Even Shackled, the Invisible
Hand Is Powerful
John Major’s letter to the editor in connection with “A Rigged Game?”
(Contingencies; July/August 2017) gives
me the opportunity to add a few remarks.
Major doesn’t dispute the glaring shortcoming of the American health care system, but
attributes them to the restrictions placed
on individuals and powerful groups that
make profit-maximizing decisions that
affect the public (the “shackled” invisible
hand). Everyone agrees that regulation
can be a deadweight and an obstacle to a
dynamic market. The question is: What
would the consequences of unshackling
the invisible hand be in the real world?
That competition in the health care
space is naturally imperfect should not
surprise anybody who has looked into the
matter. Whereas there are many buyers of
health care services, the number of sellers
is small and, thanks to mergers and acquisitions—a feature of a free market—it
is getting smaller. Most consumers don’t
understand the products they buy, let alone
the explanation of benefits they receive,
and certainly are not equipped to engage
in a medical discussion with their physicians—so much for perfect information.
Insurance products are not homogenous
(this shortcoming has been mitigated in
some instances by regulation); the services
rendered by providers are far from being
standardized; so are prices and so is quality.
Whereas consumers are price takers because they lack bargaining power, certain
corporations are not—and in fact, they can
bring prices to levels that are theoretically
impossible in a market system that exists
in the realm of fantasy.
A very imperfect market cannot be
expected to regulate effectively the use
of resources. Why do insurers, if they are
allowed to, underwrite to exclude poor
risks? Because not doing so would erode
financial results and compromise their
competitive position. Why do insurers
“optimize” coding? To make insurance
more affordable or to maximize profits?
Why is physician compensation mostly
linked not to quality or efficiency but to
reimbursement mechanism? Why is it that
the most laissez-faire approach (fee-for-
service) is also the least desirable (to the
community and insurers, not to physicians)?
Why do pharmaceutical companies in the
United States mark up their prices to levels
that many consider abusive? Because they
have the power to do so. It is certainly not
the case that executives are greedier or
more selfish than the rest of us. It is simply
the case that they chose the dominating
strategies that are permissible in the game
they play. Doing otherwise would bring
an end to their careers, jeopardize their
companies’ earnings, and in some cases
even threaten their existence.
The fact is that most of us try to maxi-
mize profits with little or no societal con-
cern. Who would use his retirement savings
to invest in an insurance company that is
socially responsible but generates low or
To put dominating strategies in theo-
logical terms, when executives maximize
profits regardless of consequences to others,
they are, in fact, led by an invisible hand.
In the United States, the invisible hand is
constrained, but even with shackles it has
managed to produce by far the worst health
care system in the industrialized world.
This is not a surprise—the invisible hand
is incapable of doing its magic in markets
that do not regulate resources effectively.
Deterministic vs. Stochastic
Iappreciate Ken Steiner’s response to my commentary, “Using Stochastic Modeling
to Analyze Retiree Income Strategies”
(Contingencies; July/August 2017). His
preferred strategy of using a deterministic
approach based on financial economic prin-
ciples is transparent and easy to understand.
One uses a conservative rate of return, an
assumed life expectancy, and an inflation
assumption to calculate an initial spending
budget that is to be adjusted annually by
expected inflation. I, however, have some
concerns with this strategy.
1. Most retirees need to take some risk and
will do so with their nest eggs to achieve a
spending budget that can keep up with in-
flation. Steiner’s approach generally assumes
that investments will mirror near-risk-free
rates or return. But this is not how retirees
and their advisers behave in this low-interest-
rate environment we live in.
2. Selecting a life expectancy to fund toward
is challenging. The Academy, along with
the Society of Actuaries, highlights a more
probabilistic approach under its Longevity
Illustrator. Under a deterministic approach,
we can of course calculate a spending budget
based on a variety of life expectancies—but
which one should the retiree rely on?
3. Stochastic modeling provides a method
that can compare thousands of different
strategies. Strategies can be analyzed and
compared based upon achieving an income
level or a success level. This cannot be done
under a deterministic approach.
I grant that the deterministic approach
is easier to understand. And I trust that
this debate will go on.
Florham Park, N.J.