Three Puzzles In Insurance

In my career I noticed three strange things about insurance that made it stand out among other industries:

  1. Why does nobody ever want to buy insurance yet it is a massive industry? 
  2. Why do companies and individuals crave outside guidance (regulators, peers, rating agencies, etc) when making decisions about risk?
  3. Why was the discourse in the business so moralistic? 

I used to think insurance was strange, now actually I’m coming to think of insurance as the most human of all business pursuits and it’s all other commercial activity that’s weird.

As a result, I think the deep insight we’ll gain into insurance by answering each of these questions will also reveal much about human nature and, I think, a view into how our culture will evolve over the next decade, century and even coming millennia (assuming we don’t kill ourselves!).

So here are my answers as they stand today!

1. Why insurance exists despite nobody wanting it

I sometimes am surprised I don’t get more pushback on the premise of this statement. In some sense insurance is buying nothing (protection for some imaginary thing that hasn’t happened yet) for something (money). No right thinking ape would ever do such a thing and we are right to hate insurance and be very skeptical of its purchase. Even when we think it’s a good idea, do we really know? Daniel Kahneman won the Nobel Prize for his work showing how clouded our personal judgement is about risk.

But insurance exists because in another sense we actually know very well how poorly we understand risk and our culture has evolved systems for compelling us to protect ourselves. Insurance as we think of it today is just one feature embedded within a whole universe of risk management techniques. They mostly all, however, boil down to one simple concept: our cultural compatriots, our community, protect us from risk. It does this by your neighbor offering a couch if your heat conks out in the winter, by your spouse forcing you to buy life insurance or by the nation state mandating liability insurance for your use of the most dangerous tool humans have ever created, the automobile.

In short we buy insurance because it’s compulsory. The amazing thing about that is that we tolerate being compelled; we are forced to be our better selves by our community.

2. Why do companies and individuals crave outside guidance (regulators, peers, rating agencies, etc) when making decisions about risk? 

I noticed this when negotiating with insurers about how much capital they should hold (in a mix of money and reinsurance). Nobody knows how to answer the question, really. How do you tell how much risk you should take? How do you even think about risk? Who takes it? Wouldn’t it be better if someone just told you the answer?

There are exceptions to this rule in the form of some folks who have unusual conviction in their own judgement. Those types often wind up as entrepreneurs and make these kinds of decisions all the time. The rest of us, however, freeze in the face of this question, and seek answers elsewhere.

The answer to why is that we have literally evolved to think this way. By think I actually mean *not* think, as we usually define ‘think’, and instead mimic authority figures when confronted with uncertainty. Here I’d point the studious reader to a book by Joe Henrich or perhaps my podcast with him.

The key idea is to realize that the world is literally inconceivably complex and a single human mind cannot figure everything out for itself. We use culture as a playbook for thriving in the world, letting us use all kinds of technology we don’t understand by just copying others. This is quite literally the secret to Humanity’s dominance and risk decisions are but one teeny, tiny application of it. Even the most contrarian and independent minded entrepreneur is a mindless, mimicking automaton in the context of the amount of true understanding he/she has for how to navigate the world.

3. Why are insurance people so moralizing?

I do feel the need to defend this statement for a sec. One thing I noticed fairly early in my career (and it always made me bristle) was how viciously insurance underwriting teams criticize their competitors.

Competitor turning a profit? Must be cheating. Competitor lost money? Must have tried to cheat and failed.

Both success and failure are the result of moral inferiority. Insurers live in a continuous test of character. Are you sacrificing the future for a quick buck today? By our nature we are critical of others we don’t know but in insurance this human quality is dialed up to a white hot intensity.

The investigation into morality is probably one of the more surprising undercurrents of my podcast given its insurance focus, even to me! But this behavior really puzzled me and it was a while before I finally started locking onto an answer. And the beginning of the answer came from the work of another anthropologist, the little known Mary Douglas, in particular in her book with Aaron Wildavsky, *Risk and Culture*. I devoured that little book, it was like finding a barrel of water on a desert island.

The key here is that questions of uncertainty are resolved through social decision making, as I mentioned above. We have a term for social decision making processes, it’s called politics. And politics, in its purest form, is rooted in morality. As Jonathan Haidt teaches us in the excellent *The Righteous Mind* the fiercest political debates reduce to competing moral frameworks, to differences of emphasis of values we all mostly subscribe to. The piece that I could fill in after reading Mary Douglas was that morality is the foundation of our technology for making decisions about risk. Moral systems are what guide us in figuring out which risks to focus on and how do deal with them. In ancient societies this means rain dancing and food taboos and in modern societies it can mean what kind of insurance to buy!

I have much more to say on these topics, in particular about how we can use these insights to make a better society. Stay tuned!

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