It’s not always fair

Reducing risk in insurance pools

When you talk about insurance, you talk about pooling risk with a group of people. That’s the essence of what insurance is. The insurance industry has always been creative in reducing the risk in their pool. There are in general two options to reduce risk:

  1. reduce the risk of your existing pool of customers
  2. raise the quality of the risk profile of applicants

The first one could be a free smoke detector with your home or renters insurance. The faster you can detect the fire, the faster it can be put out and thereby limiting the size of the claims.

The second one is more controversial. You focus on a particular group of people who have inherently a lower risk profile. Because of that lower risk profile, you can entice them with lower policy rates. The problem though is that the insurance pool is dynamic. Inherently, if some company acquires a large group of people with lower risk profiles, it will automatically increase the risk profile of the people left in the pool. That ultimately translates into higher rates and that’s not always fair and has unfavorable outcomes. The people who need it the most get shut out of insurance because it becomes unaffordable.

You see this dynamic clearly in the US health insurance market. ACA insurances are terrible – expensive given the limited coverage. The pool this insurance is targeting are the leftovers. It’s one of the reasons that universal health care works better – especially for something for which there’s a universal need.

One of the interesting aspects of the US lending market is that age discrimination – plus race, color, national origin, marital status or sex – is prohibited. Now insurance is not federally regulated and nothing of the sort exists for insurance products. Each state has their own rules. There’s an opportunity to make insurances more universal by law. One could be just that anyone can get any insurance regardless of their background. It would lower the rates for most and increase the rates for some, but in general, we find ourselves on both sides of the table in our lifetime.

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