Insurance Law

RiskProf takes the dare

By The authors are Martin F. Grace and J. Tyler Leverty, professors of insurance and risk management a

I could be wrong about a number of things, but I try --in this forum --to be correct in applying economics to situations involving risk and insurance.  My opinions are based upon economic theory which includes the theory of how insurance is priced.  In a comment to a previous post on free insurance someone said

"No one is asking for free insurance. Compare the expected losses to the premiums. I dare you."

So, I take up the dare.  Except I punt a little.  I do not have access to expected losses.  So I look at past performance. 
One of the problems with this incredibly simplistic assertion is that it is based on the assumption that everything works with in a one year period.  Firm's are in business for the long run, thus they expect to make profits in the long run.  In fact, they do not have to make a profit every year, just in the long run.  Otherwise they will leave the market.

In the figure below I plot the loss ratio (losses incurred in a given year to premiums earned).  Thus this is actual losses rather than expected.  Florida has the big swing in 2004 and 2005 due to the hurricanes in those years.  If we look at the average of these ratios over time Florida's is 72.77.  that means that for every dollar of insurance premium paid, the state's customers received 72.77 cents in loss payments.  Kansas (one of those middle states without any hurricane risk) has a relatively stable loss ratio and an average ratio of 62.64.  That means for each dollar of premium paid, the state's customers received 62.24 cents back in loss payments.  Finally, in the U.S. overall, the average loss rat is just a bit above Kansas'.

So, Florida's customers already get a better deal than the average customer in the U.S. given that they receive more back in terms of loss payments.  They would like an even better deal (as would I).  To get this better deal, they would like Kansas and the other states to chip in. 

The data come from the NAIC and are available from them if the commentator wants to check my work.  To be fair, maybe no one wants free insurance.  Maybe they just want less expensive insurance.  Either way, someone else who doesn't share that risk has got to chip in to make it so.

Insurance is not socialized risk sharing.  It is sharing of risks where everyone pays their risk based price price. And for the record, I was (and still am) against federal programs like TRIA.  I also believe that the private market could cover flood insurance

Full post as published by RiskProf on April 27, 2009 (boomark / email).