February 3, 2013

Insurance for us all

We don’t experience anything riskier than life itself. One view of government is as an avenue to protect us from the slings and arrows of life itself.

Traditional forms of insurance rarely give us complete security. Insurers are wary of taking all the risk sharing away from us for fear we won’t be careful with matches, won’t drive carefully enough, or won’t be responsible with choices that affect our health.

In Canada, there are forms of insurance offered to all residents. There is insurance against unemployment, called Unemployment Insurance, aptly enough, and there is insurance that one can live with a modicum of decency in retirement, called Social Insurance.

In the United States, they are more likely called unemployment compensation and Social Security. Neither program makes anyone feel very secure these days.

Human nature responds best when there is an appropriate form of risk-sharing between individuals and their insurers. When government programs or insurance funds depend crucially on the extent to which we each do our part to minimize risk while we optimize opportunity, the system works well. When we instead create institutions that place all the risk on one side and all the security on the other, we inevitably end up with what economists call “shirking” at best, or moral hazard at worse.

In the former case, we put insufficient effort into doing our part. In the latter case, we may even make matters worse by making poor choices with the full knowledge that someone will bail us out.

Many institutions and organizations have learned that the implicit or social contract between individuals and institutions requires each of us to bear some risk. Retailers offer us our satisfaction or our money back. Warranties provide us with longer-term assurances, but can be voided if we don’t behave responsibly.

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