Tuesday, February 23, 2010

What the Bank of Dad Tells Us About Health Care

In this post, I discuss teaching our kids to save by paying them very high rates on their savings, deposits in the Bank of Dad, as we call them.

My anecdotal observations of children (particularly mine!) lead me to assume they discount the future rather severely.  Thus, a dollar right now has substantially greater value than a dollar tomorrow.  Several theories could explain these results.

I generally subscribe to the notion that discount rates (the relative value of a dollar tomorrow versus a dollar today) are not constant over our lifetimes. Therefore, in our household, we train our children to save by paying them higher returns on deposits, that encourage saving behavior that would not occur at the adult "market clearing" interest rates.  I'm pretty confident stating this applies to twenty somethings too.  I suspect those with the bulk of the wealth in the world drive market clearing discount rates.  That means people over the age of 40.

(However, sometimes I'll convince myself the issue really reflects risk changes, or perceived risk changes.  For example, my kids don't control their time.  So, when confronted with the chance to buy a toy right now in the store, versus tomorrow in a store where the same item will cost significantly less, they face meaningful risk they won't get to the store tomorrow, so they pay the high price today.)

One other observation: We all think we're special.  I discuss this topic as it relates to credit risk in this post.  You've probably heard the example of driving skill--standard fodder for behavioral economics discussions.  Ask a room full of people to raise their hand if they are above average drivers.  Virtually every hand will go up.  (Although I haven't had an accident since I was 16, I confidently state I'm a below average driver.) 

So, we take these two observations: Younger people have higher discount rates, and we're all optimistic. High discount rates mean we don't care about large liabilities that will hit us far in the future, (which accounts for most healthcare spending.) A strong dose of optimism about our own health prospects, both injury risk (I'm not going to break my legs on that half-pipe) and slow deterioration, (yes, most people get fat when they get old, but I won't,) means we don't believe the liabilities matter to us anyway!

The end result: We cannot possibly get young, healthy people to willingly pay enough for their future healthcare expense (in the form of insurance premiums) even before you talk about demographics and retiring baby boomers.

One more factor makes addressing long term liabilities (healthcare) very difficult now: Low interest rates.  Just like my kids who don't want to save in a commercial bank because pathetic interest rates pay them nothing, health insurers cannot rely on the "float" of insurance premiums to cover their costs and profit margins.


  1. This seems to support the "it's all demographics" view of how the world operates. By your theory, as the US population has aged, discount rates should drop, and there should presumably be a long-term differential between aged nations (the US and Europe) and youthful ones (the Mideast and Asia), with the happy consequence that productive young people can profitably borrow from us old relics.


  2. I think a big factor in how much money kids save might be what percentage of the things kids see that they want that the parents are willing to buy. In my almost-rural life here in Madison, I notice that kids are not exposed to very much advertising, so most of what they want (goggles for swim lessons, a soccer ball, new boots) is stuff that seems reasonable for a parent to buy.


  3. @Terence: I think I agree, in that if I agree with my hypothesis of age varying discount rates, then your demographic argument follows. However, when I wake up on the other side of the bed, and believe it's driven by risk, not age, then I'm not so certain.

    @Penelope: I think your point may be interesting in a different context, but not the discounting one. For example, you are saying if kids only ask Mom or Dad to buy (healthy) food at meal time, then neither parents nor kids have any insight into discounting or saving behavior. However, the interesting (theoretical!!) experiment with kids who don't ask for stuff would be to give them food only once a week, and see how effectively they saved the food they like best to eat later in the week. My guess is that they'd still eat all of their favorite food on day one, not a little each day.