Two Canadian risk management professors (Mary Kelly at Willfred Laurier and Norma Nielson at Calgary) have written an interesting survey of the rating factors commonly used in automobile insurance. The focus of the paper is age based pricing. (Here is a link to $$ copy of a published and peer reviewed paper Here is a copy of the research report the paper is based upon.)
The paper is quite interesting in its own right. However what is interesting is the rationale for the study.
The Law Commission of Canada, in their discussion paper “Does Age Matter?” raises the following questions :
Is it appropriate to use age in our legislation, public polices and programs?
Are age-based distinctions in Canadian law just? …
Could other concepts better reflect the diversity of life choices among Canadians?
My first response is that I, like Peter Pan, choose not to age. Since I made that life choice it is unfair that I am penalized for aging.
It turns out that after a serious review of the actuarial and economic literature, age does the best job of predicting (it is the most important determinant) loss severity and frequency. This is true for younger as well as elderly drivers.
It is "unfair" that people age and lose the ability to react to certain driving situations and it is "unfair" that young drivers are inexperienced. However, if we make it easier (lower prices for all!) for younger and older drivers, we increase social losses. I suppose as a society we could say that discrimination based on age is so unjust that we must bear the costs of increased road and highway accidents. As we know, this is never how the question is framed. The frame is about justice and trying to properly reflect the diversity of life choices. It seems like though the real life choices are increased death, morbidity, and auto body work.
Today's L.A. Times has an article on Risk entitled "Insurers learn to pinpoint risks -- and avoid them."
This article talks about one half of the equation which is risk assessment. It ignores the pricing aspect of insurance which is extremely important. The technology behind risk assessment is quite good and is getting better. This has a number of positive benefits. The most important is that high risk people learn that their behavior (housing choice) has additional costs. When we pool dissimilar risks together essentially we subsidize the high risks because the costs of separating the high risks and the low risks are too great. Thus the high risk gets a lower rate and the low risk gets a higher rate.
The idea behind risk pooling is to put similar risks (or homogeneous risks) together. It is not to subsidize high risk people or tax low risk people. As technology advances and we can discriminate at a lower cost between high and low risks, then we should. This provides people with an idea about the costs of their behavioral choices (sky diving versus knitting, for example). If the market can provide people with an idea of the costs, then everyone is better off. People who don't value sky diving enough to pay the total costs will stop doing it. Society saves on the losses caused by sky divers.
More to the point, if people know that living on the coast is risky because they have to pay higher premiums, they are likely to make better choices -- which will reduce catastrophe losses. That is a social benefit. If we socialize homeowners insurance by throwing everyone into the same pool, then we make living in risky areas cheaper and we increase catastrophe losses in the long run. How is that a good thing?
The article goes on to talk about how insurers are pulling back on writing risks (hence the article's title). There are a reasons this happens and it has little to do with risk assessment strategies. One is that when insurers experience a new risk (massive hurricane or terrorist action) it takes time to understand the loss characteristics and the eventual pricing of the risk. Eventually, this gets figured out, but it may take some years. A second reason that insurers don't want to write insurance to high risk property owners is that the insurers are not permitted to price the risk at what the insurer thinks is appropriate. Price regulation keeps prices below what the insurer needs to attract capital. Since no one is compelling the insurer to sell insurance --it stops if it can't make a profit. Regulation causes firms to drop coverage more than the inability to price a risk and regulation is what is destroying the homeowners market in Florida. The same kind of regulation nearly destroyed the New Jersey auto insurance market. What is crucial to understand is Deregulation and not more regulation is what saved New Jersey. New Jersey insurers have all of those new fangled technologies that can discriminate between good and bad risks and everybody can still get insurance. Bad risks now pay a higher price and because of that they may be encouraged to drive more carefully. How is that bad?
Another fact that the article uses to bolster the insurance-industry-is-going-to-hell-in-a-handbasket theme is that "everyone seems to think that people are moving to the coast and that is increasing the catastrophic risk exposure to society." The author claims that this just isn't true as the increase in coastal states' population looks the same as the increase in national population.
So what if they are the same or different?
The fact is that there is more exposure in high risk areas than there was ten years ago. In addition, property along the coast is generally more expensive than property in Leavenworth, Kansas. So again, the amount at risk increases. It doesn't matter that population is increasing uniformly across the country--it is that it is increasing in high risk areas.
Finally, the article talks about regulators (specifically California's lame duck insurance commissioner John Garamendi) complaining that insurers are taking on "a helluva" less risk than they used to cover. This is the regulators' own fault and it is galling that he doesn't understand the business he is supposedly charged with regulating. It is so easy to blame the insurance industry for all sorts of problems (and it does have its problems). However, most of the problems the property-liability industry has is caused by factors outside the control of the industry. No amount of regulation or antitrust enforcement is going to cure anything because the problem is that the government doesn't appear to want to understand how insurance works. We tend not to talk about government failure as but insurance price regulation is a prime example.
Generally it means, more wealth and well being.
Brink Lindsey from Cato is critiquing a book (The Great Risk Shift) by Yale Poli Sci Professor Jacob Hacker in today’s WSJ. Professor Hacker says that things were better back in the day when we were all in the same boat. Lindsey responds:
But if we're talking about security from material deprivation, that's a different story. Let's start with the biggest risk of all: that of premature death. Back in 1970, during Mr. Hacker's golden age of economic stability and risk-sharing, the age-adjusted death rate stood at 12.2 deaths per 1,000 people. By 2002, it had fallen more than 30%, to 8.5 per 1,000. In particular, infant mortality plummeted to 7.0 from 20.0, while the number of Americans killed on the job dropped to three per 100,000 workers from 18.
Next, look at the two main indicators of middle-class status: a home of one's own and a college degree. Between 1970 and 2004, the homeownership rate climbed to 69% from 63%, even as the physical size of the median new home grew by nearly 60%. Back in 1970, 11% of Americans 25 years of age or older had a college or higher degree. By 2004, the figure had risen to 28%.
As to consumer possessions, the following comparison should suffice to make the point. In 1971, 45% of American households had clothes dryers, 19% had dishwashers, 83% had refrigerators, 32% had air conditioning, and 43% had color televisions. By the mid-1990s all of these ownership rates were exceeded even by Americans below the poverty line.
No matter how the doom-and-gloomers torture the data, the fact is that Americans have made huge strides in material welfare over the past generation. And with greater wealth, as well as improved access to consumer credit and home equity loans, they are much better prepared to deal with the downside of increased economic dynamism.
Mr. Hacker leans heavily on his findings that fluctuations in family income are much greater now than in the 1970s. But research by economists Dirk Krueger and Fabrizio Perri has shown that big increases in the dispersion of income have not translated into equivalent increases in consumption inequality. In other words, most Americans are able to use savings and borrowing to maintain stable living standards even in the face of economic ups and downs. And those standards are much higher than those of the all-in-the-same-boat era.
Could increased personal responsibility and greater incentive to manage one’s risk remove the moral hazard aspects of social insurance to create more wealth?
A bank employee faces a pretty stiff penalty in Vietnam after losing some $5.4 million in allegedly unauthorized proprietary trading according to Risk Magazine (sub required). If found guilty of taking the funds the trader at the Industrial and Commercial Bank of Vietnam could face death by firing squad.
Frank Synder at ContractsProf Blog notes this interesting case involving the risk for an insurance company which purchased/sold so-called reverse life insurance.
Someone who is dying can sell the future proceeds from a current insurance policy to a third party. The third party pays some fraction of the death benefit to the sick person immediately and then when the person dies, the third party can claim the benefits under the policy. That’s all fine and dandy if the insured dies on schedule, but what if the pesky insured gets a new treatment and lives?
I know that we professors have tons of vacation time and hardly see any students, so in between golf, long lunches at the faculty club where we chat incessantly about our golf scores and our next BMW, and posting on our blogs we actually have little to do…..
I have been creating a dataset on insurers entry and exit from cat markets for a paper we are presenting at the NBER Insurance Project next month. We need to have the paper done by Friday so that’s what I have been doing in all my free time.
However there are two items to note. The first is that according to one of my former Ph.D students I was on C-Span II last weekend discussing a book by UCONN’s Tom Baker on the Malpractice Crisis at the AEI last month. However, I can not find it on the public schedule. I must have been a super secret showing. So if you just have to see it now … you can watch it at the AEI’s site in streaming video.
Second, there is a new blog called TortsProf (part of the LawProf network) edited by William Childs at Western New England School of Law. He has postings on potential Katrina juries as well even more on that ubiquitous shrimp case.
Ted Frank at Point of Law mentions an interesting problem. Suppose a drug manufacturer attempts to lobby the FDA to get a particular drug approved. The drug goes through the normal approval process and any time the manufacturer says something to the FDA regarding labeling, drug properties, or provides data or commentary on the characteristics of the drug or the drug’s trials the manufacturer creates a record which can be used against it at some later trial.
A rational response for possibly the most informed entity (e.g. the manufacturer) in the process is to say relatively little. It is hard to make a case for less information being a socially beneficial policy.
Some groups like Public Citizen would like to remove all risks for every activity. They can lobby to stop a drug (see, for example, WorstPills.com) and a drug manufacture may find it in its best interest to be silent so as to avoid creating a record upon which punitive damages could arise.
Total risk elimination can be costly. Our system of jurisprudence has accepted cost/benefit analysis as a reasonable way to determine whether society undertakes certain actions or produce certain products. In contrast, we also have the so-called prudential approach which has as its goal to make sure no one gets harmed. Under this approach even aspirin would not be approved and we would lose out on the tremendous economic (and psychic) value of pain relief and potential stoke and cardiac harm mitigation. We have never really had is a general debate on the pros and cons of the cost/benefit approach versus the prudential approach. Some agencies have enabling legislation that give them guidance (e.g. FDA for carcinogens) and some do not.
This debate is likely to be quite boring (and this may explain why we don’t debate it) as we start talking about statistical lives saved and the like, but it seems like it is time to decide which approach is appropriate for drugs. A first reaction likely favors the prudential approach, but once people see the costs of foregoing the use of products and drugs we take for granted today, opinions could change.
The Financial Times reports on the effects of one Japanese trading house’s mistaken stock purchase. What is striking is that the market knew a mistake had been made in the trade, but not by which bank — so everyone was selling shares in all trading banks. Can you spell Contagion? The trade wiped out the Christmas bonuses for the firm too.
“Hey, don’t let the Attorneys General get all the lime light, we want some too,” says nine state treasurers or investment managers who want insurers to do global warming studies to assess the risk of global warming on the insurer’s portfolios of assets and liabilities. The Treasurers sent a joint letter (along with some religious retirement funds) to 30 insurance companies asking them to undertake a global warming risk analysis. Here are the state treasurers:
|Alan G. Hevesi||NY||D|
|Denise L. Nappier||CT||D|
|William R. Atwood||IL||?|
|Richard H Moore||NC||D|
There seems to be a pattern here……I don’t know anything about the politics of any of these folks, but it seems like there are many Ds on this list. (See this article for the rest of the group.)
Of course there are two approaches to managing one’s investment. One can either own shares and if one doesn’t like the performance of the company, then the one can sell. Alternatively, one can try to dictate how the company should be run.
Here’s a quote of interest….
"Hurricane Katrina reminded all Americans of the destructive power of natural disasters," said California State Treasurer Phil Angelides, a board member at the California Public Employees' Retirement System (CalPERS) and the California State Teachers Retirement System (CalSTRS), the nation's largest and third largest public pension funds with over $300 billion in assets. "Insurance companies simply can't afford to ignore climate change. As shareholders, we must hold the companies we own accountable and demand they adopt strategies that will enable them to survive in a changing world." [emphasis added — ed.]
Who do you trust more — a professional investment manager like an insurance company, or a politician who is taxing pensioners to support a political viewpoint by demanding companies undertake certain actions.
I don’t have a problem if insurers investigate the potential effects of global warming if the managers think it in their best interests to do so as they can make some profit by undertaking these studies. However, it just seems that this is a political stunt to get insurers to spend pensioners’ money on pet projects.