Sunday, July 22, 2007

Ana Maria on how NOT to think about Insurance

Over at Dailykos, Ana Maria has a rant about the insurance disputes revolving around hurricane Katrina that illustrates practically all the common fallacies of how insurance works and what we can expect from it. I'm not familiar with the specifics of the Katrina issues, but unless one has a better grasp of the basics than she does, one has no hope of having a good understanding of what is going on there. She begins:

"Just as a bookie collects from its gamblers, these companies collect money from us, the home and business owners of America."

The only commonality insurance has with gambling is the presence of unknown events and their financial consequences. However, with gambling, we make our own risk. If I bet $100 on the cowboys to win, I now have a potential loss of $100 where I had no risk before. However, in the case of a hurricane destroying my house, or injuries to me that produce medical bills, the risk of loss exists whether I buy insurance or not. Likewise, if the cowboys win, I come out ahead on my bet. Insurance is not designed to put us ahead, but to restore us back to our previous state by replacing our house, car, or paying our medical bills. It's hard to say any scenario is a "win" in insurance as it is in gambling.

"If we never have a situation where we need to make good on our policy, the insurance company has kind of made out like a bandit."

This is a case of equivocation with the term "we". If she means every single policyholder, then she is correct. However, the probabilities of such results are so small as to be negligible. Also, in her arder to attack insurance companies, she conveniently omits the reminder that in this scenario no one has any damages that need repairing. Hardly a tragedy.

On the other hand, if she means by "we" each individual, then it is completely inaccurate. Every insurance policy has a large number of policyholders that do not makes claims in a given year. That is the whole point of insurance: a large number of people pooling small individual sums of money into a large balance so that the few that experience a loss can use that balance to rectify the situation. If everyone had a claim, insurance wouldn't work.

In essence, we’re essentially betting that we may one day need to tap into our policy, our legally biding contractual agreement with our legal bookie. "

This is a very narrow and flawed few of insurance. It's like saying we only buying health insurance because we hope we'll get sick. We don't buy insurance hoping we'll make a claim. We also buy insurance so that we don't have to rearrange our lives in preperation for having our house burn to the ground, or our car is wrecked. Having insurance allows us to live without a spare car, and spend our money and energies elsewhere. Many businesses couldn't be nearly as efficient as they are now were it not for insurance allowing them to be exposed to risks they could not recover from on their own.

It also keeps our lives from coming to a virtual end if we are unfortunately enough to have many of these things happen to us at once. That makes for a lot of peace of mind, and that matters. Insurance is not a bank account. We are paying for a product, and we get the benefit of it whether we make a claim or not.

From this point in the article, Ms. Maria goes into the controversies over some of the insurance claims related to Katrina. Having not studied these issues I don't have much of an opinion to offer. I will, however, say that I don't have high expectations of Ms. Maria's analysis of insurance issues if these flawed presumptions are the lenses through which she sees them. Insurance companies are not bookies, and having insurance means a lot more than just getting a claim paid.


Ian said...

I'm a little confused about what you mean by "and having insurance means a lot more than just getting a claim paid." What benefit is there to having insurance if your claim isn't paid (assuming that you have a claim to make)?

ScienceAvenger said...

It's as I described in the article. Having insurance on those critical items frees up your time and effort and money to be spent elsewhere. For example, if your car is essential, and you'd basically starve if you were without it for a week, you'd have to keep enough cash on hand to buy a new one on the off chance yours was destroyed. Same with your house, and potential medical bills. Having insurance to cover those huge costs for the essentially random subset of us that gets unlucky allows us to better invest our assets elsewhere.