Sunday, April 12, 2009



Americans spend almost 2% of the entire Gross Domestic Product on “insurance products.” Other countries do not spend nearly as much on insurance. Is there a reason for this? Do Americans really live in deathly, financial fear of lawsuits every day? Insurance comes in many types. In my view, it’s all stupid. Why? Simple: Because insurance creates an automatic adversarial relationship that fosters mistrust, resentment, dispute, uncooperativeness, bitterness, stinginess and dishonesty. I have little difficulty making this judgment because insurance kindles intensely bad relations between men. I have little doubt that insurance is “necessary” and “beneficial” for commerce. That does not mean it is not stupid. “Commercial benefit” generally involves negative emotions and conduct anyway, so it is not surprising that insurance is “good for commerce” and “bad for the spirit.”

What is insurance, anyway? Most people associate insurance with cheap salesmen who operate from faux-wood-paneled offices in bad suits. They don’t really know what it is. They just buy it so they don’t have to pay when they get in a car crash. You buy insurance to protect yourself against the unknown. Risk is out there; according to popular logic, if you have insurance, then you won’t lose all your money when “bad things happen.” Insurance acts as a shield against unforeseen dangers. The longer we live, the more we see that life can take incredibly random turns. Insurance provides a hedge against these terrifying mishaps. That is why people buy it. They think it will protect them from lurking, unforeseen disaster. Even the word “insurance” relates to the word “assurance,” meaning to soothe someone by “positively informing” him that the future will not bring ruin. Insurance “assures.” People like assurance because they know life will smack them in the face sooner or later, and they’d rather not have to both suffer and pay money when it does.

This all sounds wonderful in theory. Insurance protects people against inevitable life risks, providing “assurance” and “peace of mind” to millions. Why, then, do I say that insurance is stupid? To understand why, we must examine the intersection between “providing assurance” and “making a profit.” Insurance companies began in 17th Century England and Holland. These companies pooled together their money and offered to “cover” trans-Atlantic shipping expeditions against various risks, such as shipwreck, piracy, fire or theft. Merchant captains were terrified that these risks would strike. After all, a single pirate could bankrupt an entire merchant house, so why not pay a small sum to protect oneself against that risk? Insurance companies, however, did not provide “assurance” because it made them feel like good Christians. No, they wanted to make a profit, and they did. Historically, insurance companies have made enormous profits. Selling “assurance” against the “terror of risk” is a hot item.

Still, it may seem counterintuitive that insurance companies make more money than they pay out. After all, people buy insurance on the assumption that the company will pay some money out when a disaster strikes. Unlike other enterprises, insurance companies offer value by offering to pay for others’ damages. While they take in money on the one hand, they necessarily must pay it out on the other. It is in the nature of their product. People would not buy insurance if they knew the company would not pay for their damages. How, then, do insurance companies make so much money? Simple: They doggedly contest every assertion that they are liable to make promised payments.

Insurance companies hold sway over a tilted playing field. It is always easier to win disputes when you have more power than your opponent. Insurance companies, for example, write the insurance contracts; you simply read and sign. Many routine insurance contracts run into the hundreds of pages, spelling out every single potential liability and excluding dozens of others. They minutely define every single word, making it possible for the company to argue away anything. An insurance contract could even define “Tuesday” to mean the third Wednesday each month, but not Sunday the 23rd, then exclude coverage on “Tuesdays.” Insurance companies also have far more financial resources than an individual claimant. If a claimant does not like an insurance company’s decision, he alone must confront a massive entity with batteries of lawyers all too willing to find “reasons” to deny him.

All this plays into the insurance company’s hands. They promise to pay money when a “covered risk” happens, but they cut into their profitability whenever they pay out anything. Businesses exist to make a profit, not to suffer losses. In that light, insurance companies have an institutional interest in contesting every single claim made against them for coverage. When they cover losses, they negatively affect their bottom line. When they refuse to cover losses, they positively affect their bottom line. Which alternative do they have an institutional incentive to choose?

In legal terms, insurance represents a “contract” between the “insurer” and the “insured.” As in any contract, one party promises to do or not to do something in exchange for the other’s promise to do or not to do something. Insurance contracts, however, are slightly more nuanced. In an insurance contract, the “insurer” promises to pay the “insured” money—or provide some other service—IF a particular event does or does not happen. In exchange, the “insured” promises to pay money (“the premium”) for the right to make a claim against the “insurer” IF the particular event happens or does not happen. The law calls this an “aleatory contract.” The dictionary says that “aleatory” means “depending on a contingent event.” v. 1.1. While that is no doubt true, the Latin etymology much more clearly illustrates the “insurance relationship” than the English definition. In Latin, “aleator” means “gambler.” In essence, then, insurance is gambling: The insurer bets that you will not get sick; you bet that you will. The insurer bets that you will not get into a car accident; you bet that you will. And just as the stakes are high when dice fly, so too are they high in “aleatory contracts.” Gambling implies a game, especially a game of chance. When people play games for money, they stoop to anything. That is why insurance leads to such acrimonious mischief.

Insurance relationships are intrinsically adversarial. Although insurance advertising attempts to lull people into thinking that they are “in good hands” or that they can feel “safe at home” once they pay their premiums, nothing could be further from the truth when the “chips are down.” Insurance is gambling, and when the “chips are down,” the house does not like to lose. Insurance companies are corporations; they have a duty to their shareholders to maximize profits. Paying claims jeopardizes their corporate mission. Thus, when an “insured” makes a claim, the insurance company must take sides against him. The company has a duty to enrich shareholders, and paying the “insured” would contravene that duty. This is why insurance companies fight tooth and nail to exploit any ambiguity against the “insured.” This is why insurance contracts minutely define every single word and stack advantages in the company’s favor. This is why insurance companies send investigators to probe the “insured’s” story for inconsistencies and lies. When there is no pending claim between the “insured” and the company, it is all smiles and “good hands.” But once the “insured” suffers a compensable injury, it’s war. The insurance company will attempt to pay nothing. If necessary, it will pay something, but never everything. Before the dice fly, a good gambler does not sit around and wait for the throw; he tilts the table or loads the dice first. Insurance companies can do this. And they do.

I have always reserved special cynical bile for insurance companies. One must merely understand corporations to see that insurance companies have an institutional incentive to wage war against their own customers in order to maximize shareholder returns. Insurance companies, in other words, operate under numerous conflicts of interest; and ultimately their duty to their own shareholders prevails over all other duties. Still, some will doubtlessly counter that insurance companies pay for damages on many occasions. I know they do. Nonetheless, I believe this has less to do with honor than with the threat of legal compulsion. Although the legal system clearly favors insurance companies through contract rules and common law indulgences, it does provide some recourse against particularly egregious, “bad faith” refusals to pay in unambiguous cases. After all, even an insurance-friendly court could not in good conscience refuse to compel an insurance company to pay a claimant who bought “pedestrian injury insurance” two days before being run over by a car in a crosswalk. In such clear cases, insurance companies would lose more than they would stand to win by contesting the customer. Thus, when insurance companies “pay like they are supposed to,” they have merely calculated whether it would be cheaper to pay than to contest. But their overall policy is: “Contest unless the facts warrant otherwise.” That must be the policy. We saw it at work after Allstate refused to pay Hurricane Katrina victims because they suffered “wind damage,” not “flood damage.” It is the only way to minimize expenses and maximize profit.

We all need insurance. There is no other way to spread the cost of inevitable losses in life. But that does not save insurance from being stupid and unfair. Insurance companies are for-profit enterprises that ostensibly “pay claims” to people who suffer covered losses. This creates a fundamental conflict of economic interest. This conflict, in turn, generates automatic acrimony and mistrust between insurers and their customers. It also provides an incentive for the company to pay as little money as possible to the customer. Further, it offers an incentive for the insurance company to protect itself through unfair legal processes, such as writing its own contracts and conducting its own fact investigations. In all these situations, the customer stands at a material disadvantage. He can only hope that he suffers a clear, provable injury that even an insurance-friendly court could not refuse to acknowledge. Otherwise, he must lock into a “gambling contest” with the insurance company. And in this crap-shoot, the odds are against him; the house always wins.

1 comment:

SteveW said...

Many of the evils of insurance are, in fact, evils perpetrated by the government via this highly regulated industry. However, that is not where I want to spend my phonetic capital in this post.

Insurance is a pooling of risk, providing a mechanism for society as a whole to absorb catastrophic losses that will be incurred on a few. Therefore, the losses must be occasional, i.e. they will not happen to everyone (house burns down) or they will happen at a highly variable time (e.g. death - or you could say the loss of "dying too young" doesn't happen to everyone). The losses must be catastrophic, the type that should not be borne by an individual. The losses should have a random element, not that they are necessarily truly random but they occur in a predictable statistical relationship of the insured population but in a way that the future victims cannot be known in advance (eg we can be certain that 20 in 100,000 will suffer, but we don't know which ones).

To the extent these three characteristics are not present, we have a serious problem and the insurance model should not be expected to work. Thus, life insurance (the term kind) is a fantastic product that if the consumer is not abjectly ignorant, they can get good coverage at a good price and the company will undoubtedly pay (barring some government created exceptions such as suicide). Health insurance should be expected to be a miserable failure because the vast majority of items covered under it do not have the good insurance characteristics. Some events could - for example getting cancer or needing heart bypass surgery, but these potentially insurable aspects of the health care system are obscured by the garbage of the system and we have what we have.

The cycle goes like this - an insurance product is created, if it is a bad fit (see above) a consumer gets screwed, a politician steps in to regulate the insurance product creating a group of rules, consumers get screwed under the rules but no insurance company is protected because it followed the rules, the government changes the rules and a different group of consumers gets screwed, etc. etc.

The bad cycle starts whenever the characteristics of good insurability are not present in the underlying events. Instead of complaining that our hammers no longer drive screws well, my humble suggestion is that we stop trying to drive screws with hammers.