Tuesday, December 25, 2007
The Risky Business of Insurance
I just read somewhere that Indians are one of the most underinsured populations in the world, and that this market will grow to INR 200,000,000 by 2010. Many more Indians will be employed in the insurance sector, which is a good thing (I remember growing up that some of the richest people around were LIC sales agents). Many more Indians will also be insured, and I am not sure that is a good thing. I just think that the less wealthy sections of the population will be more likely to buy insurance and that it will make them strictly worse off.
The theory of incomplete insurance markets is fairly well-known, imbedded in the economics of information. The idea is that at any given price (reflecting the risk premium) there will be adverse selection (meaning that due to information asymmetry between the provider of insurance and the customer set, the riskier subsegments -- smokers/genetically predisposed to disease -- will be more likely to buy), thus causing the a priori actuarial fatality outcome distributions for the issuer to be incorrect, in effect causing incumbent issuer losses, and a decline in the market for insurance over time. This reasoning has sometimes been used to nationalize insurance providers, as in India. It also causes severe cyclicity in insurance markets, leading to, for example, GE exiting the insurance/reinsurance markets citing "volatility of earnings". Adverse selection affects markets like credit and mortgages as well, where exotic derivative instruments may transfer risk or generate fees for bright young MBAs but eventually are no different than Ponzi schemes. That's partly the story of the ongoing mess in credit and mortgage markets, but that's another day's blog.
To me, getting insurance, particularly life insurance for after when you are dead, appears remarkably silly. The other forms of insurance, such as those for fixed periods/disability, or against damage to your home or other shiny baubles, prey on our insecurity, and there may in some cases even be positive externalities, as in the case of mandated third party claims; they are second-best solutions I can understand to a degree.
However, life insurance where payout is in the event of death, bothers me because it preys on you through your loved ones as well as on your own fears, depending on how much of a wimp you are. Older people, in general, would naturally be wimpier than younger ones when it comes to death, so they pay more! The marketing is very targeted, hoardings being put up near hospitals/cemeteries, and the names are well chosen, for example, Scottish Widow.
But basically, when you are dead, you have no loved ones (except, with some probability depending on your religion, God/Goddess/Devil). When you are dead, its all over and you cant relish the fruits of your labor (as in the premiums you paid), you are rotting in the ground, not looking down from heaven or (up from) hell at your loved ones thinking about how well you have taken care of their needs and how much they now fondly remember you (not!).
Lets imagine that you can look down from heaven after you are dead. Is the insurance payout the best you could have done for your loved ones? Would God really be pleased with you (this is the key question -- it does not matter if your spouse is displeased with you after you are dead) that you acted in the best interests of your family?
The answer is very likely No! If you had invested in various asset classes with a view to providing yourself (and your loved ones after your death) with an optimal earnings stream, and if insurance were one investment option, it would likely generate a very poor rate of return since it reflects the risk you think the provider is taking on your behalf! Therefore, other than misguided ego and guilt, you should not really be investing in insurance if you strictly have your loved ones' financial interests at heart.
In summary, when you are dead you are dead, and so why do you care what anybody is paid afterwards. Even if you had post-mortal caring, you would be castigated by your particular divine being for not making the right investments.
Invest in stocks, real estate, commodities, currency futures, even your children's higher education if that makes you feel better....but not insurance, surely?!!
Unconvinced? Here is an alternative point of view: