There’s a view becoming established in the UK insurance market that it’s only fair that premiums should become more personalised to your own losses. ‘Why should you pay for the losses of your accident prone neighbour’ is the question being asked. And insurers are now able to deliver increasing levels of personalised premiums, but will the outcomes of this trend always be positive for customers?
We know that insurers has always sought to base the premium you pay on the level of risk you present. This seems only fair; what I’ve previously referred to as the ‘fairness of merit’. It’s not however always been possible to accurately gauge what that level of risk is. Information about the risk may be incomplete, leaving insurers to sometimes rely on proxies for the actual risk involved. And this has proved problematic: some proxies have turned out to be less representative than first thought. As a result, some people have paid more, and some less, than they perhaps should have.
And then there’s the basic reality outlined in this earlier post that risk assessments are inherently subjective: there is no such thing as an ‘objective premium’. So insurance premiums will always be imprecise to some degree.
There can of course be swings and roundabouts here. You may pay more for one aspect of your risk, while paying less for another. However, risk pooling blends many of these aspects together and, in the round, many people are satisfied, even though some will be paying less than they should have.
So should such individuals be eliminated? Are they a drag on the efficiency of the market? Not always, according to an interesting paper by the philosopher Xavier Landes. In the latest Journal of Business Ethics, Landes asks whether actuarial premiums might sometimes be unfair. In one strand of his paper, Landes uses the example of the great scientist Marie Curie to illustrate the consequences of a strict interpretation of such fairness.
Marie Curie would have been a nightmare risk to underwrite for health insurance. Her ‘epoch making’ research into radioactivity exerted a considerable toll on her health. Her research papers are so radioactive they can still only be accessed today using protective clothing. Yet we are all now benefitting from her determination and scientific brilliance. A world without the likes of Marie Curie would be a universally poorer one.
Yet someone like Marie Curie clearly presented a risk to the pool of French health risks far in excessive of the premium she would have paid, yet alone been able to pay. A personalised premium for her health insurance may indeed have seemed fairer on her contemporaries, but in the long run, her contemporaries would have paid an even greater price without the benefits that the pooling principle behind Curie’s health risk brought to them all. A key point in Landes’s paper is that such benefits only come apparent over the mid to long term. If you view actuarial fairness only in the short term, you fail to account for the benefits that risk pooling can facilitate in the longer term.
To sum up. Insurance reduces a lot of the uncertainty that individuals face: that’s what’s caused it to become so interwoven into our everyday lives. Historically, it has catered for the complexity of personal and working lives, and the risks they create, through a pooling mechanism that has also enabled the risk from certain unusual or adventurous endeavours to be absorbed within a community of like minded people. Out of this has come great science, new inventions and new markets, the benefits of which has fuelled progress at many levels of society. Take away that pooling and not only will insurance change, but so will society too.
So, when weighing up the merits of personalisation and pooling, remember to take account of the long and short term, and the benefits and the costs, and the insurance case and the social case. And don’t forget to tip your hat to Marie Curie, as I did recently while waiting for x-rays of my daughter’s back after a riding accident.
Duncan is the founder of the Ethics and Insurance blog and the author of its many posts. He's a Chartered Insurance Practitioner, having worked 18 years in the UK market. As an adviser to many firms on ethics issues, as well as a regular conference speaker, he is one of the leading voices on ethics and insurance.