Is Insurance A Social Transfer Mechanism?

This story in the LA Times implies that it is, but I disagree.  The story is a well-written examination of the implications of improved risk assessment methods used by insurers and provided by companies like Risk Management Solutions, Inc. But one foundation of the story is that more sophisticated risk assessment discriminates against people in socially unacceptable ways: against the poor, against minorities, against people with bad credit or low education. 

Martin Grace and George Wallace have already written some good posts analyzing the story, and I refer you to their pieces here and here.   Here is a bonus link with a third perspective on the story.  Since Martin and George have already done a fine job of looking at the story, I’m going to confine this post to one point: the purpose of insurance is not a transfer of wealth to achieve social leveling, it is a transfer of risk from a present "you" or group of "you’s" with similarly classed risks to a future you or a future group of people like you. The premium you pay consists of money that "present you" transfers to a future you who suffers a loss, minus money off the top to the insurer for performing this service, bearing the risk and for its cost of doing business.  If you never arrive at the point of suffering the covered future loss, that version of "future you" does not exist and you do not collect.

Here’s a paragraph from the story to highlight how it mixes up this concept with social welfare transfers:

When RMS specialists recently gathered in a sleek company conference room to discuss their analysis of millions of insurance claims from the last two years, they were particularly excited about the finding that big houses seemed to fare better in hurricanes than small ones. The group buzzed with ideas about why this might be. But until a visitor raised the issue, no one mentioned the socially dicey implication that owners of big homes could end up being charged lower insurance premiums than those of small ones.

Question: who do you think the "visitor" was? None other than the author of the story, you can bet, and that viewpoint pervades the story.  Why is it "socially dicey" to charge a lower premium for a lower risk?  Does the writer think insurance should group dissimilar risks so the high risks get subsidized, or that premiums should reflect social goals? I guess so.  That in itself, it should be noted, is risk assessment by another name.

1 Comment

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One Response to Is Insurance A Social Transfer Mechanism?

  1. My comment is late in the game — it is now 12/10 –but thought I’d enter it anyway. Your thinking is too narrow.
    There is a tendency among risk and insurance people (especially quantitatively oriented reseacerhs) to isolate the design of risk transfer mechanisms from the the other risk management factors — what I call the risk management equation — which are loss avoidance, loss prevention, and loss mitigation.
    When you address risk transfer as inder-dependent with these other factors, then the societal values of cohesion, trust, legitimacy fairness, etc. all of a sudden flow into consideration of what makes superior risk transfer solution. I have traced this back, at least to me own satisfaction, to the organization of fire insurers, first in past 1666 London, and then 19th C America.
    If you look closely at what is behind a lot of captive development today, you will see the equation at work. Captives I do no think make sense, nor risk retention groups, in many instances when you are solely considering risk transfer without the other factors, and when you bring in the other three factors and societal type issues smack up in the face.