Wednesday, January 20, 2010

On the Loan Reserve

The challenge in creating a medical savings and loan is finding the money to serve as the base of the loans. There are numerous ways to get the money. For example, one could borrow the money for the loans on an open speculative market.

After examining, alternatives, I've decided that the best source of the loans would be the medical savings accounts.

One could create a program where the money for medical loans came directly from the medical savings accounts. As the loans are interest free and have a high default rate, the medical savings account would have a negative rate of return.

The problem with directly using the savings accounts as the basis for the loans is that there is an indirect relation between the amounts of money a person has in savings and the chance that they will borrow money for medical expenses.

To solve this problem, one needs to create an indirect mechanism for lending money from the savings accounts to the loans.

I've decided the best way to accomplish this task is to create a "loan reserve." All accounts will contribute the same amount to the loan reserves. For example, a group with 10,000 policies might set their loan reserve at $2,000 per policy. That would raise an immediate $20,000,000 for loans.

Ideally, the loan reserve will be substantially higher than the amount lent out. Imagine that $10,000,000 is lent during the year. The $10,000,000 not lent out can be credited back into the savings accounts. The policy holder's perspective is that they paid $2,000 in the loan reserve and got $1,000 back at the end of the first year. Now imagine that 50% of the loans get paid back in the second year. The policy holders would get $500 back in year two, and so on.

There is a high default on the loans. Imagine that $300,000 never gets repaid. That would end up being a loss of $300 per account. This long term loss is the premium that policy holders paid for having access to a guaranteed medical loan.

From a policy perspective, one would see this as the amount of money transferred from the healthy to those in need.

There would be a new loan reserve for each year. Policy holders would be repaid $1000 at the end of the first year, but they would need to buy a loan reserve for the second year. The Medical Savings and Loan might decide that $20,000,000 was insufficient and raise the reserve to $25,000,000.

Since policy holders get much of the money in the loan reserve back, it is desirable for the loan reserves to be substantially higher than anticipated lending. This encourages savings and helps the group prepare for catastrophic events. Personally, I think a group would want the loan reserves to be about 3 to 4 times anticipated lending. After all, the money in the reserves will be gaining interest on the open market to the benefit of all policy holders.

Determining the amount of money to go into loan reserves in the first year of a group policy will be tricky. One could use the amount that a group currently pays in health care for guidance. If a group has medical expenses of $5.000 per policy holder, one could guess that the loan reserve would be something less than $5,000.

From a mathematical viewpoint, over-funding the loan reserve is not that big of a problem. The over-funding of the reserve in the first year simply shows up in the account as a credit in the second year. So, one could comfortably start a medical savings and loan by setting the loan reserve to the current insurance premium, and set the amount in the savings accounts to the current deductible. As people repay loans made in the first year, things will even out.

Setting the loan reserve too high might have a psychological affect of encouraging people to lean too heavily on the loan reserve and not saving.

Regardless, this loan reserve program coupled with the savings account creates a paradigm in which policy holders have equity in their own health care and will start becoming more responsible for health care spending.

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