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A closer look at insurance markets

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Illustration What’s going on with insurance markets? Why are policies so expensive and riddled with exemptions? Why do insurance companies have a bad rap when it comes to making claims? These are frustrating questions because the principle behind insurance is straightforward and the benefits are obvious: occasionally in life, something unlikely but potentially ruinous occurs. Because no one can be expected to live life to its fullest and remain prepared for every possible eventuality, insurance policies spread the risk around a large group of people.

Cover art for “Risky Business: Why Insurance Markets Fail and What to Do About It”

According to Risky Business, a gem of a book The authors’ first example of the problems faced Keeping selection markets afloat proves to be a stubborn problem. The key is information. Customers know things about themselves—such as a love of luxury flying, aspects of their medical history, or their confidence as a driver—that would affect the insurer’s willingness to sign them up. And customers will always seek to get the most out of their policies. The authors highlight research from a health economist, Marika Cabral, which showed that when customers of a dental plan offered Insurers have tried a few different strategies to mitigate the disadvantage of asymmetrical information. Among them are introducing holes into the coverage. Life and car insurance policies will often include waiting periods to prevent customers from signing up only to make an immediate claim. Or there will be more subtle nudges to encourage the “right” customers to join, such as health insurers offering discounted gym memberships. Fascinatingly, one study of life insurance customers found that those who enrolled and were offered access to a wellness program did not benefit, from a health perspective, over those who did not participate; they were already fitter to begin with.

One study of life insurance customers found that those who enrolled and were offered access to a wellness program did not benefit, from a health perspective, over those who did not participate; they were already fitter to begin with.

Even when the amount of information available to insurers increases (and insurers have become much more sophisticated at gathering and analyzing data than they used to be), customers still seem to have a better sense of their own future. Another study cited But—and this is what makes selection markets so puzzling—the authors argue convincingly that customers shouldn’t be striving for the complete sharing of information, either. Although insurers are desperate to know as much about their potential customers as they can, they often refrain from asking questions that they are legally allowed to ask. If insurers knew that a customer came from a family with a history of chronic disease, they could opt against insuring them altogether. Or, as the authors put it, perfect information would “destroy people’s ability to buy insurance against being (or becoming) a bad risk,” which is entirely the point of being able to be insured in the first place.

In an excellent section, the authors refer to a New York Times article from 2020 that uses one particular case to rail against Medicare Advantage, the system that offers subsidies for private insurance for elderly Americans. At 65, a healthy man enrolled in a “light” policy with low premiums. Seven years later, he was diagnosed with cancer, treatment for which was not covered by his policy. He found he couldn’t switch policies, a decision the newspaper criticizes. Reading the article, it is easy to feel the customer has been treated unfairly. But to the authors, his case reveals a common misconception about insurance, which “you’re supposed to buy…in order to insure against a possible event or risk, not to pay for that eventuality after it happens.” It takes some courage to argue that an ill, elderly man should not be entitled to more comprehensive healthcare, and it also takes skill to avoid coming across as cold-hearted, dismal scientists while doing so, but these authors manage it. As a primer on how a seemingly simple industry is actually infernally complicated, Risky Business is a superb read.