Wednesday, June 24, 2009

Insurance is a bad idea

I'm looking for a house in Cambridge at the moment, and due to the lack of central places being privately advertised, I'm being drawn into the clutches of letting agents. They always impose vast numbers of unnecessary charges and bits of bureaucracy, and are usually a pain in the neck. The one exception was the now-deceased Camflats, who were great. But obviously there's something in the business model that means that if you're great you go bust.

For instance, why do they demand that people take out contents insurance on letting an unfurnished house? There's not much of the landlord's property there that can be damaged.

Insuring against small risks has always seemed like a bad idea to me.

The idea of insurance is to spread risk around so that occasional bad things won't hurt you. Take car accidents. You can't really control whether you have one or not. If you could then you'd presumably just opt not to.

However the costs of a car accident are immense. You could end up owing someone £1,000,000 without too much trouble. Usually this would mean that you're bankrupt, and rather more importantly that the poor person you've hurt is left without any means of support and has to starve to death.

For this reason, almost all governments make third-party car insurance compulsory for all drivers.

This is a good thing. Instead of being bankrupted once in 100 lifetimes, everyone chips in £10000 over the course of their driving career to cover the costs of the unlucky driver and his innocent victim.

So far so good. Except that there are many consequences of the insurance scheme itself.

For one thing, the very fact that the consequences of crashing are reduced means that people will drive a little more carelessly. If you know that your car will be repaired if there's an accident, then you pay more attention to getting places faster than to getting there without scratching the paint. So accidents happen more often (including the serious ones). This effect is called 'moral hazard'.

Similarly, if you've got theft insurance, you'll be a lot less worried about whether you remembered to lock your car. More cars will be stolen as a result.

Also, as anyone who's ever dealt with an insurance claim will know (or even filled in the application forms), there's lots of paperwork. This is something you'd probably rather not be doing, and it's certainly something that the people at the insurance company would rather not be doing, and so they need to be paid.

There need to be salesmen and offices and advertising, so that the insurance companies and their customers can get in touch in the first place.

And there's fraud. Insurance fraud is so common that you probably know someone who's admitted doing it. I don't know why we don't really think of it as a crime, but we don't. Of course someone who sets fire to their house to collect the insurance money is a criminal in most people's eyes, but what about the elderly couple whose freezer packs up, and ruins all their food, and to cover the excess on the claim and make it worthwhile claiming, they add a couple of packets of smoked salmon to the bill?

Of course now the innocent are paying other people to defraud them. And the insurance company is paying more people to watch out for the fraudsters.

It all adds up.

If you take out insurance you have to pay all these costs, as well as what you're really after, which is to share your risk with other people so that you pay a small fixed amount rather than an occasional large amount.

Car insurance is still a good idea, because the risk has to be covered (for the sake of the innocent).

But what about small risks? If you know that the maximum you could lose is, say, the cost of a new fridge and dishwasher, wouldn't you be better off just waiting to see if anything bad happened? That would be just like setting up an insurance company yourself, and only writing policies to people you absolutely knew would be trustworthy and careful, with whom you could make perfectly understood agreements that either side would always be happy with. And all your advertising would be free.

You could keep all the profits. That sounds like a great business model to me.

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