Arnold Kling  

Why Get Insurance?

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What I'm Saying... The Moral Hazard Story...
My best guess is that most insurance is bought not to reduce risk but instead to signal prudence and caring. The first life insurance companies had a terrible time selling "bets on their death," and only succeded when they framed insurance as what a caring and prudent husband and father did to take care of his family. While simple adverse-selection theories predict that high risk folks buy the most insurance, in fact low risk folks buy more insurance. And we don't want to insure our big life risks because such a desire would signal a lack of confidence in our prospects.
Of course, that is Robin Hanson.

Of course, prudent people may select insurance because they really are prudent. The trick is to measure how much additional demand for insurance is motivated by the desire to signal prudence.


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COMMENTS (8 to date)
Brad Warbiany writes:

When my first son was born, I took out a sizable policy largely out of prudence. I want to be sure that he, my wife, and now my second son are more than able to live for several years (and likely longer) without having to worry about whether or not they can eat or pay rent. It may not be enough to ensure they'll live in luxury, but at the same time it's more than enough to take worry off their mind.

Of course, the comment I'm leaving here (and the comments I've made to family about life insurance) is pure signaling.

I made the decision for prudence, but the signaling is a really nice side benefit :-)

Robert Speirs writes:

Isn't the desire to signal prudence itself a sign of prudence? Making other people aware that you are prudent is the only prudent thing to do.

z writes:

And safe drivers use their signals frequently to signal to others that they're safe. C'mon, this is just silly (and yes, I did bother to read his whole piece).

"Most insurance is bought not to reduce risk, but to signal caring and prudence."

Well, let's see:
-Corporations buy insurance for a whole host of things...so they don't lose too much money if something bad happens.
-People buy car insurance because it's mandated, and because most people could afford the unexpected costs associated with a car accident out of pocket. Don't know anyone who has ever bragged about their how prudent they are by talking about their great GEICO policy.
-People buy health insurance, or get it through work, because they think it will cover unexpected health care costs and hopefully provide them better access to care.
-People buy life insurance to provide for their families if they unexpectedly die. If making a reasonable investment signals prudence (as opposed to say, buying $100 worth of lottery tickets a month as a 'life insurance policy'), then, I guess you could argue his point, but it's a stretch.

Nathan writes:

How useful would buying insurance be for someone eager to signal prudence? It's a singularly invisible signal.

It's hard to imagine anyone aside from your spouse and your insurance broker who would know how much insurance you have. Your spouse presumably knows enough that you won't be able to fool him or her very easily and it's unlikely you care much what your broker thinks of you.

I suppose you could talk to others about your insurance, but then it's unlikely you would be invited out of the house much, so opportunities to signal would be limited, and you could easily lie so why bother getting the insurance?

Z writes:

"How useful would buying insurance be for someone eager to signal prudence? It's a singularly invisible signal."

Great point. Now, on street corners in New York, along with knock-off Coach and Prada bags, maybe they'll sell knock off Met Life policies. Now you, too, can brag to your friends about how well off your family will be if you drop dead. Everyone will be so impressed by your prudence.

DanT writes:

Many people are not inclined to pursue logical financial strategies. The exceptions (myself included) buy insurance purely for risk hedging.

Those disinclined towards rationality pursue financial strategies based upon emotion. These people are likely prone to using insurance for emotional reasons, such as signalling prudence. Prudence signalling is a private phenomenon: my spouse will know and care if I have insurance, but my neighbor will not.

Us logical types are puzzled by the phenomenon of people who hold insurance in excess of their logical needs; the industry calls this being "over insured."

To the extent people are over insured, they are signalling something; they could be signalling prudence or signalling wealth. Since insurance premiums are not public, it is only effective as a private signalling mechanism - thus for prudence and not wealth.

Given associative mating, it is likely that the spouse of an emotional finacial decision maker does not understand that not being over insured is prudent. It is also likely that the spouse of a logical financial decision maker knows it is prudent to not be over insured.

So logical financial decision makers are not over insured, and thus signal prudence to their spouses; while emotional financial decision makers are over insured, and thus signal prudence to their spouses.

There is a correction to the above for those who are under insured because they are only using insurance for signalling and not risk hedging. Under insurance is harder to measure due to self-insurance, so it is left out of this analysis.

Since the logical financial decision makers incur no signalling costs (since singnalling costs are not efficient), the amount of over insurance is a lower bound to the cost of signalling prudence.

Dezakin writes:

Did signalling somehow become a euphamism for anxiety management? I sure as hell dont buy insurance to tell anyone about. I buy a flashy car, a new suit, or a ivy leugue education to signal to people, but the only signalling I'm trying to do with insurance is to tell the cop I dont deserve a no insurance ticket. Unless signalling is signalling to myself that I dont have to worry about unfortunate circumstances, the insurance as signalling hypothesis doesn't hold water with me.

We might as well suggest that buying lottery tickets or playing roulette is done to signal an adventursome personality.

Joe Cushing writes:

"we don't want to insure our big life risks because such a desire would signal a lack of confidence in our prospects. "


I agree with this. What kind of return would it take to get you to face the risk this guy is taking.....?


.......He faces a 50% probability that he will lose half of his wealth and 30% of his gross income for up to 2 decades. In addition to this, the debt that based on 30% of income is slow to adjust to a loss of income. This debt is enforceable by jail time.

The largest financial risk the average man takes is to get Married and have children. Today, we are sending fathers away to the west's only debtor's prison where inmates are mixed with regular prisoners. The closest thing we have to insurance is a prenuptial agreement that can save most of the wealth but do nothing for the income and jail risk. Yet,many people won't even take out this protection.

Of course many men are reluctant to enter into this agreement and we are ridiculed by women for being afraid. I think fear in this situation is rational. They don't' sell marriage and child support insurance.

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