 I want to talk about the difference between two types of surprises or two types of contingencies. The one type of surprise is what is referred to as risks and risks we can ensure against. The other type of surprise are uncertainties, uncertain events against which we cannot ensure ourselves. This distinction between risks on the one hand and uncertainty on the other hand was introduced in the economics literature by Frank Knight, a famous book, Risk, Uncertainty and Profit that appeared in the early 1920s. Frank Knight was one of the big men of the Chicago School but has in fact, when it comes to this distinction, little in common anymore with what came after him. Later on, Ludwig von Mises made the same type of distinction. He didn't call it a risk and uncertainty he called it. There are two types of probable statements, one that he referred to as class probability and the other one that he referred to as case probability. This distinction that both of these economists made has its foundation in some work that was done by Ludwig von Mises' brother, Richard von Mises, who was a famous mathematician. He was also a member of the Vienna Circle, the Schlickkreis that I mentioned in my introductory lecture. Just let me say a few words just to introduce Richard von Mises to you. Richard von Mises was two years younger than his brother but was born in 1883. Mises was born in 1881 and Richard died in 1953. In my introductory lecture I missed Ludwig von Mises' year of his death. I dated that in 1981, in that case Mises would have been 100 years old. Actually he died in 1973. The 81 was just his birthday but 100 years before. That's why I messed up on that. Richard von Mises was a professor of mathematics at the University of Strasbourg from 1909 to 1919. Strasbourg at that time was part of Germany and was then lost to France after World War I and became a French city but it is still in character a German city. I will not blame Guido Hülsmann for this event that happened. Obviously he had nothing to do with this. He had to leave Strasbourg because it became French. In 1921 he was appointed professor of mathematics and director of the Institute of Applied Mathematics at the University of Berlin which was at that time probably the world's foremost university. He was a colleague of Albert Einstein who was the head of the Institute of Physics and he was the head of the Institute of Mathematics. When the National Socialist dismissed Richard von Mises from his post because he was Jewish actually at that time he had already converted to Catholicism but nonetheless the Nazis did not recognize something like this I guess. In 1933 Richard von Mises went to Istanbul in Turkey where again he worked until 1939 as a professor of mathematics and then he emigrated to the United States where he finished his career as professor of aerodynamics and applied mathematics at Harvard. His most important book dealing with probability theory was initially published in German translated into English, it's called Probability, Statistics and Truths. I should mention that for the theoretical part that I'm covering here I have also an article that was published a few years ago in the Quarterly Journal of Austrian Economics with the title The Limits of Numerical Probability so if you want to deepen your understanding of what I'm going to say here I would simply refer you to this article. I have some sort of theoretical problems that I want to discuss and then I want to apply these theoretical considerations in particular to the problem of health insurance. So I begin with the slightly more difficult theoretical things and then I hope things will become clearer as I apply them to the case of health insurance. Let me begin by giving you an intuitive understanding of the workings of insurance and then delve into some theoretical problems a little bit more deeply. Any type of insurance involves the pooling of individual risks and it implies that to some of the insured more will be paid out than what they paid in terms of insurance premiums and to others less will be paid out than they paid in terms of insurance premiums but the decisive mark of insurance is that no one of the people who takes out insurance knows in advance who the winners will be the winner being those of course who get paid out more than they paid in and no one knows if he will be a loser that is if he will be one of those that paid premiums but nothing happened to them. So the winners and the losers are distributed so to speak randomly and every insurance does involve obviously some income redistribution but the income redistribution is random it is unpredictable no one knows whether he will be on the winner's side or on the loser's side otherwise if the winners or the losers could be systematically predicted the losers would not want to pool their risk with the winners but only with other losers. To give you an example let's say you are a professional football player and another person is like myself sitting behind a desk and then riding and look at the example let's say of an accident insurance now if an insurance would pool the risk of professional football players with the risk of those people who work behind a desk then you can automatically predict who the winners will be and who the losers will be. The losers will obviously be the people who sit behind the desk because very unfrequently do they fall over and break their neck whereas in the case of professional football players that happens to be some daily risk that can occur. So in that case it is easy to predict that the desk worker so to speak would say I don't want to pool my risk with the risk of a professional football player I rather pool my risk only with somebody who does a similar occupation that is similarly non-dangerous as my own. Now if we look at the market of insurance we would see that competition defined as free entry into the line of the insurance business competition between insurers would eliminate all systematic redistribution should it somehow exist. Unless of course the motive of voluntary subsidies on the part of the losers would be involved that is to say if I love professional football so much and they are so dear to me that I want to support them and I might want to insure myself with professional football players also but if this motive is not present then obviously what would happen would be that affirm that wrongly grouped people with different group risks into the same group that mixed people with objectively different risks in the same group would be outcompeted by other companies that realize that some misgrouping has occurred because the other insurance company noticing hey there are obviously significantly different risk groups involved here would be able to offer lower insurance premiums to the losers than would shift from the wrongly classifying insurer to the insurance that classifies people in the correct way and those football players would then be left only with other football players having to pay a higher insurance premium reflecting the higher risk of these people. So what we can say then is competition between insurers would lead to ever more and refined subgrouping discriminating according to the actual group risk and the premiums that they would charge would reflect this genuine insurance risk of people who fall in the same group and the price differentials that is the different types of premium charged would reflect this difference in risk that these various groups represent on the average prices would tend to fall and the discrimination could be based on all sorts of criteria that is something that insurance companies would have to learn in the course of time finding out that they made mistakes there are other insurance companies entering the market doing different types of discriminations charging lower rates or higher rates and so forth So this is as a preliminary introduction into how insurance works Now I want to come to the question of what type of risks are insurable what type of contingencies, what types of events, what types of contingency surprises are insurable and what types of contingency surprises are uninsurable and I begin with what is necessary in order to ensure something what type of surprises can be insured and there I want to begin by giving you first the definition of Richard von Mises The theory of probability that Richard von Mises formulated is usually referred to as a frequency interpretation of probability and he defines it in the following way First, it is possible to speak about probabilities only in reference to a properly defined collective Collective means nothing else but a group, a class of individuals Second, so unless you have a group, unless you have a class, every talk about probability is nonsense according to Richard von Mises Second, a collective appropriate for the application of the theory of probability must fulfill two conditions The first condition is the relative frequencies of particular attributes that is attributes are this occurs or this does not occur a person dies or doesn't die, a roll of six or a roll of seven or five my dies sometimes have seven things on it so the relative frequency of particular attributes within the collective tend to fixed limits I'll explain it in a second and the second condition is these fixed limits are not affected by any place selection I will explain that term in a second also that is to say if we calculate the relative frequency of some attribute not in the original sequence but in a partial set selected according to some fixed rule then we require that the relative frequency so calculated should tend to be the same should tend to the same limit as it does in the original set and then he says condition three is the fulfillment of condition two will be described as the principle of randomness was a principle of the impossibility of a gambling system and now I come to an explanation of this that makes clear what he has in mind here there he says imagine for instance a road along which milestones are placed large ones for whole miles and small ones for tenths of a mile if we walk along enough if you walk along enough along this road calculating the relative frequencies of large stones the value found in this way will lie around one tenths the deviations from the value point one will become smaller and smaller as a number of stones past increases in other words the relative frequency tends toward the limiting value of point zero point one this is the first condition that he has but then he says that is condition one is fulfilled however absent in this case is condition two because the sequence of observations of large or small stones differs essentially from the sequence of observations for instance of the results of a game of chance which is of throwing the dice in that the first sequence obeys an easily recognizable law exactly every tenths observation leads to the attribute large and all others to the attribute small the essential difference between the sequence of the results obtained by casting dice and the regular sequence of large and small milestones consists in the possibility of devising a method of selecting the elements so as to produce a fundamental change in the relative frequencies we begin for instance with a large stone and register only every second stone past the relation of the relative frequencies of small and large stones will then converge toward one fifths instead of one tenths the impossibility of affecting the chances of a game by a system of selection this uselessness of all systems of gambling is a characteristic and decisive property common to all sequences of observations or mass phenomena which form the proper subject of probability calculus the limiting values of the relative frequencies in a collective must be independent of all possible place selections so you realize with a milestone example if you choose a certain selection mechanism of using the members you get different limiting values and because of that there are so to speak laws that we can discover about the behavior of small stones and large stones whereas we could not observe anything like this when it comes to throwing a dice now for my purposes I want to just summarize quickly the fundamental statements that Richard von Mises makes now as a consequence of this definition of the range of applicability of the probability calculus first he says and is quite emphatic about it that the application of the term probability to a single event such as the probability of Mr. X dying in the course of the next year for instance is utter nonsense there is no class defined at all you can obviously not form ratios say 1 in 10 or 1 in 20 if something refers if we are dealing with an individual case you should realize from the outset that when you listen to a TV and various economists talk about the probability of such occurring the probability of such occurring like the probability of will the debt ceiling be increased they give you numbers obviously they have not the faintest idea of what probability theory is all about this is just bullshit there is of course a way to say something about how probable this sort of thing is but it is not based on probability calculus I can tell you the probability is 100% that the damn thing will be erased because they have done that all the time before but this is not based on long run frequency observation that I have made but simply by understanding how politics works and then he says the theory of probability can never lead to a definite statement concerning a single event second, Richard von Mises is equally insistent that the probabilities of the probability calculus are objective things empirical properties and magnitudes rather than subjective beliefs or degrees of confidence they are based on experience and further additional experience may lead you to revise the measurements and may lead you to a reclassification of various singular events into various collectives however only in referring to objective probabilities can the probability calculus ever be of any practical use and third and this is an implication of this he says he categorically rejects the notion of a priori probabilities no such thing as a priori probabilities exist again let me make clear what his criticism is of conceiving of probabilities is not as something objective, observable but of just degrees of subjective confidence as regard the subjective element he says criticizes John Maynard Keynes who is a subjective probability theorist Keynes for instance fails to recognize that if we know nothing about a thing we cannot say anything about it and its probability and then he notes that the peculiar approach of the subjectivists lies in the fact that they consider the statement I presume that these cases are equally probable to be equivalent to the statement these cases are equally probable since for them probability is only a subjective notion so there is obviously a difference between I think they are equally probable and they are equally probable and in order to find out whether they are equally probable we have to make observations we have to have data that show that they are and as far as the idea of a priori probabilities are concerned he says it is frequently held that if one plays with a perfect or correct coin, heads or tails and makes sufficiently large numbers of throws it is almost certain that the proportion of heads will deviate by less than one per mil from one half of all cases now with regard to this we only note that transition from the arithmetic proposition to this empirical proposition can be made only in declaring a perfect coin to be one for which the probability of both outcomes is one half and thus defining probability precisely in the way suggested by us namely as relative empirical frequency in long sequences so whether something is a perfect coin must be shown also by engaging in some sort of experimentation we cannot a priori know that the coin is whether the dice is indeed a perfect coin or a perfect coin or a perfect dice now getting a little bit easier Frank Knight on this question again Frank Knight explaining what risks are to which the probability calculus can be applied and which refer to events against which insurance is possible Frank Knight says if all changes were to take place in accordance with invariably and universally known laws they could be foreseen for an indefinite period in advance of their occurrence and would not upset the perfect apportionment of product values among contributing agencies and profit and loss would not arise now this is the same insight that you find also in Mises when he talks about general equilibrium or what he calls the evenly rotating economy I'm not sure if you have encountered this so far in the lectures but Mises there assumes what would happen if there is no change occurring anymore whatsoever and all future events could be perfectly predicted would there then be profits and losses and the answer that he gives no profits and losses would then disappear there would be still a uniform interest payment but profit and losses are no longer in place if there is no uncertainty in the world and then Knight continues however perfects foresight need not involve the ability to forecast every singular event and the absence of any kind of contingency or surprise for profits and losses to disappear Knight explains then it is unnecessary to perfect profitless imputation that particular occurrences be foreseeable if only all the alternative possibilities are known and the probability of the occurrence of each can be accurately ascertained even though the businessman could not know in advance the result of individual ventures he could operate and base his competitive offers upon accurate foreknowledge of the future if quantitative knowledge of the probability of every possible outcome can be had fore by figuring on the basis of a large number of ventures whether of his own business alone or that of business in general the losses could be converted into fixed costs thus for example the example will make it clear what he has in mind the bursting of bottles produced champagne or so that was the bursting of bottles does not introduce an uncertainty or hazard into the business of producing champagne since in the operations of any producer a practically constant and known proportion of bottles burst it does not especially matter even whether the proportion is large or small these losses become a fixed cost and even if a single producer does not deal with a sufficiently large number of cases of the contingency in question to secure a constant C in its effect the same result may easily be realized through an organization taking in large numbers of producers this of course is the principle of insurance as familiarly illustrated by the chance of fire loss no one can say whether a particular building will burn and most building owners do not operate on a sufficiently large scale to reduce the cost to constancy but it is well known the effect of insurance is to extend the space and to cover the operations of a large number of persons and convert the contingency into a fixed cost so this is Knight nowhere refers to Richard von Mises Knight could read German but I don't think Knight was interested in mathematics that much and Richard von Mises had come out with his main articles on the subject just a few years before Knight published his book but the idea is precisely the same only where the probability calculus can be applied where we have a collective where place selection is impossible only those things are insurable now Ludwig von Mises Ludwig von Mises says in order to be insurable something must be given that he calls class probability class probability obviously related to this idea of a collective that Richard mentioned interestingly even though Ludwig von Mises wrote his stuff much later than his brother did he does not refer in the sections that deal with his problems to his brother at all I indicated that two brothers had some sort of difficult relationship with each other so they might not have like to side each other he says the condition that must be fulfilled is the following I the insurer and the insured assume to know with regard to the risk concerned everything about the behavior of the whole class or the group or the collective of events but about the singular event me dying tomorrow, you dying tomorrow about the singular event we know nothing but that they are elements of this class we know everything about the class of males at age 62 for instance but about the risk applying to me as an individual falling into this class we know nothing except that I am also 62 and I am a member of this group for example I assume to know everything based on objective long run frequency distributions about the risk of hurricane damage to the residents of some specified territory about any particular individual and his particular risk I know nothing except that I am a resident of this territory for which we do have these frequencies calculated now you note the character of this definition the definition that Mises here gives first implies the absence of any systematic redistribution that takes place what I pointed out at the beginning about insurance if I know nothing about any particular person's risk except that he is a member of a group with such and such a group risk then all redistribution must be random must be unpredictable it also implies so to speak the homogeneity of all cases I know nothing that distinguishes other people who are 62 from me who are 62 as far as our likelihood of being dying in the next year is concerned and if in so far as I know nothing about a particular individual within a group except that it belongs to this group then in so far as they are homogenous this also implies that things that are insurable must have the character of an accident in order to be insurable events now then the question what types of surprises what types of contingencies are uninsurable and there Mises says that is the case if I know with regard to a particular risk some or all of the factors determining its outcome if I do know something about an individual case only about this individual case that has some influence or total influence on the outcome then we have a case of case probability in front of us and as far as case probability is concerned we can never make numerical statements because it is just an individual case now if we raise the question what types of events are of this nature that cannot be insured because we know something about individual cases then Mises is not always perfectly clear on this but the answer is that when it comes to human actions then we can say human actions are indeed always singular events why are they always singular events why can we not classify human actions into classes of events about which we have objective probabilities collected and the answer is for individual actions of course we always do know what the motive of this guy was what the reason of this guy was what the knowledge was that he had at this point in time what the knowledge was that he had at another point in time that is we have a method of place selection that is the method of place selection is the method of understanding people we can understand individual situations I can distinguish your action from the action of somebody else by knowing you by knowing your motives I cannot distinguish one stone falling from another stone falling because there is no way of me to understand what the stone is thinking if he is thinking anything at all so while accidents can be insured against actions that are individually motivated and driven by individual knowledge actions and the results of actions cannot be insured against but are something that falls into the realm of individual responsibility and this is a task of entrepreneurs so to speak to predict these sorts of things but not predict them according to objective probabilities now to applications as I said I have control over my actions you have control over your actions hence every risk that may be influenced by my actions is uninsurable and what is not controllable through individual actions is insurable provided long run objective frequency distributions exist and if something that was not controllable becomes controllable then it loses its insurability status with respect to risks of the type of natural disasters floods hurricanes earthquakes fires insurance is obviously possible because these events are outside of individual control I know nothing about my individual risk except that I am a member of a certain group of individuals on the other hand take risks like suicide or arson or unemployment or not getting up in the morning these are uninsurable events because I do have control over this I cannot insure myself against burning my own house down because I obviously do have control over this I cannot insure myself against becoming unemployed because I also have control over this whether it is big control or small control does not matter all that much you can always accept a lower wage rate for instance than you did before and you can become instantly unemployed if you kick your boss in the behind so there are many ways that you can affect the likelihood of being unemployed or being employed for that reason unemployment insurance is impossible that we have something that is called unemployment insurance means nothing governments always find nice words for things that are obviously completely different from what they really what they really are social security is another example that is obviously precisely social insecurity but they call it of course social security I obviously cannot insure myself against feeling ill in the morning and not wanting to get out of bed if I could insure myself against it I would pay the premium and I would always feel ill and not get out of bed I cannot insure myself against committing suicide tomorrow because if that were my intention to kill myself I would pay the premium my wife will be a millionaire tomorrow and I am dead insurance companies that do this sort of stuff will not last for very long in the market in all of these cases we cannot really say that I am a person and like all other persons I am afflicted by this risk of not feeling good in the morning and not getting up we know that we have control over this and we know that people do not fall into one and the same class but are different individuals and this sort of stuff belongs into the realm of individual responsibility and is uninsurable I can also not insure myself against making business losses because obviously it is easy as pie to make losses if I insure myself, make losses and then I collect from the insurance company I can also not insure myself against fractional reserve banking because if I can insure myself I will hold zero reserves and in that case my bankruptcy is guaranteed so no insurance company would ever take on a risk such as this so now applying this further to health insurance the immediate inside is obviously that health insurance is insurable only in so far as the health risk for a given group is accidental such as maybe accident insurance being stricken by cancer some bodily melt functioning and so forth but since most health risks and with the advance of medical technology more and more of such risks fall within the province of individual control very little in this field is actually insurable such risks again must be assumed individually and paid out of pocket or out of individual savings now it is noteworthy that in all recent discussions about healthcare reform this has been almost completely overlooked that there is no way that we can insure this type of stuff or most of it at least except for Mises early on in his career in his book Socialism he wrote this great foresight he said to the intellectual champions of social insurance and to the politicians and statement who enacted it illness and health appeared as two conditions of the human body sharply separated from each other and always recognizable without difficult or doubt any doctor could diagnose the characteristics of health and illness was a bodily phenomenon which showed itself independent of the human will and was not susceptible to influence by will now every statement in this theory is false he says there is no clear defined frontier between health and illness being ill is not a phenomenon independent of conscious will and of psychic forces working in the subconscious immense efficiency is not merely the result of his physical condition it depends largely on his mind and will thus the whole idea of being able to separate by medical examination the unfit from the fit and from the malingerers and those able to work from those unable to work proves to be untenable those who believe that accident and health insurance could be based on completely effective means of ascertaining illnesses and injuries and their consequences were very much mistaken the destructionist aspect of accident and health insurance lies above all in the fact that such institutions promote accidents and illness hinder recovery and very often create or at least intensify and lengthen the functional disorders which follow from illness or accidents I should mention to underline this insight that if you look simply at self-employed people on the one hand as compared with let's say ten-year university professors or in the German system life-guaranteed jobs if you look at how frequently they are sick you find a clear difference between them self-employed people keep working under circumstances where all ten-year university professors would long have turned in an application that for five, six weeks they would be unable to perform their duties which might be actually better sometimes if they wouldn't do that so as regard health one would expect that most risks are assumed individual and insurance would be limited to the strict accident variety of risk with strictly limited coverage and so forth now if we look at the present world then however we find some fundamental difference and to make it brief I'm running almost out of time here to explain what has happened in the current world is this due to various regulations of insurance companies two things have happened first insurance companies are by law prohibited from discriminating groups correctly that is people are pooled in groups who clearly belong into different groups in Europe if I remember correctly there was just some law passed that any type of difference in health insurance premiums for males and females would be outlawed despite the fact that there are significantly different health risks for males and females in existence which every actuarial would be able to tell you so and I'll give you a few examples of what sort of nonsense regulations there exist in this regard in a moment and the second thing is that insurance companies are not only legally required not to discriminate even though they know they should discriminate and group people into different groups the second thing is that insurance companies are also obliged to insure people against uninsurable risks a few examples of this huge amount of mandates I have not followed this sort of stuff closely anymore years ago that I looked into this in 1991 for instance there existed 992 regulations that insurance companies had to follow in order to be allowed to operate as an insurance company I'll give you some examples here treatment of alcoholism must be covered by insurance companies in 49 states even though obviously it doesn't apply to everyone in the same way Islamic people for instance drink very little alcohol they would not need this sort of stuff drug addiction in 27 states in the meantime I'm sure the numbers are even higher use of chiropractors in 45 put the address to the foot doctors psychotic shrinks in 36 states I mean I know people who love to go to shrinks because they always think that they have some ailment and I know other people would never in their entire life see the office of a shrink but the price must be covered of course for those who do go to shrinks all the time social workers the same thing in 27 in 22 states in 1991 in Georgia heart transplants must be covered by insurance companies despite the fact that again not all people are equally likely requiring a heart transplant in Illinois liver transplant in Minnesota very nice hair pieces even though it should be perfectly clear that I mean I know my father never lost his hair my grandfather never lost his hair I will not lose my hair so I don't need this but if I am insured I must cover that cost also in California marriage counseling that is of course a state where that is really very urgent very urgent topic pastoral counseling in Vermont and sperm banking in Massachusetts California also outlaws any type of genetic testing in order to determine whether you belong in this risk group or that risk group even though in many cases of course you can very easily determine by simple tests this guy must be in this group and that guy must be in that group there exist certain diseases that occur only if certain people have things that can be immediately determined by a genetic examination now what is the consequence of these mandates now what you can imagine is of course the price for medical insurance continuously rises as a consequence of this because all that nonsense has to be covered they are required to cover all of this what is then the consequence of prices for insurance premiums continually going up it is that more and more people will opt to drop out of insurance entirely because as I say look this doesn't apply to me why in the world should I just insure myself against having getting a wink paid by the insurance company why in the world should I insure myself against alcoholism if I'm not drinking a drop of alcohol not that that applies to me but there are people like this obviously so more and more people come to the conclusion hey I have to pay for all sorts of nonsense none of that applies to me and they drop out entirely what is then the consequence now those people who remain in the system of course must then pay still higher premiums so here we have a case of what Mises describes in the dynamics of interventionism one intervention leads to the next intervention and that leads to the next intervention so what do you do if people drop out prices even go up higher then you have to introduce compulsory insurance that is people are no longer allowed to drop out of this nonsense system they must be in there and what happens if the prices then continue to go up what then happens is eventually they will introduce some sort of rationing system that is then politicians will be the ones that determine what are good diseases that deserve to be treated and what are bad diseases that do not deserve to be treated that is the government then becomes like Dr. Kevorkian determining who can live and who must die and as you can see in the United States we are approaching this type of system quickly where it will be our beloved members of congress and senate and presidents and whatever they are who determine who is a good guy and is allowed to be treated and relieved of his ailments and who are the bad guys and who deserve to die thank you very much