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Why Insurance Markets Fail on the Price Writers Podcast Episode 29
22 Plays21 days ago
In this episode of The Price Writers Podcast, Jeremy and Catrin explore Why Insurance Markets Fail and What to Do About It by economists Liran Einav, Amy Finkelstein, and Ray Fisman. They tackle the tricky concept of anti-selection, sharing why it confuses even seasoned insurance professionals. With examples ranging from U.S. medical insurance to American Airlines’ baffling ticket offers, they make a complex topic surprisingly clear and even entertaining. Add the book to your summer reading list (or just let us summarise it for you). #InsurancePricing #Risk #AntiSelection #ThePriceWritersPodcast #BookClubForPricingNerds
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Transcript
00:00:00
Speaker
I really should mention that his chair's really squeaky.
Introduction and Book Focus
00:00:13
Speaker
Welcome to the Price Writer Podcast with Katrin Townsend and me, Jeremy Keating. Join us as we explore and discuss the world of insurance-related books, offering our insights, recommendations, and crucially, how to apply this to insurance pricing.
00:00:29
Speaker
Our last two books we had on the podcast were a bit more general, but this one is really insurance-focused. It's called Why Insurance Markets Fail and What to Do About It by Liren Inav, Amy Finkelstein and Ray Fissman, three economists who want the public to understand anti-selection.
Book Themes and Critiques
00:00:49
Speaker
So, hi, Katrin. Hi, Jeremy. Hello. So, what did you think of the book? Overall, I really enjoyed it. I think it did a really good job of explaining the concept of insurance and it went into a lot of detail about anti-selection as well.
00:01:06
Speaker
That was really well explained and it was really accessible, which I enjoyed. I thought overall the book was quite US focused. So if you like that, then you'll probably really enjoy this book.
00:01:19
Speaker
It did spend a lot of time on medical insurance, which isn't so relevant in the UK. But i like that it wasn't political that criticizes all governments equally and was more about general regulation rather than any particular government's attitude to medical clean insurance.
00:01:40
Speaker
And I just, I thought was really fun though. It had lots of examples anecdotes that weren't insurance related. So you could kind of start to understand where it was going build up that picture. it was just a lot of fun. I had this as an audio book. I enjoyed listening to it.
00:01:55
Speaker
I thought that the chapters were quite long. They were one hour. i probably would have broken that up a little bit more just to make it a little bit more bite size. But it was perfect when I had a whole hour to really get into it.
Understanding Anti-Selection in Insurance
00:02:09
Speaker
Yeah, I listened to the audio version as well. And I, yeah, thought it was a fantastic explanation of why anti-selection is the driving force between a lot of how insurance is structured.
00:02:19
Speaker
And often people grumble, or hear these startup ideas, and like, I'll fix this bit of insurance. And actually, often the reason it's complicated is because of anti-selection.
00:02:31
Speaker
So most people both in and outside of insurance probably don't really get it or at least not to the level that they really ought to. and So I think people outside insurance would benefit from knowing more about it simply because now I think the public would appreciate insurance is how it is.
00:02:47
Speaker
But I think inside insurance, a lot of people don't get it as well. So i I did really like the non-insurance examples. There's a really good one about the American Airlines had this like fly anywhere offer.
00:03:00
Speaker
And it was really expensive. So it was like a couple of hundred thousand dollars. But for the rest of your life, you could fly anywhere. And they did their maths and were like, well, the average customer does X, Y, Z. So if we charge this much for it, we'll make loads of money.
00:03:14
Speaker
And of course, they only sold it to people who had done the maths as well and were like, oh, i have to make this many trips in order to make more from the ticket than I paid out. So so they actually then found that they were losing a lot of money on them. and And what they did was kept raising the price.
00:03:30
Speaker
And of course, what happened is the customers kept making more and more trips. and Until it became just like ridiculously expensive. And even then the few people that were buying it like a million dollars were traveling like on 10 flights a week and stuff like that. So it still didn't work.
00:03:47
Speaker
So I thought that was a brilliant example of the T-Selection and why it really is a problem.
00:03:53
Speaker
Yeah, I thought it was fantastic that they've written a book that makes insurance really accessible. And this is a book that's not written by people who work in insurance as well. I mean, that they're three economists.
00:04:06
Speaker
So I thought that was wonderful. don't know, surely everyone in insurance who's been around a little while, surely everyone insurance understands Auntie Selection, right?
00:04:17
Speaker
I don't feel they do, actually. i feel that quite often people think they get it. And then when it comes to it, they actually don't necessarily. i mean, it's driven by asymmetries between the customer and the provider.
00:04:31
Speaker
But any time a customer probably knows more than we do about at least some aspect of their insurance. And I think we forget that. Anytime that a customer suspects they're going to cost more to serve than the insurer charges, we've got an anti-selection problem.
00:04:48
Speaker
And remember, when a customer buys insurance and they think about what price to pay and stuff like that, things that are going on in their heads is whether it's a good deal for them, whether it's cheaper than other providers and so on.
00:04:58
Speaker
So actually, i think it goes on a lot. And I often hear calls inside insurance. So I'll see articles or podcasts where people go, let's do this. And it's like they're getting themselves on the train, the anti-selection train, and it's eventually going to crash.
00:05:17
Speaker
And you'll end up with um just the insurance not working anymore.
Legal and Policy Discussions in Insurance
00:05:22
Speaker
You've been in insurance for a while. So is it anything in this book surprise you? Yeah, I think the biggest surprise is broccoli.
00:05:30
Speaker
So yeah. So in the US Supreme Court, so during the Obamacare court cases, they had to rule whether it was acceptable to force people to buy health insurance. So whether it's mandatory health insurance was legal.
00:05:47
Speaker
And um it was argued repeatedly that saying that having to make people buy health insurance is the same as the government saying people have to eat broccoli. And it's just not.
00:05:58
Speaker
It's just not the same. um That's just really silly. And in fact, the final ruling, this is mentioned in the book, the final ruling mentions broccoli multiple times.
00:06:09
Speaker
And it mentions anti-selection. I think it was twice. So, so yeah, so actually ah think people, I think people don't know enough about this and it did really surprise me.
00:06:20
Speaker
So I think often regulators and policymakers either don't know enough about this or don't put it as being a priority. But the problem is that Too much anti-selection in the system becomes unsustainable.
00:06:33
Speaker
Now, here's an interesting one. You just wouldn't be able to own a home. You wouldn't be able to start a business, drive a car if you had to have um the financial resources that your insurance replaces for you. So these are really substantial amounts of money that you can buy a policy for a very small amount of money.
00:06:51
Speaker
And I just think that policymakers fail to really appreciate this. And because of that, they can often drive insurance markets into inefficiency and potentially collapse. Yeah, I don't want to stop regulating it to pile on. But I do think that there's definitely ah lack of understanding about, okay, you want premiums to be cheaper as a regulator or as a government. Yeah, I mean, everyone wants premiums to be cheaper. But even the insurance, really. I mean, insurers don't like charging high prices because usually their risk costs are quite high that go along with that. So...
00:07:26
Speaker
I often think that, you know, insurers should reduce the premiums. It's like, yeah, and then what? I think all you do is you almost penalise. You penalise the insurers who following the rule the letter, to the spirit, and then the insurers who are maybe kind of a little bit finer on getting that anti-selection problem and it's being pushed onto the insurers who are actually trying to do the right thing in a slightly more straightforward way so I think that's a real problem and I think we see quite a bit of that now you know there's so much external data and stuff out there some of which is
00:08:07
Speaker
A little la close to the wind, maybe, in terms of the regulation. And I think that that is definitely a real issue. And I actually have the regulator not talking about anti-selection and saying, well, who is going to insure those people?
00:08:22
Speaker
How come... with a regulator ensure that
Challenges in Catastrophic Insurance
00:08:25
Speaker
it's not that they're getting insurance but also you know their cost is fair so I think that's really important and and definitely a big part of Flood Re has been trying do a really interesting sample I wish the book had talked a little bit more about Flood Re and about the camp side of things they they did focus a lot on health And I think that the cat side of this is really interesting because America has similar issues with that Florida homes, flooding, for example. People not moving because their insurance will pay.
00:08:55
Speaker
An anti-selection effect that insurers have to provide some of that insurance. Yeah, it is a really tricky problem, is Because you want to be able to provide cover to people.
00:09:06
Speaker
But if you mandate insurers have to provide cover to people who are really, really very likely to claim, then insurers have to charge a price that covers that. And that forces people who don't have these high-risk properties out of the market because they can't afford the cover then.
00:09:24
Speaker
So sub what do you do? And it's a real problem. If you don't get this right, you end up with a spiral that eventually removes everyone from the system except the ones that are really, really expensive to provide insurance for.
00:09:38
Speaker
One of my favorite parts the book was when they talked a little bit about things that insurers can do to reduce the risk or that customers can do to reduce their own risk. So things like co-pays or initial exclusion periods for health insurance, dental insurance. They talked about that example a little bit.
00:09:55
Speaker
And the idea that if it's non-emergency, you'll probably push it into the following year. And then in the intervening time, you'll increase your cover. So, you know, you can do things like that. but they said But if you can create a system whereby people are incentivized not to do that and actually reduce the risk themselves, then that's obviously the most ideal situation because then you actually are reducing the overall amount of risk in society, which is very important. I think we see a lot of that with car manufacturers at the moment, right, in the UK.
00:10:24
Speaker
They've actually... are the ones or the key people who can reduce ah the overall amount of of risk, particularly when it comes to the theft. And and also things like that the car parts inflation.
00:10:37
Speaker
ah They're the ones who can really help to control that. So that discussion around what insurers can build into their T's and C's to help control their costs but in a way that is fair and doesn't penalize I'm going to the good customers that was my favorite part of the book what about you Yeah, I think similar. It's, um, it is a really interesting, those points around how do you make a system work? Because if you start mandating how insurance has to function, solely chips away at actually the underlying kind of principles of it.
00:11:14
Speaker
i I really liked the discussion of unemployment insurance. And this is why I say, i don't think people really get anti-selection even in insurance. So everyone that was involved in setting this product into the world was like an insurance expert and people were discussing how the product was too profitable.
00:11:32
Speaker
And then it turned into a disaster and ended up being pulled ah because it was just paying out too much. So actually I think people, even insiders would very much benefit from this book.
00:11:43
Speaker
I think the question of fair value is really interesting. Like you often hear people say, oh, insurance cost me, you know, however many hundreds pounds month and I don't get them back. And therefore it's too expensive.
00:11:58
Speaker
And I think that that there is a and a misunderstanding of what insurance is selling. it's It's not that you will definitely get money back within the how many years you have insurance. Well, we're selling you security that if something did happen, yeah then you would be covered. So I think more understanding of we're selling security.
00:12:19
Speaker
i think actually insurers could could do really, I'm sure some marketing person could do a really good campaign about that somehow. Yeah. I think the fair value assessments for property insurance, in particular properties that are exposed to cats, is actually really interesting because I have to look more into it. But I think it it is done on an annual basis. you know There's no idea that if your home has a one in a hundred year flood risk that actually...
00:12:54
Speaker
that that risk still has to go be priced into your annual cost even if it's not expected to happen very frequently at all so i think that there's something there that's more complicated than the fair value tag necessarily suggests there is a lot of complexity on the particularly volatile events Yeah, I think so. So my home insurance costs me about one two thousandth the value of my house a year.
00:13:25
Speaker
Like it's a micro cost compared to the ownership of my house. And I just I'm like, it's fair. and That's really, really, really good value. What we should be saying is, wow, that is incredibly good value.
00:13:40
Speaker
We should be so proud that we deliver a product for such low costs. And, you know, i' just i'm just I'm kind of annoyed about people not appreciating how fantastic value it actually is.
00:13:55
Speaker
I really like the lens of the UK student loan being
Comparing Insurance to Other Systems
00:13:59
Speaker
an insurance scheme. I'd never thought of it that way before. They didn't specifically talk about the UK student loan scheme, but they talked about American equivalents where some colleges offer this. So you pay back a percentage of your salary in return for re-tuition.
00:14:16
Speaker
That was totally new way of thinking about it for me. And and I really enjoyed that. It really helped me reframe it and under understand why the student loan system in the UK is kind of failing.
00:14:27
Speaker
I don't think that's too controversial to say. and Because wealthy families can and do just pay the tuition or the the loan amounts straight after graduation.
00:14:38
Speaker
And therefore their kids and aren't paying that proportion of their income. And we know that wealthy families are more likely to have kids who ah have high incomes and therefore that extra interest, which otherwise would go back into the pool and help finance it is actually not going back in because they're opting out because of bounty selection.
00:14:58
Speaker
And so that for me was a really just It just so was a light bulb moment for me and kind of understanding why that's not quite working. and um Anyone who is involved with setting student loan policy, i feel like this would be the book I definitely want them to hear about because, ah like I say, that was a brand new insight for me.
00:15:19
Speaker
I feel like it's really useful all over the place. And done I mean, something something that I think they make really nicely clear as well is that you move to a more mutualized system.
00:15:30
Speaker
You just have winners and losers from that. And the winners are typically the wealthy. So they they end up with bad properties being subsidized by everyone else because if everyone pays kind of set amounts for their insurance, even intracept even if you link it to the sum insured, it's still beneficial for the wealthy. and not So it's interesting. Often people are like, oh, let's mutualize. That would be better for worse off people.
00:15:56
Speaker
But actually, it's often them that see their premiums rise because of it. And they're the ones that are forced out of the system. They're the ones that can't get cover anymore. So in that way, it's actually really unfair. So, so yeah, I've talked about as many a time, how people see like neutralization as being fair, but in fact, it's actually really unfair. Would you recommend this book, Catherine?
00:16:18
Speaker
Yeah, I thought it was fun. would recommend it, particularly a if you're new to insurance or you're just interested in finding out more about how insurance links to society and drive society.
00:16:31
Speaker
Um... I mean, yeah, I would recommend this to anyone new to insurance or if you don't work in insurance at all. I mean, but if you don't work in insurance, please can you let me know? Get in touch because would be fascinated to hear how you found us because we're normally in the insurance nerds corner of the internet.
Who Should Read This Book?
00:16:47
Speaker
So if I ask please do let me know.
00:16:50
Speaker
um But I don't if I'd recommend this book to more experienced insurance professionals unless you're in a really regulatory type role just because...
00:17:01
Speaker
Like everyone's busy and I don't know if this book is necessarily going to impact your day-to-day as an insurance pricing professional. Do you think it's a good refresher on a lot of stuff though?
00:17:15
Speaker
yeah Yeah, I think that that's definitely true. I guess I'm just coming at it with, you know it's a really good book, but it's potentially not going to change the way you work you know every single day.
00:17:28
Speaker
And i know time is so precious that a lot of people, let's be honest, like a lot of people aren't going to read that many nonfiction books, particularly about insurance this year.
00:17:40
Speaker
but yeah I guess. You know, it really depends what kind of people are looking to pick up, so... But if you do just want to refresh it and you're just really a bit tired of insurance and like, oh, what I doing?
00:17:51
Speaker
um I think this book actually is really fun and engaging. It's going to probably bring back the feeling of purpose to your work. So I would recommend it, you know, if you're in that situation. What about you?
00:18:02
Speaker
Yeah, I guess I agree, actually. ah yeah i I really liked it. i thought it was really fun. I genuinely thought, especially for an insurance book, it's a fun read. The anecdotes are quite good.
00:18:15
Speaker
And the situations people and companies have got into because of like information they're synonyms is really fascinating. And, you know, I have myself been like, why is dental insurance just so rubbish? I would never buy dental insurance because it's so rubbish.
00:18:31
Speaker
But it takes you through really nicely. And it was a reminder to me. I was like, oh, yeah, that's why it's rubbish. And that totally makes sense because the people that buy it all know that there's stuff they want done to their teeth.
00:18:42
Speaker
um say yeah So, yeah, in that way, i thought it was really good. I would definitely recommend it to anyone involved in insurance policy and regulators. Do I think it's worthwhile if you're sort of a maybe a manager in a pricing team?
00:18:56
Speaker
Probably not. But I would also say i I found it a fun read as books go. So, you know, if you think about what to do for CPD and things, definitely, definitely give it a try.
00:19:07
Speaker
The audio books available, which isn't that common for insurance books as well. So you can just listen to it. I think I did really like it actually. And I... I would recommend it, but wouldn't necessarily say if you're like 10 years into your career that you'll learn ah lot that you didn't know from it.
00:19:26
Speaker
Maybe that's what I'm thinking. Okay, good. So kind of we recommend it to specific people out there. Yeah. Yeah. I think if he if you're in a pricing team, you're a manager and you want an insurance read as a refresh, um it's a good one so it's quite a fun read.
00:19:44
Speaker
If you're new in, yeah, I think it's a good one to read to understand how things work, why they work like they do. And if you're if you're thinking of a startup business, if you're like, what I think the world really needs is, and actually it's a genuine example from the book, say what the world really needs is divorce insurance.
00:20:00
Speaker
This is a brilliant book for explaining to you why it's not going to work.
00:20:06
Speaker
And we're nearing the end of June. Has there been a standout book for you this quarter? Well, do you know, I've got a run of disappointing nonfiction books this quarter, actually. yeah and But there is one. There's one that's been very good, which is Ultra Processed People.
00:20:22
Speaker
So it's not insurance related, but it's it's about the food industry and it is very good. Like it's the it's written in a ah passionate but non-preachy way.
00:20:35
Speaker
And it really makes you think about... is the aims of the food industry because spoiler in alert, it's not to provide you with a good diet. um So yeah, so I thought that was really good. Although another spoiler, if you really like ice cream, maybe give it a miss because I'm off ice cream and I used to really enjoy it.
00:20:56
Speaker
I think I gave that one five stars last year as well. I loved that book. I think I read the whole thing about weekends and I went back and reread it. Again, different section. Wow. That was so, I thought it was so interesting. There was so much in there that i was like, that's like gross and so informative at the same time.
00:21:14
Speaker
so was something about coal tar butter, butter made with coal tar, a marketing name, coal tar. And I thought, There's so much in there. I know that's not an insurance book. um Insurance people probably won't get anything out of that book other than will be absolutely horrified with the food that you sometimes eat. But I thought it was a really good book as well.
00:21:33
Speaker
i I agree. I totally agree. And I do wonder if you work in commercial insurance and you insure the food industry at all, I think actually it is really worth the read.
Next Episode Preview
00:21:43
Speaker
We'll be back next time talking about not one,
00:21:47
Speaker
but three award-winning books. ah Jeremy, you'll be sharing some takeaways for insurance professionals. Tell us about it. Yeah, so it will be a bit more quick fire. So going to try not to talk for like 20 minutes or half an hour about each one. We're going to be fast, fast, fast.
00:22:04
Speaker
But yeah, so it's three books. They all won an independent press award, just like Pricewriter did. So they're all the recipients of a statuette just like that one.
00:22:14
Speaker
So it's fantastic. I thought when I was there in um in New York and I met the authors of some of these books, I thought to myself, oh I should really talk about them and think about how they relate to insurance pricing and what we can get from those books.
00:22:29
Speaker
So I chose three. So we're going to have Passion st Struck. We're going to have Hiring Veterans and we'll have The Connection Playbook. So I'm very much looking forward to that. So I'm going to be talking about those three books and what we can learn about insurance pricing from them.
00:22:46
Speaker
Thanks for joining us. We'll see you next time.
00:22:54
Speaker
Pricewriters is a training and education company focused on insurance pricing. Find out more about our engaging training, graduate schemes and workshops by visiting pricewriters.com.