for them.

A federal disaster fund, if experience to date is any guide, would encourage overbuilding and inadequate construction in hurricane prone areas. The real problem is that nobody who lives in these areas wants to pay the economic cost. The “solutions” proposed by politicians and Mr. Schultz invariably have the innocents pay for the consequences of the inappropriate behavior of the irresponsible.

The real solution is to have those who insist on living in hurricane prone areas (like Mr. Schultz and me) pay the full average cost of living there. This requires that those living in hurricane prone areas pay for all the hurricane damage, averaged over a suitably long term. That requires a real, economically viable insurance industry, not one required by law to charge “affordable” premiums that are below the average loss and to build up a reasonable reserve.

In reality, though, the Legislature will have to act. For nearly 60 years, Congress has left insurance regulation to states, which enables the industry to set rates state-by-state and work the system to its advantage. That's how the property insurers made record profits in 2005 despite Hurricane Katrina and two bad storm seasons in Florida.

Rates should be set state by state, or even better by risk area. Why should someone who decides not to run the risk or expense of hurricane losses be forced to subsidize those who do so that the latter can live where they shouldn’t in homes that are inadequately constructed?

Focusing on profits in one year when the problem is losses over many years is wrong. Do we want the insurance company to go broke precisely when the big loss is incurred? How can that be prevented if the insurance company is not allowed to have big profits in years when the losses are below average or when reserves are below where they should be?

Yet Gov. Bush continues to insist that Florida has "more a hurricane problem than an insurance problem." The committee he formed to study property insurance is to seek only solutions that restore the private market.

Gov. Bush is right and Mr. Schultz is wrong. If private insurance is not economically viable, presumably due to government meddling, neither will be public insurance. Politicians are smart enough to realize that they will have to bill citizens for the average loss and that the average loss will be just as large as what private insurers will charge. When the big loss comes, we will simply get an enormous tax bill and a partisan outcry about the failed government insurance program set up by the other party.

Test question: Why might the average cost of private insurance be less than the average cost of government provided insurance?

That would be the same private market that has dumped hundreds of thousands of higher-risk policies onto the state, restricted what their policies will cover, sought relief from having to cover certain perils, delayed or refused to pay some claims - then acted as though Floridians should be grateful that the private market is still here.

It appears that Mr. Schultz thinks that an insurance company should be forced to run at uneconomically viable insurance premiums. This is obviously impossible. Who would invest in the insurance company?

If an insurance company is not allowed to charge a premium appropriate to the risk, it would be foolhardy to sell the policy? If price controls make some segment of the insurance market a long term loss, the message is that government has done something that will, on average, hurt its citizens. If Mr. Schultz wants more risks covered, he shouldn’t be fighting for lower premiums.

There's a case to be made that the solution for Florida is to leave the private market out of any solution, since the private market has brought about the crisis. Making that case is Americans for Insurance Reform, which proposes "a privately run state insurer for the hurricane wind portion of homeowners' insurance coverage." Private companies would continue to write non-wind coverage, covering fire, theft and liability. Democrats in the Legislature supported this approach, but they didn't get a serious hearing.

To think that the private market has brought about the crises is wrong. It is the Mr. Schultz’s of the world who have messed up the insurance market by demanding “affordable” insurance when no such thing is possible. The only insurance premium viewed as affordable by the Mr. Schultz’s of the world are well below the average loss they are supposed to cover.

Fortunately, the Democrats didn’t get a serious hearing . . . . , or did they? A serious consideration should take no more than 60 seconds and should lead to rejection.

The key to any such plan would be how much to charge. That, in turn, would depend on who decides what the risk is. Americans for Insurance Reform suggests using models that are developed by state government and run by state government. As the group notes, Florida insurance regulators now have to rely on the industry's computer-generated risk models. One of those private models, Risk Management Solutions, said this year that projections now will be based on five-year periods. That means Floridians are paying property insurance based primarily on 2004 and 2005. Is that spreading risk?

Mr. Schultz is indeed misinformed. No hurricane loss models are accurate year by year. Even if they were, paying the current year’s expected loss each year would lead to wildly fluctuating premiums. The whole point of hurricane insurance is to average over years. Yes, Mr. Schultz, 2004 and 2005 should be included.

Mr. Schultz, have you any idea what the right tail of a probability distribution is? If so, do you have any idea of the implications for insurance?

On this one, really, get past politics.

Past politics and past the kind of dumbth Mr. Schultz and the politicians espouse.

Politics may keep some Republicans from taking Americans for Insurance Reform seriously. The group is part of the Center for Justice & Democracy, which gets money from those dreaded plaintiffs' lawyers Republicans like to criticize unless one of them - Sen. Mel Martinez, for example - is running as a Republican. Also, Michael "Fahrenheit 9/11" Moore sits on the Center for Justice & Democracy's board.

Well, those are some pretty good reason for expecting Americans for Insurance Reform to make the problem worse. I don’t see how anyone could take AFIR seriously, given what it is trying to accomplish.

Last Sunday's Post featured an update on how drastically higher premiums are hurting homeowners and the real estate market. Combined with higher tax bills from soaring values, the costs threaten to undermine the state's economy. Florida has managed to get by as a low-cost, low-wage state, but Florida can't be a high-cost, low-wage state.

Too bad. That is the cost of living in Florida. If you don’t want to pay for your cost of living here, move. Don’t try to force others to pay the cost of your inappropriate decision.

The sad truth is that Florida is a high-cost state.

What would help is high enough insurance premiums to make it worth while to build stronger structures that make economic sense instead of the weaker structures that make sense when you can count on having your damage paid for by others who don’t choose to run your risk.

A decade ago, after Hurricane Andrew, the state created another committee to study property insurance. Under the changes that became law the next year, Floridians were supposed to get this deal: Rates won't go down a lot when there are few storms, but rates won't go up a lot when there are lots of storms. If the insurance companies didn't live up to their end of the deal the last time, why should Floridians think that they would do so this time?

The only way to achieve level rates is to have high level rates.

Of course, all that said, I am willing to continue to be subsidized if you are silly enough to elect politicians who will do me the favor.

Friday, October 06, 2006

Tradeoffs. The New York Times editors on the national debt

Here is an editorial, “Deeper and Deeper” from the New York Times. The title is apt. The editors get themselves deeper and deeper into analytical trouble as they go along.

There is fresh evidence, if any more were needed, that excessive borrowing during the Bush years will make the nation poorer.

The NYT editors have yet to realize that what matters most is the size of the government budget, not how it is funded. If the borrowing will make the nation poorer, it is because the government is spending too much.

From the standpoint of a fixed government budget and the country as a whole, there is little if any difference between funding the budget with taxes or funding it with borrowing. Since the NYT editors are for increased taxes, they should not be worrying about the impact of funding those same projects with debt.

Hint: The present value of interest payments on debt is the proceeds of the debt. The present tax required to accomplish the same spending is the amount of the debt.

For most of the past five and a half years, interest rates have been low, allowing the government to borrow more and more — to cut taxes while fighting two expensive wars — without having to shoulder higher interest payments.

The NYT editors fail to appreciate the equivalence of funding spending with debt vs taxes. The additional interest payments from using debt are offset by the additional interest earned by taxpayers on funds they get to keep because they don’t have to pay the equivalent tax.

That’s over now. For the first time during President Bush’s tenure, the government’s interest bill is expected to rise in 2006, from $184 billion in 2005 to $220 billion this year, up nearly 20 percent. That increase — $36 billion — makes interest the fastest-growing component of federal spending, and continued brisk growth is likely. According to projections by Congress’s budget office, the interest bill will grow to $249 billion in 2007, and $270 billion in 2008.

So, one year’s increase is a permanent growth rate?

All of that is money the government won’t have available to spend on other needs and priorities. And much of it won’t even be recycled back into the United States economy. That’s because borrowing from foreign countries has exploded during the Bush years. In 2005, the government paid about $77 billion in interest to foreign creditors in China, Japan and elsewhere.

If foreigners buy US Debt, the US gets their money. US taxpayers do not have to pay now, either in the form of taxes or debt. The interest they pay later has a present value equal to the tax or debt they would have paid. Moreover, if the foreigners don’t treat us right, we can renege on the debt.

And that’s not the worst of it. While foreign investors were putting up most of the $1.5 trillion the federal government has borrowed since 2001, they were also snapping up hundreds of billions of dollars in private sector securities, transactions that have been a big source of the easy money that allowed Americans to borrow heavily against their homes.

Let’s see, having willing buyers for private debt makes it more difficult for Americans to borrow? Isn’t borrowing selling debt?

The result, as The Wall Street Journal reported last week, is that for the first time in at least 90 years, the United States is now paying noticeably more to foreign creditors than it receives from its investments abroad. That is a momentous shift. It means that a growing share of America’s future collective income will flow abroad, leading to a lower standard of living in the United States than would otherwise have been achieved. Americans deserve better than this financial mess.

The future collective income flowing out is offset by the debt proceeds flowing in now? If the consequence is a lower standard of living, it is due to a government budget that is too large, not how it is financed.

Sunday, October 01, 2006

A nice lesson from STATS (checking out the facts behind the news)

Here is a link to a STATS article, “Fingering the Media”. It shows why much of the statistical quotes in the media are nonsense.

Here are a few excerpts from the article.

The media just loves a finger story. Last year, the Express Newspaper of the U.K. reported on a study finding that male aggression is linked to finger length – the longer the ring finger is as compared to the index finger, the more likely the male is to be aggressive.

The problem with these kinds of studies is two fold. First, these researchers don’t have a plausible mechanism to justify their claim.

Secondly, there are rarely studies published about what finger-length is not correlated with. Some might argue this is irrelevant, but it actually is extremely relevant from a statistical point of view.

Any time you test for a correlation, there is a small possibility (about five percent) that you will measure a relationship (such as finger-length and athletic talent) when it isn’t actually present in the whole population. These “findings” will seem as “true” as any other statistical finding, such as the fact that lung cancer and smoking are correlated. But this means that if you try to correlate twenty different traits to finger length –even if none of them are actually related to finger length – you will likely find some correlation, just by chance.