The Economics of Insurance: a few thoughts

Insurance – it's that thing we all kinda hate but know we need. Let's break down the economics behind it, without all the fancy jargon.

Price Elasticity: How Much Does Price Matter?

Price elasticity is basically how much your demand for something changes when the price changes. With insurance, it's not always straightforward.

Health Insurance: Most people see health insurance as a necessity, so even if it gets more expensive, they're probably still going to buy it. That's why health insurance has low price elasticity.

Car Insurance: This is a bit more flexible. If your premiums get too high, you might consider dropping optional coverages like comprehensive or collision, or shopping around for a cheaper policy. So car insurance has higher price elasticity than health insurance.

Unlimited Supply: Insurance Companies Can Keep Selling

Unlike physical products, insurance companies don't have to worry about running out of stock. They can keep selling policies as long as they can manage the risk. This means that the availability of insurance isn't limited by production costs or supply chains, which is very different to a e-commerce model, that can create scarcity and run sales to get rid of old or depreciating stock.

Loss Ratio: Balancing Premiums and Claims

The loss ratio is a key metric for insurance companies. It's basically the ratio of how much they pay out in claims compared to how much they take in as premiums.

A high loss ratio means the insurance company is paying out more in claims than they're taking in. This isn't sustainable in the long run, and they might need to increase premiums or reduce coverage.

A low loss ratio means the insurance company is making a profit. This is good for the company, but it also means they might be able to offer lower premiums or more benefits to their customers.

Adverse Selection: The Risky Pool

Adverse selection is when the people who are most likely to need insurance are also the most likely to buy it. Imagine if only the people who knew they were going to get sick bought health insurance – not good for the insurance company!

Insurance companies have to be careful to avoid adverse selection. They use underwriting practices to assess the risk of each individual applicant and set premiums accordingly.

Moral Hazard: Taking Advantage of Coverage

Moral hazard is when people change their behavior because they have insurance. For example, someone with car insurance might drive a bit faster if they think they're covered.

Insurance companies try to discourage moral hazard by using things like:

Deductibles: This is the amount you have to pay out of pocket before your insurance kicks in. Deductibles can help to discourage people from making small claims.

Premium surcharges: If you get into an accident or have other risky behavior, your insurance company might charge you a higher premium.

Insurance can be a bit complicated, but understanding these basics can help you make better decisions about your cover, or understand the sector in a little bit more detail.