 6. Insurance In a free market society, insurance may play a central role in the operation of many services, ranging from security, title dispute resolution, the alleviation of the devastating effects of natural disasters, and more. However, there is a large amount of misconception present in the current environment as to the nature and proper scope of insurable events due to massive interference and misinformation propagated by the state. This chapter will focus on the general nature of insurance and its corresponding power and limitation in free markets. With this insight it will become markedly easier to understand exactly how other services may be feasibly provided by individual actors through the use of insurance in a free market. A natural starting point for this topic will be to examine the nature of insurance itself. Hopper describes the incentives each person faces in an insurance pool. Quote Any insurance involves the pooling of individual risks. Under this arrangement there are winners and losers. Some of the insured will receive more than they paid in premiums, and some will pay more into the system than they ever get back. This is a form of income redistribution, from the healthy to the sick, but the characteristic mark of insurance is that no one knows in advance who the winners and losers will be. They are distributed randomly or unpredictably, and the resulting income redistribution within a pool of insured people is unsystematic. If this were not the case, if it were possible to predict the net winners and losers, the insurance losers would not want to pool their risk with the insurance winners. They would seek to pool their risk with other losers at lower premiums. Now even if the insured themselves do not recognise that there are systematically predictable winners and losers, free competition in the insurance market would eliminate all systematic redistribution among the insured. In a free market, any insurance company that engaged in any systematic income redistribution mixing people with objectively different types of risks into one single group would be outcompeted by any company that did not engage in this type of practice. Another insurance company might realise that there are people who sit behind desks and rarely fall off their chair and injure themselves. They would recognise that they could profitably offer a lower premium to desk jockeys and ensure them in a separate pool from the professional athletes. And by offering lower premiums, they would of course lure away those people who had previously been misinsured. As a result, the various companies that had misgrouped people by mixing their low-risk clients in the same pool with their high-risk clients would have to raise the premiums for their higher-risk clients to their naturally higher level. Winners and losers in this context simply refers to those clients who receive more winners or less losers in reimbursements than he or she paid into the system. This should not be confused with someone who comes down with cancer which his insurance covers as being a winner in the general sense of the term. Furthermore, when Hopper references income redistribution from the healthy to the sick, he is referring to those who didn't experience the occurrence of a covered risk to those who did. This clarification may seem obvious. It is important, however, to make clear that the above description applies to all forms of insurance. The most efficient way to pool clients, given the goal of insurances to bear risk, is by grouping together those who have like or homogenous risks, at least to the extent of which may be objectively determined. If clients with different or heterogeneous risks were to be pooled together, then the less at-risk clients would be effectively subsidizing the more at-risk clients in the form of higher premiums. As a consequence, those lower at-risk clients would be incentivized to relieve themselves of this coverage in the pursuit of a company that charged premiums which correspond more closely to the actual risk they present. Finally, for a risk to be insurable at all, one must be unable to predict with relative certainty those clients who will be winners or losers as defined above. If the winners or losers were able to be identified in such a way, then insurance companies would likely refuse to insure there would be winners, and there would be losers would likewise refuse to purchase insurance. A delicate balance is sought in the insurance industry, where the upper limit of what may be charged is tempered by the presence of other competitive industries willing to lower their premiums offered, and the lower limit is tempered by the desire to avoid negative cash flows or losses. To more effectively determine optimal pricing at any given point in time, insurance firms will be compelled to engage in continual, in-depth research regarding the field covered. Determining the premiums for natural disaster occurrence, for instance, will largely be based upon a given client's geographical residence. In order to determine a price figure for this client, the insurance agency in question will have to invest in research that reveals the risk of such an event occurring in the proximity of the client's residence. Naturally, those companies that attain more accurate data on such risks will be at a relative advantage to their competitors, as such information will reveal more precisely the potential risk and frequency of its payouts to clients. This information will allow an insurance agency to ascertain the lower limit of what it is willing to charge its clients with greater precision. The incentives mentioned above will drive these insurance companies to determine ever more refined groupings and subgroupings for their clients. This process of discrimination will likely be based off objectively verifiable criteria and not subjective, bigoted prejudice, as the former will result in greater market share and profits, and a latter in a loss of market share and losses. In other words, if a company uses poor data or unverifiable prejudice to determine prices, it will either overcharge for its services, driving clients away to lower cost alternatives, or undercharge relative to actual risks, resulting in losses which will either cause the company to alter its practices or go broke, thereby freeing up the resources it once commanded to more efficient and profitable firms in the marketplace. Risk and Uncertainty Risk and Uncertainty are categorically different phenomena. Risk refers to a chance occurrence in a knowable long-run probability distribution. Uncertainty refers to a chance occurrence in which no information regarding probability is known. Mises introduces the terms class probability and case probability to refer to measuring the probability of repeatable events and unique events, respectively. Those events whose approximate likelihood can be known from repeated testing, such as the odds of a coin flip, can be mitigated by the use of insurance. The likelihood of one's property catching fire can be predicted on the basis of long-run frequency distributions, and thus, by acquiring insurance, one can defend himself from the consequence of a fire. It is only possible to determine risks for classes of people or events, but not for singular events or people. Mises affirms this point. We know or assume to know, with regard to the problem concerned, everything about the behaviour of a whole class of events or phenomena, but about the actual singular events or phenomena, we know nothing but that they are elements of this class. The danger presented to someone without insurance is quantifiable. The risk of one's property catching fire in the future can be extrapolated from the whole set of past fires. Because the probability of one's house catching fire is determinable, it is considered a member of class probability. Conversely, those events whose probability cannot be determined by any past outcomes are uncertainties, and have no determinable probability of occurrence. Suppose Billy the Kid and Jesse James enter into a duel. In such a case, it would be impossible to determine the probability of a given outcome, as each of their prior duels would have involved a unique context and environment. For instance, their prior opponents may have had different skill sets, felt ill, carried a different firearm, or maintained it differently. Perhaps the humidity was higher, the sun brighter. There may have been a distracting member in the audience. Either the Kid or James may harbour emotional attitudes about each other. Perhaps the landscape offers greater or lesser cover, etc. All of these contingencies affect the circumstances of the current duel, and it would thus not be an approximate replica of past duels. The outcome of a duel is uncertain, not risky. Risky implies knowledge of the probability of occurrence. Other uncertain events include the presidential election of 1944, the performance of athletes, the creation of art, the emergence of social movements and revolutions, entrepreneurial activities, and many more. These events have uncertain outcomes as they all occur within heterogeneous circumstances. These are not insurable events. The best way to prepare for such uncertainties is to accrue savings in the form of money. This is because money, in contrast to any other good, allows its holder to acquire the maximum amount of uncertain goods at uncertain times and locations in the future. Should one of our dualists take on injuries, it would be far easier for him to acquire medical care by paying the asking monetary price as opposed to attempting to barter for it. Events that fall within the category of class probability are those which are known to occur at relatively constant frequencies within a given set of parameters. An example of an event that falls into the category of class probability is coin flipping. The circumstances behind coin flips are approximately the same and it has been demonstrated through repeated testing that the odds of a given coin falling on heads or tails is 50-50. In other words, because fair coin flips are nearly identical, one may extrapolate the probability of an outcome for a particular coin flip based on trends observed from the results of numerous past coin flips. Another example of a repeatable event is a lottery. One knows from the outset that there will be a lottery winner. However, this knowledge does not reveal to him whom the particular winner will be. Thus, because it is known that there will be only one winner of a lottery, the likelihood that any one person may be the winner can be appraised and quantified based on the proportionate amount of tickets he purchases with the total number of tickets available. The ability to appraise and quantify the risk of such an event occurring, along with the inability to definitively determine who the particular winner will be, renders it viably insurable. If it were possible to determine or predict the occurrence of a particular event with a high degree of certainty, then insurance would be unnecessary. Insurance is only valuable in so far as the various particular occurrences of events are unable to be predicted with relative certainty. If an insurance company were to attempt to cover a highly predictable occurrence, then the presence of competition in the insurance market would render coverage for the event unprofitable. In such a situation, it would be cheaper for one to save up money oneself, as the insurance company would not be willing to charge less than what it knows it would have to pay out in the future. In addition, it would also have to charge more to cover its operating costs, rendering its service more expensive than merely saving up for this impending disaster oneself. An example of something an insurance company may be unwilling to cover is the purchasing of glasses, contacts or laser eye surgery for a client who is known to have deficient eyesight prior to being covered. The insurance company would understand that it is highly likely that this client would need to purchase some good or service which treats deficient vision. Thus, in order to be profitable, the rate the agency would have to charge for this coverage would cost the prospective client more than if he just purchased said good or service directly. Mises clarifies the strict distinctions between classes and members of a class. Quote, We have a complete table of mortality for a definite period of the past in a definite area. If we assume that with regard to mortality no changes will occur, we may say that we know everything about the mortality of the whole population in question. But with regard to the life expectancy of the individuals, we do not know anything but that they are members of this class of people. End quote. In addition to the characteristic of a particular event being highly predictable, another condition that renders a particular event uninsurable is whether or not its occurrence can be largely affected by the prospective client's individual actions. In other words, if one is able to affect the risk of an event transpiring through his deliberate behaviour, then this event is not one for which insurance can be taken out. Hopper elaborates. Quote, Every risk that may be influenced by one's actions is therefore uninsurable. Only what is not controllable through individual actions is insurable and only if there are long run frequency distributions. And it also holds that if something that was initially not controllable becomes controllable, then it would lose its insurability status. With respect to the risk of a natural disaster, floods, hurricanes, earthquakes, fires, insurance is obviously possible. These events are out of an individual's control. And I know nothing about my individual risk, except whether or not I am a member of a group that is as a group exposed to a certain flood or earthquake or fire risk. End quote. Imagine a scenario involving Florida Coast customers purchasing hurricane insurance. Obviously their choice to live near coastal areas will be reflected in the premiums they pay. This is because the insurance company groups one with others who live in similar proximities to the coast and who have had similar frequencies in the past of being hit by hurricanes, or grouped with others who have similar overall risks to be hit by hurricanes, as determined by relevant meteorological or geographical criteria. Relative to the other members in the insurance pool, one's individual actions will not increase or decrease the chance of being hit by a hurricane. The insurance company will likely assess what measures one has taken to defend against such damage. For instance, they may offer lower premiums in exchange for the construction of 20-foot walls around one's residence. Such actions will be what are used to determine pooling, and in turn what premiums one will be charged. Any additional risks taken by subsequent actions, not considered in the risk appraisal, will likely not be covered by the insurance agency. That is to say, individual behaviours or actions not expressed to the insurance agency when it appraises your risk fall into the realm of personal or individual responsibility, of which the insurance company has no part. An example of something that is undeniably uninsurable is committing aggression. Any given person is fully in control of whether or not he or she decides to initiate uninvited physical force against another, and as such no insurance can be taken out for this action. An insurance agency which attempted to ensure clients against the risk they will commit aggression will soon go broke as clients will be incentivised to engage in aggression deliberately for the sake of receiving insurance payouts. This should make clear the financial untenability of offering insurance against those risks which are largely within one's control. Any insurance company who refuses to pay out for covered claims would be considered fraudulent if they are truly in breach of contract. Should they be found in breach of contract, then the matter may be handled via private arbitration. The arbitration agency used and the process taken for any perceived breach in contract will likely be agreed upon by the client and insurance agency in their service contract. As most people are concerned with the threat of not being indemnified, they would likely prefer those insurance agencies which accounted for such contingencies, as opposed to those who did not account for them. As a consequence, the former insurance agencies, all other things equal, would tend to drive the latter ones out of business, if not cause them to change their own policies accordingly. However, even absent any legal rulings, if a given insurance agency develops a reputation for not granting payouts to its clients, they will quickly lose business to eager competitors with more attractive offers. Of course it would also be in their competitor's best interest to maintain watch over this type of foul play, so as to absorb any disgruntled clients. Unfortunately, in today's environment, the utility and cost of insurance is greatly skewed against the consumer's favour by state interference, taking the form of regulations, taxes, minimum coverage requirements and prohibitions against various types of discrimination, up to and including pre-existing conditions in the health insurance markets. Regulations and licenses serve as aggressive barriers to entry into various industries, resulting in decreased competition, higher prices and less availability. Mandated coverage requirements force many to buy more than what they need, neglecting what those resources could have serviced if they were tailored to one's personal situation. The preceding analysis is simply meant to be an evaluation of what types of insurance practices will be financially viable in a free market, and which ones will not. There is no question that any insurance company may offer coverage for anything it deems appropriate, to include insurance against suicide or self-inflicted arson. It's just likely that such practices will result in huge losses in revenue and business to their more sensible competitors. Thus the true scope of that which may be covered efficiently and to what extent, will ultimately be revealed by the marketplace in the varying degrees of profits and losses. Remember profits earned without aggression or legal favouritism represent value added to society, as they require an entrepreneur to combine certain inputs in such a way that they are worth more together than they are separately. We may rely upon such businessmen to work in pursuit of providing value to society as a whole, for achieving this end results in their greatest personal gain. The marketplace reveals the illusion of the personal gain social gain dichotomy, and instead serves to align the two, the only assumption being that man acts towards his own interests. As for those who do not add such value, their command over resources will be diminished in the form of losses, and be increasingly transferred to those who use them in such a way that values society the most, as measured by profits. This is the way in which markets perpetually equilibrate, in light of the ever-changing advancements in technology, consumer demand, and the supplies of various goods, so as to allocate all scarce resources in a manner most favourable to both our long and short term interests.