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Friday, January 16, 2009

"Recession Insurance"

Robert Shiller:

Recession Insurance, by Robert J. Shiller, Commentary, Project Syndicate: The Chief Economist of the International Monetary Fund, Olivier Blanchard, and several IMF economists have proposed ... that governments should offer what they call “recession insurance.” Companies and/or individuals would buy insurance policies, pay a regular premium for them, and receive a benefit if some measure of the economy, such as GDP growth, dropped below a specified level. ...

Recession insurance might ... help alleviate the economic crisis by reducing uncertainty. After all, the real problem that we are currently facing is one of paralysis: uncertainty has placed many spending decisions – by businesses ... and by consumers ... – on hold. Reducing uncertainty might augment, or even be superior to, fiscal stimulus programs, for it would address the root cause of the unwillingness to spend.

Moreover, recession insurance might, in contrast to fiscal policy, impose no costs on the government, for if it stimulates confidence, then the risk being insured against is prevented. The government’s ability to offer such insurance on a scale sufficient to make it costless is one reason to favor a public scheme over private insurers. ...

Governments are in a good position to create new risk-management policies... But, as an alternative..., there could be purely private recession insurance.

Such insurance already exists on a small scale in the form of credit insurance against unemployment. A New York-based firm, the Assura Group, has been working for four years on a plan to launch privately issued supplemental unemployment insurance to anyone. Their policies would piggyback on US state unemployment insurance programs, allowing Assura to avoid getting into the monitoring business.

One problem with market-based policies is strategic adoption and cancellation. GDP risk is a long-term risk. The price of the insurance would have to be adjusted regularly to adjust for varying ... likelihood of a recession, and people could not be allowed to cancel their policies, and stop making payments, whenever the economic outlook became rosier.

The Assura Group ... will set prices by a formula, rather than using a fixed rate, so that their prices vary in rapid response to changing economic conditions. ...

Once we have a market price for recession insurance or similar products, the question then arises: will it be so high that few people want to buy? We know that we are probably in a recession right now, and may be for some time, so the expected losses currently are enormous. As a result, people may balk at the price and not want to buy the insurance. ...

There are uncertainties with any really new proposal. But the proposal from the IMF is an important step, because it deals with the essential problem...: fears about the future of the economy become a self-fulfilling prophesy. We should not look askance at such a policy because of its potential shortfalls.

The current global economic crisis is an opportunity for some new experimentation that might not only lead to its resolution, but might also set in place institutions that help to prevent future crises. Recession insurance is one such idea.

I have a hard time getting by the argument that if a private market for this insurance could exist, it would already be operating, so I am not confident that the Assura Group proposal will work. (And if it does work and turns into a large program covering most households, would the government step in if the insurance company failed during a recession due to, say, oh, I don't know, the mispricing of risk? I think they would, so there would be an implicit government backing of the insurance in any case.) This is likely something the government does directly or indirectly through guarantees or other mechanisms, or it doesn't get done at all (due to market failures). And in that regard, this comes under the general heading of social insurance, and there are a variety of ways that we could strengthen our social insurance programs. The only question is where the highest return for an effort to reform social insurance is likely to be. Right now, I think the highest potential return is in the area of health care reform, so that is where I would like to see the social insurance reform effort concentrated (the unemployed are particularly vulnerable to losing health care coverage). If we can make households less vulnerable to business cycle variation, and to exogenous variation in household income more generally, we should do so, and if the private sector is up to the task, great, it can help with this task. But right now, beyond the immediate task of stabilizing the economy, the primary focus should be on providing broad-based, affordable health care.

    Posted by on Friday, January 16, 2009 at 05:58 PM in Economics, Social Insurance | Permalink  TrackBack (0)  Comments (24)


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