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The whole purpose of insurance is to normalize the price. Without insurance, people who take the most risks with their health/driving would be more likely to pa

by mcbits 10y ago

The whole purpose of insurance is to normalize the price. Without insurance, people who take the most risks with their health/driving would be more likely to pay (or at least owe) millions, while the health-conscious and risk-averse would generally pay much closer to $0 (until they get old or unlucky). It's interesting that insurance premiums can act as behavioral incentives in some cases, but I doubt it has ever led someone to change their gender or race.

witty_username 10y ago
No, the purpose of insurance is to hedge the risks (i.e. one would prefer to take 0$ than to take a 50-50 bet on 1000$). For example, the price of bond insurance is not normalized between bonds with different ratings.
- mcbits 10y ago
  Risk analysis is just an implementation detail that aids price discovery in a competitive market. If an insurance provider can identify customers with lower risk than the consensus, they can offer lower premiums and attract that business. If they identify customers with higher risk, they can charge higher premiums and push that unprofitable business to a competitor. Supposing this price discovery were perfect, customers who make a claim would have already paid premiums equal to the claim, and customers who never make a claim would pay nothing (plus fees in each case). This aspect of insurance obviously serves no core purpose. The purposeless of it is just hidden in the noise of uncertainty, and we see pricing differences emerge out of the uncertainty. The actual purpose is to blunt the effect of catastrophic losses by spreading a smaller burden across a larger population. One caveat is that insurance can sometimes have the effect of "rewarding" risky behavior and "punishing" cautious behavior. Now, it's interesting that price differences can sometimes balance that by reversing the punishment/reward incentives, but only if prices are based on risk factors that the customer can actually control.

by mcbits 10y ago

witty_username 10y ago

No, the purpose of insurance is to hedge the risks (i.e. one would prefer to take 0$ than to take a 50-50 bet on 1000$). For example, the price of bond insurance is not normalized between bonds with different ratings.

mcbits 10y ago
Risk analysis is just an implementation detail that aids price discovery in a competitive market. If an insurance provider can identify customers with lower risk than the consensus, they can offer lower premiums and attract that business. If they identify customers with higher risk, they can charge higher premiums and push that unprofitable business to a competitor. Supposing this price discovery were perfect, customers who make a claim would have already paid premiums equal to the claim, and customers who never make a claim would pay nothing (plus fees in each case). This aspect of insurance obviously serves no core purpose. The purposeless of it is just hidden in the noise of uncertainty, and we see pricing differences emerge out of the uncertainty. The actual purpose is to blunt the effect of catastrophic losses by spreading a smaller burden across a larger population. One caveat is that insurance can sometimes have the effect of "rewarding" risky behavior and "punishing" cautious behavior. Now, it's interesting that price differences can sometimes balance that by reversing the punishment/reward incentives, but only if prices are based on risk factors that the customer can actually control.