Financially Sound?

Bluke, at The Jewish Worker, has two interesting posts about how the declining dollar is affecting people in Israel. In short, while the Israeli economy works on the shekel, the chareidi economy works off the dollar. Since kollel families and others get paid in dollars, they are finding that since the dollar's decline, they are getting fewer shekalim for the dollar -- reducing their purchasing power.

While this is truly an unfortunate circumstance, there are those in the community who seem to think that they can rewrite economic law by fiat. For example, while the dollar is now worth about 3.6 shekalim, the kollellim, in order to help support the people who are learning, are still paying at the rate of 4 to 4.25 shekalim per dollar. That's fine and well, I suppose, except for the fact that the dollars they bring in still only fetch 3.6 shekalim. Thus, the institutions have to raise about 10-20% more to cover the difference.

Bluke points out that the decline of the dollar is hitting the community hard in another area -- that of the Areivim "insurance" program. This is a program whereby several thousand residents band together and self-insure each other, agreeing to pay $50,000 to any unmarried child who loses a parent. In the past, such a sum would fetch well over 200,000 shekalim. Now it's down to about 180,000. In order to deal with this situation, the administrators of the program have decreed that the program will pay out benefits at a minimum rate of 4 shekalim to the dollar. That's all fine and well, but, as we all know, there is no such thing as a free lunch. You can't make the shekel equal a quarter of a dollar by fiat. The only way this could work would be to increase the amount that families have to contribute. I don't know if that has happened or not.

In any event, as some bloggers have pointed out, this plan is not really actuarially sound. I'm not an actuary, so I'm not going to pretend that I know exactly what the problem is; but it seems that several actuaries have already commented that the plan will not work.

One thing that I am curious about, however, is how they avoid the problem of adverse selection. For those who don't know what adverse selection is, I'll give you an example drawn from Charles Wheelan's book Naked Economics.

When Bill Clinton was running for president in 1992, he proposed an idea called "Hope Scholarships." Hope Scholarships would provide loans for college. However, instead of paying back a set amount of money over a set amount of time (as in a traditional loan), a person receiving a Hope Scholarship would pay back a set percentage of their incomes.

The program was supposed to pay for itself. The administrators would figure out the average salaries of people after they graduated, add a small amount to cover the cost of administering the program, and viola - those who earn more would pay more, those who earn less would pay less and the differences would "all come out in the wash" as we like to say.

The problem, however, was that the program did not (and, indeed could not) account for adverse selection. While this program might sound attractive to teachers, social workers and artists, it would not be a good deal for future heart surgeons, Wall Street tycoons and high-powered attorneys. For all these people, a regular student loan is a much better deal -- and they know it. As a result, they would simply opt out of the program. However, once the highest-income people opt out, you can't count on their income to subsidize the educations of the teachers and social workers. So, you have to rework the math so that the program pays less. But once you've done that, then those who are now the highest-income producers of the remaining students will opt out. And so on and so on. Since people know their future economic positions better than the administrators of the program, they can choose to opt out of a program that forces them to subsidize others.

I'm wondering if the same problem exists with the Areivim program. After all, surely there are those in the community who can afford to buy actual insurance. Those people are the ones who have more financial means than the ones who are dependent on the program. If they can get a better deal elsewhere, they will simply opt out of the program, leaving a smaller pool of contributors to support the rest. I'd be interested to hear from any actuaries out there regarding this.

But one thing should be fairly obvious, even to those of us without economic degrees -- you can't just change the exchange rate of currency by decree -- something that some of the community leaders in Israel are trying to do. They are simply ignoring the economic reality and decreeing that in their community, the shekel is worth a quarter of a dollar, when, in reality, it is worth more. To me, that sounds like a recipe for trouble.

The Wolf