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CHRISTOPHER TAYLOR'S BOOKS

Friday, January 21, 2011

THOUGHTS ON INSURANCE

"I don't want to tell you how much insurance I carry with the Prudential, but all I can say is: when I go, they go too."
-Jack Benny

One of the stranger concepts in finance to me is insurance. I understand it from one perspective, wanting to pay a little bit each month into a fund that can help you in emergencies, I just don't understand it as a business. The concept of someone you pay to hopefully never use just doesn't make sense to me.

Because unlike most companies, they aren't about your return business or giving you fine service, they are about you not using their service. Insurers are about taking your money away to give you nothing as much as they possibly can. The only similar endeavor I can think of is a bank.

Insurance companies advertise as being good, helpful, forgiving, protective, and neighborly. They are portrayed as smiling, attractive, non threatening people who rush over with a check when things are tough, given cute mascots. But really, they're a lot closer to loan sharks than the kindly pastoral figures they're advertised as. Insurance companies spend billions trying to make themselves look good when their primary purpose is to make money off you. They want you to pay forever and never make a claim, that's their ideal customer. Someone who has a policy as long as possible but never uses their business.

Some companies advertise that their "deductible" gets less the longer you go without actually using it. Now think about this a bit. The entire concept of a deductible is a fee charged to make sure you don't use their service much. They want to dissuade you from frivolously charging their company, so that you only use it for significant damage, something notably greater than the deductible. They charge you a fee to prevent you from using the service you're paying for to begin with.

Lets consider this further. The principle of a vanishing deductible is that every year that goes by without actually taking advantage of the service you pay regularly for - by law, if you own a car - the total of the deductible goes down, actually reducing to zero. Until you use it. In other words, once you actually take advantage of your paid service... you now are punished by having to pay more for the next time you use it. Can you imagine anyone in any other business trying that kind of stunt?

Thank you sir, we hope you come again, but it will cost you more next time. That first gallon of gas was cheap because you haven't filled up for three months, but the next one costs extra. Those frequent flier miles you accrued make this ticket cheaper but the next one will cost you extra because you flew on our plane.

Consider: how many businesses in existence charge you more every time you use their service? I can understand insurers trying to handle increased risk by increasing costs in one sense. If someone is shown to be reckless and irresponsible, they should cost more to protect. But the presumption that someone is reckless and irresponsible when they have an accident is not just insulting, but counterintuitive. Accidents by definition are not the fault of the person involved. Ever see the movie Hot Fuzz? Remember this exchange, when Nicholas Angel tells his colleague that it is official police policy to call it a "collision" rather than an accident?

BUTTERMAN: Hey, why can't we say "accident," again?
ANGEL: Because "accident" implies there's nobody to blame.

If you have a genuine accident, something you did not cause, why should your insurance go up? I can understand raising someone's rates if they are steering with their feet with a blindfold on while high on amphetamines and texting, but just an accident? That's simply punishing someone for using the very service they paid for.

It seems to me that insurance shouldn't be a for-profit business at all. We use the term ghoulish sometimes to describe certain jobs like lawyers and undertakers, anyone who profits from the misery and misfortune of others. What does that make an insurer? They are trying to make money off people who merely want to protect themselves. part of the reason we don't have private police forces in America is that people reasonably do not believe they would find justice and any hope of an uncorrupted force with people that are paid to enforce the law for a profit. But we do it every day with insurers, we pay people to protect us from misfortune and they're looking to make money off us doing it.

Non profit insurers would have a rough time of it, to be certain. Insurers are required by law to keep enough money to pay off the full policy cost for more than 50% of their customers at once, and that's a gigantic amount of money. Ever insurer has to have that set aside in a pool just in case they have to pay all at the same time. It is not easy for insurance companies to stay afloat in many areas, such as California or New Jersey where the legal requirements and absurd demands on their business get worse and worse.

Yet it seems to me that making money at the business of insurance changes its focus. Insurance, I believe, ought to be more like a co-op than a business. A fund that lots of people pay into as a pool in case they need to draw on it rather than a company taking payments and trying not to pay out so they can maximize profits. The entire business model seems shockingly misguided, at best and we all take it so for granted these days.

*Just for the record: I have no insurance of any kind, unless you count a few hundred dollars of Social Security money piled up in earlier work years.

6 Comments:

Blogger Philip said...

If you have a genuine accident, something you did not cause, why should your insurance go up?

I could run through all of the math, but suffice it to say it's partly due to either 'no-fault' laws, or 'apportionment of blame' laws, or simply, that your accident just screwed up your risk-statistics, i.e., if you had an accident, your chances of having another one just went up.


I have no insurance of any kind

Is that like "I don't care about gas prices, 'cause I take the bus"?

FWIW, there are co-ops. USAA is one; its pool of insured comes from military, retired military and dependents. Profits are either(I'm not sure of the current status) distributed among its membership, or applied to lowering premiums.

5:28 PM, January 21, 2011  
Anonymous Erica said...

Christopher,
I've been working for the evil insurance folks for three years now as an adjuster, so I know my stuff (at least in the less labyrinthine property field).

So far, with the caveat that this only applies to my company in the property lines, I've found that we strive to give the insured the benefit of the doubt whenever possible. You have to remember that insurance is a contract, and the payable damages are determined in advance. The fact that people don't read or understand their contracts is truly unfortunate, but not entirely the fault of the insurer.

It may be surprising, but the profit for the insurer is not really made on premium, but in the investing of collected premium.

Deductibles are necessary to prevent moral hazard. Being entirely insulated from risk would encourage people to take riskier behaviors. For example not taking good care of the electrical system because if the building burns down "oh well, it's covered."

On a note on the 50% liquidity: You may not know that insurance companies are insured. If they have to make a tremendous payout at one time (like we did after Hurricane Ike) the company can make a claim for reimbursement to their carrier.

Please ask me stuff about insurance if you want to know... it's my favorite subject since I have to deal with it all day.

7:16 PM, January 21, 2011  
Anonymous Christopher Taylor said...

The reason I pointed out that I'm not insured is that it seemed important to give full disclosure. Its not some kind of personal statement or rebellious streak, I simply am too poor, and do not own enough stuff to have insurance of any kind. I have no car, I have no house, I have nothing worth more than a few hundred dollars (the computer I work on).

And while I understand the concept of deductible (I pointed that out), the fact remains that you are penalized for taking advantage of a service you are paying for in insurance, which is just bizarre. No other business could hope to survive this sort of model.

7:43 AM, January 22, 2011  
Anonymous Erica said...

I have no doubt you understand the deductible, I didn't mean to insinuate otherwise.

Given all the water and fire damaged apartments and condos I see I invested in renter's insurance a few years ago. It's less than $20 a month for $50,000 of coverage. If you had to suddenly move out or replace everything you own, I believe it would add up quickly, even for someone with less junk than I have.

Of course, the zombie apocalypse is still not covered, so I do make other provisions as well.

3:39 PM, January 22, 2011  
Blogger Perry The Cynic said...

Christopher,

Genuine insurance provides a genuine service - that of bringing large pools of people together to smooth out their exposure to unlikely, devastating risks.

Let's say that there's a 1% chance I will need a million dollars to survive. I may not have a million dollars. But I can get together with 99 others; if we put $20000 each into a pot, we can probably all survive. Insurance companies are in this putting-them-together business. It doesn't matter if it's for-profit or co-op or government-mandated; this is what insurance does.

You say, "It seems to me that insurance shouldn't be a for-profit business at all." Do you believe that other businesses should be for-profit and insurance is somehow special, or do you generally frown on profit as an element of the U.S. economy?

You say, "Insurance, I believe, ought to be more like a co-op than a business." I'm not sure why you think a co-op is better at this than a "business." Specifically, I believe that the advantages of co-op style economic activities do not scale past a few hundred people. With 50 people, personal relationships may still govern the behavior of the members. At thousands, your insurance pool will be faceless people dealing by rules and regulations, whether the outfit is commercial or co-op (or government-run). Those running the place, as their livelihood, will maneuver for power and personal gain; some of the insured will try to take advantage of the others; the majority will just want to get on with their lives. This is human nature.

Actually, insurance is a prime example of a business that cannot be run as a small, human-scale co-op. Insurance requires scale to survive - the whole point is to aggregate many independent risks to smooth out the cash flow. There is, by definition, no such thing as a small insurance company.

So why can't we just have lots and lots of small, co-op style insurance companies that keep their human faces by staying small? Let's say government just passes a law for all those small, co-op, non-profit insurers to share a pool of customers. That only works if the pool is homogenous, of course, which means that all the insurance policies must be standardized by law. And this is exactly what ObamaCare is trying to do (except for the small part). The problem is that by homogenizing the policies, you've also removed the flexibility and personal scale and choice that was supposed to keep the insurers from turning into faceless, cold, cruel withholders of money. The cost savings now come from government telling everyone to spend less money, which from the insured's perspective is quite indistinguishable from those venal, Capitalist insurance companies that don't want to spend money on you either. Except in that world, you can't change companies, because they're all legally required to use the same rule book...

Yes, it's a hard problem. But I don't think that profit is the cause of it; in fact, profit may be our best chance for improving it. (We'll never beat it any more than we'll beat poverty, say.)

Cheers
-- perry

1:55 PM, January 24, 2011  
Blogger Philip said...

the fact remains that you are penalized for taking advantage of a service you are paying for in insurance, which is just bizarre

Let's try a simplistic analogy.

You use a pencil for work. If you lose the pencil or it gets stolen, you will need another. However, replacing the lost or stolen pencil is an expense you don't want to pay when you lose it, or have to put money aside to buy a new pencil if and when you lose it(also known as self-insurance). So you buy pencil-replacement insurance.

Now this is where the math comes in. The insurer figures out what you'll pay, using statistics such as how many pencils an average person loses or has stolen per year, how many people in your job/zip code/age group/city/industry lose pencils or have them stolen, the average cost of replacing a pencil in your area, etc. Then they factor in how many people who already have the insurance (the "insurance pool") and how many claims have been made. They come up with a price based on your personal /your environmental/the insurance pool's chances of losing a pencil.

When you lose your pencil, you file a claim for a replacement. Leaving out the mitigating or causal factors (i.e., "no fault"), the odds of you losing another pencil just went up by a percentage. Hence you're going to pay more in insurance. Maybe for a few years, maybe forever.

You have the choices of shopping around for another company that will sell you pencil-replacement insurance at a lower price, self-insure, pay the higher price, or go without insurance and hope that you don't have to pay for a lost or stolen pencil.

Like I said, it's rather simplistic. Not covered is litigation, or deductible (which says "I agree to pay a lower price on the insurance if I front a percentage of the replacement cost"), or apportionment of blame, or legal limitations and factors, and compliance with local, state (each state will have its own requirements), and federal laws.

And one last thing (excuse the preaching) - insurance companies are generally owned by stockholders who expect a return of the company's earnings based on their share of stock, or (as in the case of Lloyd) are fronted the money by individuals or consortiums in return for receiving a percentage of return (again based on statistical odds of claims being made). So there is the pressure on the company to make good on the money given.

6:12 PM, January 24, 2011  

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