There is one perspective on fairness that dominates the minds of insurers. It is the fairness of merit, which involves higher risks pay higher premiums and lower risks pay lower premiums. Most of the recent innovations in insurance have focussed on singling out those lower risks, so as to attract them to your portfolio. And every established insurer has a strategy that aims to tackle the associated concept of adverse selection. However, I think a certain amount of group-think has crept into the sector’s thinking on this. And so I want to challenge the primacy given to fairness of merit, drawing on recent research into how people act in real life.
Fairness of merit is premised on the notion that it is only fair that higher risks pay higher premiums and lower risks pay lower premiums. It underlies the digital strategies of most new and established insurers. More and more data, turned into insight by ever more clever analytics, will identify lower risks in more and more detail. They can then be offered better rates, so improving portfolio performance. That’s the sector’s line of thought.
This is also a race to achieve informational primacy. The quicker insurers can find out more about us, the sooner they can adjust rates and draw lower risks in and push higher risks out. As a result, insurance has entered into what one of the sector’s data scientist told me was a ‘data wild west’, with insurers doing all they can to collect as much data as they can, before others get to it before them.
A Lop Sided Narrative
Behind the sector’s focus on fairness of merit lies a belief that consumers share in its sentiments. Why pay for the claims of your accident prone neighbour, goes the sector narrative. Yet it is a frequently lop sided narrative, focussed almost exclusively on the upside and saying little of the downside. That downside of course is that as the fairness of merit narrative rolls into every more detailed data, you will end up not only not paying for the claims of your accident prone neighbour, but paying for your own claims when they arrive. After all, if you’re not paying anything towards other people’s claims, why should they pay anything towards your claim. It will be just down to you.
The fairness of merit narrative is written in relation to individual consumers. It’s all about you, rarely about us. It all feels like too much of an appeal to narrow self-interest.
It’s a lopsided narrative for another reason. People can often make decisions that go beyond their narrow self-interest, reflecting instead wider community and social interests, even in situations where they’re not known to each other. This isn’t altruism, but a sense of what researcher are calling strong reciprocity – the ‘predisposition to cooperate even when there is no apparent benefit in doing so’.
Acting with Strong Reciprocity
Why is this so? Part of this ‘sense of fairness’ may come from ‘the shadow of the future’ – the sense that eventually we too could be at the receiving end of self-interested behaviour. We tend then to respond with a sense of cooperation instead. Another reason may come from trust – we give in order to receive, and in doing so, build a virtuous circle of trust. This is not unconditional – we’re brought up to read all sorts of cues and signals on trust, but also to recognise that we have more in common than we often think, can be better off by acting together.
Now some of you might be thinking that this is all rather old fashioned thinking. Surely, they say, data and analytics can replace those judgements with lots of real actionable insight. Well, the opposite might actually be the case – the deluge of information can often exceed our capacity to process it and we fall back on our intuition about what others will do.
Experiments by behavioural economists have found clear evidence for strong reciprocity. A number of studies show that those who act purely in self-interest are often in the minority – most seek some level of cooperation, even at cost to themselves. Researchers have since extended this work into ownership structures.
Now some of you will be thinking along the lines of ‘remind me what this has to do with insurance’. It points to us not always acting in self-interest, thereby exposing to question the assumption that we want our insurance to be organised according to fairness of merit. Think of all those mutuals and friendly societies established in the 19th century, building pools of risks based more on group interest rather than self-interest.
Insurance as a Political Technology
In modern times, this sense of reciprocity has helped to raise awareness of financial services paying attention to two other dimensions of fairness: fairness of access and fairness of need. Both of these are now significant initiatives close to the heart of regulators like the UK’s FCA.
So does that mean fairness of merit is now a non-starter? Not at all. It’s just that I think its use has been over extended. And if that over extension continues to build, and if the primacy that it holds in sector thinking continues, then, as I have explored in earlier posts, this could ultimately lead to the deconstruction of insurance and a vacuum of provision for much of society. That is why insurance is sometimes referred to as a ‘political technology’.
The Fairness of Crowds
So what might stand, if not in place of fairness of merit, then at least alongside it? I’m going to call it the fairness of crowds. And I’ll illustrate it with something that I’ve long had an interest in – common pool resources. This has its origins in the common land found in many parts of England before the ‘enclosures’ of the 17th and 18th centuries. This was land held collectively by local people that carried both rights and responsibilities.
One argument that backed the enclosure movement was that if all commoners exercised their rights, the common land would be over-exploited and so damaged. Better, the argument went, for it to be divided up so that each person could manage their own allotment in their own interest. What this argument overlooked, was how commoners worked together to maintain their commons so that it continued to provide for them over the years. Doesn’t this remind you a bit of the modern case for sustainable development? I think it does.
Insurance as Common Pool Resource
Let’s move this firmly into the language of insurance. I see an insurance pool as a financial form of common pool resource (CPR). In other words, the contributions built up over time to pay out claims on risks that might happen once every 5, 10, 50 or 100 years. I see the notion of fairness of merit regulating the interpretive divide between (in CPR terms) the stock variable and the flow variable. In other words, how much must be kept in the pool to make it sustainable, and how much (and under what rules) can the pool be safely accessed without endangering the sustainability of the pool.
What this means is that fairness of merit, in very simple terms, does not determine the make-up of the core insurance pool, but does help manage the way in which risks are added to or subtracted from the core pool. The danger is that in today’s world, fairness of merit is being used to determine both the make-up of the core pool and the way in which risks are added or subtracted from it.
And I would further suggest that the reason why fairness of access and fairness of need now underpin regulatory initiatives like vulnerability and inclusion, is that before, they were less of an issue because common pool resource naturally encompassed those consumers. Not brilliantly, but, I would say, better than we are increasingly finding in today’s market. Nowadays, because of the way in which fairness of merit has been extrapolated to the extent of dominating modern insurance discourse, vulnerability and inclusion are more of an issue because that common pool resource is no longer as accessible as it was in the past.
What Consumers Want
And this is not what consumers want. It is not how consumers think and act. Research into strong reciprocity points to us wanting the common pool resource protected, but not to the extent that it erodes access to the resource over time or across the diversity of people reliant on it. We want fairness of merit, but not to the extent that it imperils fairness of need and fairness of access. We want what I’m calling the fairness of crowds.
What I’m calling for is a balancing of discourse on the fairness of merit, with that on the fairness of crowds. This would bring sector thinking more into tune with societal thinking. If this balancing of discourses fails to take place, if fairness of merit comes to define modern insurance, then the sustainability of the sector is cast into doubt.
I am conscious that, in developing this notion of fairness of crowds, I have linked, in layman terms, several academic disciplines, in none of which I have expertise. However, what I would also say, is that I have sought to link their core concepts with the current debate on the future of insurance. In simple terms, exploring where the sector could innovate its thinking, in order to achieve an equality of fairness across insurance and society.