Mr Podcast: Insurance!

In our new Marginal Revolution Podcast Tyler and I talk insurance, the history of insurance, the economics of insurance, the prospects for new types of insurance and more. Did you know that life insurance was once considered repugnant and was often illegal?

Tyler and I were both surprised how little good work there is on insurance. Here’s Tyler:

[Y]ou look at microeconomic theory. You feel all insurance should be a simple thing. There is risk aversion. You buy the contract. You look at the actual history. It’s very hard to make sense of it. The more I learned, I found the more questions I had. I didn’t fall into some, oh, now I understand what was happening kind of pattern. And the second is simply, I had been underrating Charles Ives. He was more than a great composer. Those are my takeaways.

Here’s one more bit:

COWEN: I want to get to the big, big question about insurance and see what you think. This is my worry. My worry is the agency problems behind insurance never have been solved.

….TABARROK: It is a peculiar market in the sense that all of your revenues come early.

COWEN: That’s right.

TABARROK: You’re selling all of this insurance, and everything is great because all of the money is coming in and your costs don’t come until much, much later. Your customers need to be convinced that you’re going to be around for a long time and are going to fulfill these implicit debts. Which is one reason insurance companies like to have big buildings with giant columns, like banks, to make them look solid. How do we guarantee that? I absolutely agree that’s a huge problem. I hate to say, but, there is a lot of insurance regulation which is precisely meant to deal with this problem.

COWEN: At the state level, you can choose the state. There’s reinsurance through Bermuda or other locales….[But] the problem is not just the company, it’s the person buying the insurance. You could have an insurance company. They advertise, we hold only T-bills and you know they’re safe. People don’t want that. It’s not what I would want. I want the riskier life insurance to get a higher return on the package.

The fact that it’s not for me, makes it really easy to spend for something that promises higher return. They don’t pay it all off, or oh, whatever, but I’ll be dead then, and you don’t think that explicitly. But your ability to monitor the true safety is maybe fairly weak. Maybe it’s efficient to have a bunch of these not pay off, and you get the higher yields on average. You don’t want full safety in most spheres of human existence. The real risk is that you die, right?

TABARROK: If anything, the insurance markets have becoming safer over time because as they get larger, law of large numbers does mean that the risk falls.

COWEN: Assets are more and more correlated over time, I would say.

TABARROK: Well, so we have reinsurance…

COWEN: It’s not that everyone’s going to die at once. The problem is the assets all go crazy at the same time. The world’s more globalized, the gains in the S&P 500 have been concentrated in seven or eight stocks lately. There’s a lot of worrying signs on the asset side, this higher correlation and the law of large numbers is working against you. Fewer publicly traded companies. A place like China is not really somewhere you’re going to be investing in. Maybe you would have thought that 15 years ago. It seems to me going in the wrong direction.

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