For most of us, insurance is an article of faith. Has the insurance industry rewarded that faith? Have we been misled?
I reckon there's prudence in skepticism:
With most (if not all) insurance provided by commercial entities, we have little alternative to commercial products. Is that the best idea?
In the early 1980s, I began building in a bush fire-prone area. For the first couple of years, I had commercial insurance: the high risk attracted high premiums. Then I did my sums: within two decades, I'd have paid more in premiums than the value of the house and contents.
Instead of paying premiums to an insurance company, I invested similar amounts. Within a decade, I'd accumulated enough to avoid taking out a loan to buy a new vehicle. I kept saving what I would have paid in premiums, plus what I would have paid on a car loan. That isn't the only debt I avoided. Making a point of always saving what I would otherwise have paid to others, my financial cushion grew.
After nearly three decades, I've accumulated more than enough to replace the house and contents. In that time, there have been some heart-in-mouth moments; that's the risk I chose to bear.
Watching the tribulations of others, as insurance companies delay, deny and point out weasel-words in obscure paragraphs, I reckon I made the right choice. If the worst happens, at least I won't have to put up with that.
Insurance is intended to mitigate risk by spreading it across many entities. The entities might be, for example, people in a community or cooperative (mutuals) customers of a company (commercial) or citizens of a State (government). Participating entities pay into a pool of funds, from which those who suffer a qualifying event can draw. The pooled funds are invested so that the total available should be more than the total paid in by participants.
In theory, we all pay a little so that the unfortunate won't have to pay a lot. It seems to me that, over time, we all end up paying quite a lot.
For the insurer to survive, their net income (total of payments by the insured plus investment income minus overheads/running costs) must equal or exceed the total of claims paid out. In commercial insurance, payments to shareholders add to costs and reduce funds available to pay claims.
Most of us claim rarely or never. Very few will claim the full value of their premiums. If we did, the insurer would probably go broke. For most of us, then, most of the time, insurance is a bet that won't pay off.
Options for insurance include:
In a mutual, the entities insured are members of the insuring organisation. Overheads are generally lower than those in the commercial model (there being, for example, no shareholders demanding dividends), which should maximise funds available for payment of claims (assuming comparable investment outcomes). Customers being the equivalent of shareholders encourages fair treatment.
The commercial model is most efficient, or so I've heard from True Believers. I've seen no evidence to substantiate the claim. History shows treatment of customers which, to this untrained eye, seems grossly unfair.
Most commonly, products are sold which the insurer should know will not meet the ultimate needs of the customer. Premium payments are accepted, often for decades, before the product proves inadequate.
Self-insurance involves managing our own risks. That's essentially what I did.
In self-insurance, we're on our own. If the worst happens and our resources prove inadequate, then we're out of luck. That's the risk we take.
Of course, chances are pretty good that the worst won't happen. The insurance industry profits most from our fear of the improbable.
Another downside is that, in some states, volunteer organisations such as bush fire brigades and rescue teams are supported by levies on insurance. Anyone who relies on such volunteers probably donates already, which mitigates the problem, but it should be kept in mind.
On the upside, self-insurance is very flexible. Accumulated funds can be invested or put to other uses. One obvious alternative is using the funds to avoid loans, with their high interest rates. When our finances don't stretch to covering the full risk, we can at least partially insure. We avoid the opportunity cost of paying insurance premiums.
As mentioned above, an insurer's income must exceed its expenditure or it will fail. An individual's costs in managing self-insurance are far below those of other insurers. This gives us an advantage in the income/expenditure equation. We therefore don't need to be very canny investors to potentially outperform the others (albeit on a relatively small revenue base).
Unless the law makes it so, insurance is not indispensable; we can live without it. Sometimes, there just isn't enough to go around; other things must take priority.
As with self-insurance, we bear all the risk ourselves. Unlike self-insurance, a financial cushion does not accumulate. That leaves us more exposed to the risk.
Insurance has much in common with gambling:
Perhaps the most substantial difference is that gambling has well known rules which all participants are in a position to understand.
Historically, insurance companies and their agents have repeatedly sold products that they should have known would not meet their customers' needs, when the need was greatest. At best, that's negligence. I consider it fraud.
I've long seen substantial overlap between business and crime. It's often difficult to see a difference between business behaviour and practices of organised crime. Is the behaviour of the insurance industry inconsistent with that view?
There was a time when government was involved in the insurance industry (the Government Insurance Office of New South Wales, for example). As far as I know, that is no longer true anywhere in Australia. Extremists chant that business is not the business of Government. In fact, it's a responsibility of Government to mitigate the excesses of business. One of the best ways for a government to meet that responsibility is for it to participate in the market.
Under some circumstances, the law compels us to buy insurance. While probably justified, that imposes costs. I see no substantial difference between costs imposed in that manner and taxation. It may be that, in the current political climate, taxation demands more integrity and courage from government.
When government mandates insurance, shouldn't government be the insurer? Though perhaps contrary to the dogma of Market Capitalism, I think so.
In the light of history, can we trust a commercial insurer to provide what we think we've paid for? Isn't government a better provider of, for example, third party motor vehicle accident injury insurance or health insurance?
More fundamentally, is insurance a natural commercial market at all? My feeling is that it's a better fit for a mutual - and isn't government the ultimate mutual?
Centuries of indoctrination notwithstanding, I guess the ultimate question is: under what circumstances is insurance really worthwhile?
This work by David Boxall is licensed under a Creative Commons Attribution-ShareAlike 3.0 Unported License