Systemic Risk and Deposit Insurance Premiums

In the wake of the financial crisis, many economists are trying to come up with creative new ways to deal with systemic risk: the risk of a “wholesale bank failure” and failure of the financial system in general. I just finished reading Judge Posner’s recent book, A Failure of Capitalism. In it, Judge Posner makes a convincing case that individual bankers can (and did) make rational decisions that, at least in the aggregate, greatly increase systemic risk. I don’t wish to go into the details of that analysis here; I just want to assume its truth.

When rational actors make decisions that create negative externalities, it often falls upon the government to adjust the incentives to account for those outside costs. In banking, for instance, Citigroup might make certain decisions that increase its risk of bankruptcy to 1%. For a smaller bank, that risk would only be negligibly important: the bank could fail and go into receivership. But for Citigroup, of course, such a failure would have broader effects: it would not be able to keep the (many) promises of payment it regularly makes to other banks (cascades); it would create a “fire sale” situation wherein bank assets would have to be sold by the FDIC at a sharp discount; and confidence in the economy overall would sharply decline. A systemic risk regulator would intervene to prevent a Citigroup (or one of its similarly-sized cohorts) from taking these individually rational (but systemically risky) actions. Even Tyler Cowen suggests that we might need such a regulator, and it probably needs to be the Federal Reserve. I respectfully disagree.

I think the best way to regulate systemic risk is to use the insurance premiums charged to banks by the FDIC’s Deposit Insurance Fund (DIF). In very simple terms, the FDIC charges banks an insurance premium that is used to cover depositor losses when banks fail. Under the current system, under 12 U.S.C. 1817, the FDIC charges a “risk-based” premium that is supposed to be based on: (1) the probability that the DIF will incur a loss for that institution (i.e., that the institution will fail); (2) the likely size of any such loss; and (3) the revenue needs of the Fund. Trouble is, the premium is only based on the individual size of each bank’s risk to the Fund. Therefore, when calculating Citigroup’s premium, the FDIC does not include any of the “contagion” effects noted above. The FDIC isn’t actually charging for the real “likely size of any loss” that the bank will suffer from a big, interconnected bank’s failure.

I’ve seen a few different studies outlining how we could actually set the premiums to account for the systemic effects of a bank failure. I’m not going to venture into that. My only point is this: properly scaled, deposit insurance premiums that include systemic risk would obviate the need for any “systemic risk regulator.” If banks that create systemic risk faced increased premiums of any significant size, one would expect them to adjust their behavior to reduce the risk. In fact, the best approach might to charge punitively high premiums. One could anticipate that these punitive premiums could quash the moral hazard created by government bailouts; banks would know that they would pay a high price for setting themselves up to be “too big to fail.” Best of all, even if a bank was so brazen as to generate systemic risk in the face of high premiums, the money collected from the bank’s premiums would be enough to clean up the (system-wide) mess resulting the bank’s failure.

Of course, to accurately assess the premiums and let the market work its magic, the FDIC would need access to an enormous amount of information at banks. Not a problem! The FDIC has the right to examine any FDIC-insured institution if the FDIC’s board of directors finds the examination is necessary “for insurance purposes.” 12 U.S.C. 1820(b)(3). That would simplify the issue of setting up an entirely new systemic risk regulator with the authority to examine the books of market participants.

Still, I recognize there’s a big sticking point: any effective premium would probably have to apply to financial institutions that do not even operate with tradititionally FDIC-insured deposits. I also recognize that “excessive insurance premiums may hinder a financial institution’s capacity to resolve its bad loan problems and/or reinforce its owned capital.” (Financial Crises in Japan and Latin America, pg. 82.) And, lastly, there’s always a chance that FDIC systemic risk premiums would be miscalculated. There is some suggestion, for instance, that the FDIC misjudged the systemic risk posed by the failure of Continental Illinois National Bank in 1984. Even so, I think that’s better than just handing the keys over to the Fed, which has enough to worry about (like managing inflation).

How is Life Insurance Premium Calculated?

What is life insurance premium?

It is regular amount pays to insurance company to purchase a policy and to keep it in force; in return the insurance company agrees to pay your nominee or beneficiary a sum of money upon your demise. In the event you suffer total and permanent disability, the payment will be made to you; in these circumstances the money is usually payable in installments.

How is your life insurance premium calculated?

Life insurance companies don’t take risks to cover an insured when they are determining the rates, they want to take precautions to ensure the insured won’t die prematurely, because the pay out will be more than the amount the insured paid.

The insurance companies collect the premiums from the policyholders and pay for the overhead and administrative expenses, they invest the money to create a pool of money to pay claims and make their profit from investment, premiums collected are not enough to sustain, so they have to calculate precisely, otherwise their business will be at a loss.

The calculation of life insurance premium is based on age, gender and health

A younger person has a longer life span, so his/her policy has a longer maturity, and it is axiomatic that his premium will be cheaper. According to mortality table women outlived men, so women have lower rates on life insurance. Family medical history also plays an important role, for example if a person’s parents or family members suffered diabetes or high-blood pressure he may have to go for medical check-up before he buys a policy, and he is classified as high risk buyer, the insurance company will access him and consider whether or not to take the risk to insure him.

Each an every insurance company sets its own rates of life insurance premium, the type and amount of insurance you purchase and your lifestyle habits also affect your premiums, such as if you are a smoker you will pay a higher rate.

Implications of Lower Medical Malpractice Insurance Premiums

For many years medical professionals have been grumbling over the high costs of malpractice insurance, but a new report reveals that premiums are on the decline.

The Medical Liability Monitor, a resource that has been covering the medical professional liability insurance market since 1975, published their 2014 Annual Rate Survey, which says that professional liability insurance is on the decline. Although the majority of rates for medical professionals remained the same compared to 2013, specialists such as internal medicine physicians, general surgeons, and OB/Gyns saw their premiums decrease by as much as 1.7 percent.

So what do these lower malpractice insurance premiums mean? There are several ways we can look at it. First, these declines rates could mean that there is more competition in the insurance marketplace. Healthcare professionals have more choices available, so providers are more inclined to offer lower premiums. States like Michigan have a variety of carriers that 75% of providers in the state, and no carrier in particular has a dominant market share.

Another implication of lower malpractice insurance premiums is the decline of malpractice claims. Contrary to popular belief, malpractice payouts have actually decreased and only comprise about 2% of healthcare costs in the U.S. According to Diederich Healthcare’s “2013 Medical Malpractice Payout Analysis”, payouts were $3.6 billion in 2012, which was 3.4 percent lower than the previous year.

For medical professionals, lower malpractice insurance rates eases some of the financial burden, especially for independent physicians who have their own practice. Also, other doctors who have contemplated moving to another state because of high premiums may be able to stay put.

Malpractice insurance carriers base their rates on a number of factors, which includes the claims history of a region. How often are medical professionals held liable, and how big are the settlements? Some rates can be as low as a few thousand dollars for physicians while specialty doctors such as obstetrician/gynecologists can see premiums as high as $200,000 or more.

It’s hard to predict whether malpractice premiums will continue to decline, or if they’ll spike up again in the future. Regardless of what is happening in the marketplace, medical professionals can always do a number of things to help lower their premiums such as taking a risk management course, getting board certified, or continuously shopping around for the right policy at more affordable rates. Also, if a doctor has been claims-free for at least five years, some carriers will offer a discount.