Bryan Caplan  

Don't Call Me Stupid

Immigration... Suckers of the World, Bet!...

I've proposed several alternatives to the adverse selection explanation for missing insurance markets. Here's another, with a somewhat Hansonian flavor: In part, people buy insurance so they don't "look stupid" when something bad happens to them.

If you get in an auto accident and you don't have insurance, then most middle-class Americans will consider you an idiot. But for some reason, they don't consider you an idiot if you fail to buy long-term care insurance and suddenly need it - even though it could be argued that long-term care is a smarter buy than a lot of auto insurance.

The result is multiple equilibria. If most people buy insurance and you don't and something bad happens to you, you get a double whammy - the direct loss plus the idiot's stigma. If most people don't buy insurance and you don't and something bad happens to you, you are only out the money. If most people buy it, you want it too; if most people don't, you probably don't want it either.

By way of analogy, consider these two scenarios:

1. You lose $1000 in some unforeseen way.

2. You lose $1000 in a way your spouse specifically warned you might happen.

It seems to me that #2 is MUCH worse for most people than #1. $1000 is no big deal; but $1000 plus the scorn of your spouse is a very big deal. Now think how much worse it would be if everyone took your spouse's side against you. Ouch.

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The author at Les Jones in a related article titled Now There's a Stigma I'm Familiar With writes:
    Bryan Kaplan writes about economics and idiot's stigma: If most people buy insurance and you don't and something bad happens to you, you get a double whammy - the direct loss plus the idiot's stigma. If most people don't buy insurance and you don't and... [Tracked on September 27, 2005 9:00 PM]
COMMENTS (17 to date)
Timothy writes:

Now think how much worse it would be if everyone took your spouse's side against you.

Then you'd be any number of present-day male sitcom characters. And that would be an unfortunate life.

Bernard Yomtov writes:

Long-term care insurance may be a sensible idea in principle, but the available packages are unattractive to me. I want a high-deductible policy with generous payments once the deductible was satisfied. That is, I was worried about paying for quality care if I need it for a long time. Such a policy seems to be unavailable.

John P. writes:

Good point, Bryan. Fear of the idiot's stigma is underexamined as an explanation of why people do what they do.

Chip writes:

I think there may be something to it. A similar example:

I was in the office lottery pool where I used to work. We each pitched in a couple of dollars a week and bought Powerball tickets. In the four years since I left, I don't think I've bought more than two tickets.

The main reason I played in the pool was that if lightning struck and they won big, I couldn't bear the thought of being the poor sap left working there.

Rob writes:

You have a very persuasive model for why people may over-insure for things like auto insurance, but it does not explain why people may under-insure for long-term care. If you take out the “I told you so factor,” as you do for long-term care insurance, then people should buy just enough insurance. With your analogy, they would buy just enough to cover the $1,000 loss, adjusting for risk aversiveness, etc.

Tim Harford writes:

Clever... but aren't you slightly begging the question? You say "for some reason, they don't consider you an idiot if you fail to buy long-term care insurance and suddenly need it" - but isn't that a large part of the puzzle you're trying to explain? Your explanation allows each person to be rational in responding to his unreasonable friends - but why are the friends unreasonable?

Oskar Shapley writes:

Insurance is by definition the alternative with the higher cost (expected value), the difference being the administrative costs plus profit margin of the insurance institution.

Not insuring is the better choice since your EV will be lower. Unless of course the particular event causes you to have additional costs, which cannot be included in the insurance. For example, losing your car because of an accident may cause you to loose transportation to your employment location (which can be as far as 50 miles away).

spencer writes:

I wonder if the real reason people buy auto insurance is that in most states they are required by law to buy insurance.

Are there any states left where you can drive an uninsured car?

If your car is your largest asset driving an uninsured car is not an illogical decision.

spencer writes:

For an individual making average hourly wages --some 80% of the labor force -- $1,000 is over a weeks income and some two to three weeks of take home pay.

Kind of puts your theory where $1,00 is no big deal into perspective.

DK writes:

Note that most people only need long-term care insurance at a time when many of their friends/neighbors are dead. Thus, there are not as many people around to call you an idiot.

Also, I wonder if the tendency to underestimate long-term needs is related to the tendency to overestimate the risk of dramatic death from airplane crashes, asteroids, etc. we all imagine going out quickly.

Roger McKinney writes:

As I wrote in a previous post, I think the issue has a lot to do with time preferences. Long-term care insurance covers a distant future while extended warranties cover a near future. As a result, people discount the benefits of long-term care much more, maybe too much.

Nathan Zook writes:

Well, there were no problems for us in this particular example. We bought a house with a one-year "home warrantee" by American Home Shield. We actually had to call them out. My wife was spitting nails over their service.

Suggested solution to convincing a reluctant spouse to drop home insurance: break something.

R.J. Lehmann writes:

It strikes me one of the major reasons people do not buy long-term care insurance is that all of the items it covers would also covered by Medicaid, if one were to be in the unfortunate circumstances of suffering a debilitating illness or injury which rendered one incapacitated. In fact, in 46 of the 50 states, any payouts one might receive from a long-term care insurer would count AGAINST one's eligibility for Medicaid, thus providing further disincentive from purchasing the coverage.

Also, in thinking of auto insurance, it's useful to think of the product as essentially several different kinds of insurance bundled together. When it comes to collision coverage and other insurance against damage to the car itself, except for very pricy or one-of-a-kind vehicles, people will typically only buy the minimum coverage that the bank holding their auto loan requires them to hold. Most of what you pay for auto insurance comes from coverage of third party bodily injury. It might be wise to self-insure against dings and dents to my own car, but the risk that I might cause an accident that puts someone in a wheelchair for life is an exposure I would gladly pay a premium to transfer to someone else.

cicero writes:

From what I've learned, if there is a market failure of any type, the first cause you should look for is the Government creating preverse incentives.

Have you considered two possiblities:

1. The employer provided insurance tax exemption

2. Government provided insurance (Medicare & Medicaid)

Both of which have the effect of reducing the pool of potential buyers of individual health insurance. I suspect that this then changes the profitability factor for insurance companies, resulting in insurance plans that are unattractive to many buyers who would prefer to purchase more generous insurance plans, but prefer no insurance to the less generous plans.

R.J. Lehmann writes:

Individual health insurance is quite a different product than long-term care insurance. Long-term care would be most needed by those who suffer impairments made it impossible for them to continue working, and thus no longer eligible for employer-sponsored coverage either. It is, however, crowded out by Medicaid, and to a lesser extent, Medicare.

Robert Speirs writes:

This post reminds me of voting behavior, which seems to be more closely linked to peer pressure than to any rational political calculation (if that's not a contradiction in terms!). In some communities, you just can't admit you voted for a Republican without being shunned forever. And most people, knowing that their one vote isn't going to change anything anyway, don't see the point in getting their friends all riled up, or in lying.

Robert writes:

On the good side, this article prompted me to learn more about long term care insurance. We'll probably be getting some since, in our case, it is not that expensive.

On the bad side, it seems to me highly likely that by the time I need it, the major boomer cohorts will have driven some insurers out of the market, perhaps leaving me with no coverage at my grandfathered rate.

So, more so than with auto insurance I have to balance:
1. The risk that I will need it plus
2. the risk that my selected insurer will still provide it when I need it
I think that risk 2 is less of an issue in auto insurance. If my assessment ends up being that the next twenty years will see major players leave the LTC insurance market, then maybe I wait until age 65 to decide to purchase at the then higher premium.

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