In My Opinion

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The Times,
They Are A-Changin'
by Paul E. Lacko

It's not the best of times; it's not the worst of times. But it sure is hard to get one's bearings. The U.S. birthrate is at a 100-year low. The stock market con-tinues to wobble along, and stock portfolios have recovered somewhat from the beating they took after the tech bubble burst. Short-term interest rates are at a half-century low point, and long-term interest rates are the lowest since I started school. Young homeowners have happily refinanced at lower interest rates, but older homeowners have sadly seen a large chunk of their retirement savings literally disappear. Insurers who relied on investment income over the past twenty years to offset underwriting losses or reserve deficiencies had better dust off Plan B.

Two articles in this issue of The Actuarial Review deal with change. One article about change is a report from the CAS Examination Committee about changes in the process of writing and grading questions in the CAS exams. The exams will focus on defined learning objectives, teach practical tools for the practicing actuary, and give credit for knowledge demonstrated rather than footnotes memorized. I believe the CAS is taking a giant step in the right direction with these changes. (After reading the article and thinking about the exam process we've had for years and years, my mind brought up images from my fraternity initiation in college in the early 70's. Back then we didn't call it "hazing;" we were "forging a tighter bond.")

A second article about change is Steve Philbrick's "Brainstorms" column. Philbrick explains that "S-shaped curves" describe many processes of change in the world around us: algae growth in a pond, stock market behavior during a tech bubble, and perhaps even terrorism catastrophe modeling. If you are unfamiliar with this concept, consider the cumulative distribution function of any of the standard, well-behaved probability distributions you know. Another example would be cumulative paid losses graphed as a percentage of ultimate losses in excess or large deductible workers compensation. In both cases, the graph runs a trajectory that starts slow and low, accelerates and rises, then slows again and levels off. Often in the real world, however, there are a fourth stage and a fifth stage that I call "Crash and Burn" and "Out of the Ashes," respectively.

Speaking of change, Alan Greenspan, the Federal Reserve chairman, has discussed in recent months the Fed's concern about deflation. Most of us grew up in an inflationary world, so this is a strange, new concept. It sounds good on the surface—who doesn't want to pay less for goods and services? How could anyone feel threatened by the prospect of cheaper haircuts, cheaper food, cheaper gasoline, cheaper college tuition, cheaper prescription drugs, and cheaper insurance premiums?

But haircuts aren't getting less expensive. Gasoline isn't getting less expensive. Insurance premiums certainly aren't going down. And Congress wouldn't be increasing Medicare's prescription drug benefits if prescription drug prices were expected to drop any time soon. What's happening?

James Surowiecki, the author of "The Financial Page" in the July 7, 2003 issue of The New Yorker magazine, discusses the deflation/inflation dichotomy. He relates this example created by economist William Baumol back in the 60's:

"When Mozart composed his String Quartet in G Minor, you needed five people to perform it—two violinists, two violists, and a cellist. Today, you still need five people, and, unless they play really fast, they take about as long to perform it as musicians two centuries ago. So much for progress.

"An economist would say that the productivity of classical musicians has not improved over time, and in this regard the musicians aren't alone. In a number of industries, workers produce about as much per hour as they did a decade or two ago. The average college professor can't grade papers or give lectures any faster today than he did in the early nineties. It takes a waiter just as long to serve a meal, and a car-repair guy just as long to fix a radiator hose."

Thus, "to keep luring talent, they have to increase wages, or else people eventually migrate to businesses that pay better…In industries where productivity is flat, costs and prices keep going up…Among the service businesses that have been least productive in recent years, you'll find education, insurance, health care, and entertainment. These are the ones that have seen steep price hikes."

In manufacturing and other industries where productivity has grown so much in the last century, quality has increased right along with productivity. In labor-intensive service industries, to the contrary, quality and productivity tend to move in opposite directions. Productivity in the health care industry might increase, for example, if hospitals reduce their staffs, and if doctors spend less time one-on-one with each patient. This should result in lower costs, but we could get lower quality, too.

The author points out that "Some of the most important services that the government provides—education, law enforcement, health care—are the hardest to make more productive. To keep providing the same quality of services, then, government has to get more expensive." Thus, the author concludes, government is not necessarily bloated or inefficient; it's simply stuck providing low-productivity services.

In that case, I guess we can forget about cheaper college tuition, cheaper haircuts, cheaper insurance premiums, and cheaper health care.

Do you remember the 1960's? If so, then just asking the question can fire off a barrage of mental images, song lyrics, and other memories in your mind. And, like me, you are probably a member of the Baby Boomer generation, that huge, great wave in the demographic ocean that has crested and is now crashing into the shore. The vast majority of you Boomers will hit land ahead of me and wash away most of the sand. The rest of us, the ones born in the mid-to-late 1950's, will have a rougher landing. We late-Boomers may not be able to afford to retire from our actuarial jobs, not with the high taxes we'll have to pay.

But by the time we reach our mid-sixties, our kids will be out of college, and we won't be as active as we are now, and so we may not need the same level of income that we need now. We'll be able to provide actuarial services for less money—and still have enough to live on after taxes. What a deal for our employers—they'll be able to draw on all our years of experience, plus we'll settle for annual salary decreases!

And we'll have Medicare to look forward to when we finally do retire! After Congress "gives" us generous prescription drug benefits, productivity will increase in the health care industry, too. We won't take up a lot of time at the doctor's office or the hospital. All we'll need is enough of the pills that will keep us going. The FDA will have made a lot of those drugs available over-the-counter by then, as well.

If the 1960's ended before you began, then you are in a little demographic wave somewhere behind us Boomers. You can't help but crash against the shore behind us. Prepare for a rocky landing. And bring your checkbook.