Statistics, the Mortgage Crisis, and Bankruptcy

I gave a "Making Great Decisions" talk with my coauthor, David Henderson, to a successful mortgage lending company in late September 2006. Coincidentally, that was right around the start of the subprime mortgage crisis. Little did they know that they would be filing for bankruptcy in less than three years. Before you start faulting any advice we might have given them, you should be aware that the all-day meeting didn't go well and our clients exhibited a strange combination of disinterest, obtuseness, and belligerence. We were paid for our time and then sent away, but certainly never invited back.

What struck me as interesting was how this company set its mortgage rates. Everything was based on statistical analysis. The company had good computerized data which it analyzed thoroughly to set its rates and decide who to lend to. The first problem is that this good data hadn't been available for very long, so most of the history being analyzed had occurred during a period of low interest rates, economic growth, and stability. The second problem is that statistical analysis, while powerful, is equivalent to driving by looking in the rearview mirror. Statistics is concerned primarily with what has already happened, not what may happen. Decision analysis, on the other hand, focuses primarily on what may happen in the future. Decision analysis is the study of decision-making within uncertain and sometimes risky situations, and is inherently forward-looking.

How does all this relate to health care? Simple. The American health insurance market is about to undergo significant upheaval with the rollout of the Affordable Care Act (aka Obamacare). Here's what a recent Wall Street Journal article reported about the trouble facing insurers: "But because the marketplace created by the law is new, he says, there is no previous pricing or demographic information to help calculate rates. 'There is no experience,' Mr. Whisler says."

Exactly. Insurance companies are in the same position today that mortgage lenders were in circa 2005. Those companies that rely heavily on statistics are hereby forewarned that the future will not be like the past. The precise analysis of a market that no longer exists will not prepare them for a new world. What these companies need to do, instead, is use the techniques of decision analysis and think about what may happen, not focus on what has happened. The future isn't written in any book--we are actively creating it.

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