Is Insurance Irrational?

Regular readers know I’m fascinated by Law and Economics theory.  Even though some devotees treat it more like a religion than an economic theory, it offers a valuable perspective on the world. The big failing of Law and Economics, however, is that it stands dumbfounded and slack-jawed before examples of irrational behavior, such that it won’t even admit these examples exist.  I was therefore interested by this post from the UK about whether insurance itself is irrational.  

The way "irrational" is used in the post is different than true irrationality: whether one buys coverage from an insurance carrier or not, you are still insured — you are merely choosing to self-insure and spread the risk of loss onto yourself, your family and whatever other social safety net might exist for you.  A given risk may be low or it may be high, but it doesn’t go away merely because one fails to buy insurance.  All in all, though, a good post.


Filed under Industry Developments

4 Responses to Is Insurance Irrational?

  1. Is Insurance Irrational?

    There’s quite an interesting post over at Stumbling and Mumbling, which asks the very same question. Norm, the author of Stumbling and Mumbling, makes some interesting points regarding adverse selection, moral hazard and our tendency to over estimate s…

  2. Insurance purchases, in general, are not irrational even if the insurer charges above the actuarially fair premium. People are risk averse and that is enough to generate a rational demand for insurance even in the face of prices above expected losses. I think you are right that the example is not one that most economists would consider irrational. The author of the original complaint is upset about an ex post bad deal. It sounds like he never read the contract, but if he did and still bought the policy then he felt he was getting a good deal. That is pretty rational, ex ante.
    PS Can you provide an example of the L&E approach that stands slack-jawed before examples of irrational behavior? I am just curious to see whether it is a bad model being proposed or whether it is time to see a jaw specialist.

  3. Correct me if I am wrong (and that is a dangerous offer to make to a law professor, I know), but isn’t the field of behavioral law and economics a response to the inadequacy of law and economics to explain irrationality? Now that I am truly over my head I will shut up and listen.

  4. I guess I am not to worried about most economic models of rationality. Lots of problems can be explained by overly restrictive assumptions. I do worry that behavioral economics and associated fields are not scientific enough and can not really add much in terms of prediction. I think you are right that the behaviorists are trying to explain anomalies, but I guess it is simpler to believe the underlying model of rationality is misspecified rather than it is wrong. It is just so powerful and the fact that it isn’t perfect doesn’t bother me yet.