Does Insurance Increase Risk?
Just a few days ago I wrote a post on risk and consequences in a philosophical tone. But then I came across this TED talk and realized there is a physiological aspect to it as well. Well, the talk was really about the “counterintuitive psychology of insurance”, but it seems like insurance and risk are sort of interrelated. When I say risk, I will use the Wikipedia’s definition so we are all on the same page because risk has different definitions when used in different contexts and may even mean different things to different people.
In simple terms, risk is the possibility of something bad happening. Wikipedia
Basically risk is the probability of something (usually bad) happening. So how can having an insurance increase or for that matter even decrease risk? Remember, insurance is only a hedge against financial loss when an undesirable event happens. It does not change the probability of the event happening. For example, if you take car insurance, it protects you against the risk of theft or accident among other things. But just the action of taking an insurance will not reduce the risk of an accident or theft happening. If the probability of an accident happening before taking your insurance is 0.08%, then it will still be the same after you takes an insurance – or does it?
If taking an insurance should have any affect on the probability of an event happening (risk), you would at least hope that it should reduce the risk. However, from the TED talk, it looks like your risk actually increases! How is that even possible then? In fact, it is possible and we might have seen it in action when it comes to safety gear and there is a word for it – risk compensation.
There was a study on concussions in American football and how the incidence of head injuries increased with safety equipment. I am too lazy to search for that paper but I am sure you can dig it up on your favorite search engine. What the study found out was that when the football players had more safety gear, the probability of head injuries increased when compared to when they did not have such protection. What? If you wear a helmet to protect yourself from head injuries, the risk of concussions should reduce right? No it increased. The reason was that the players played more aggressively because they know they have protection and that increased the risk of head injuries.
Similar things can be observed in other areas. For example people driving vehicles equipped with ABS (anti-lock braking systems) were observed to be driving closer to vehicles in front of them because they now have more confidence in their braking. All of these are examples of risk compensation. So what has this to do with insurance? An insurance is supposed to protect you from risk but does not reduce the risk.
According to the TED talk, people who take insurance believe that by taking an insurance they tend to believe that somehow, magically, the negative events that they fear are not going to happen. It is irrational like believing that if you buy an umbrella it is not going to rain. The protection (umbrella) is not going to change the probability (risk) of rain. Now you would be thinking, you are not that person. Well, then good for you. But according to a study many people seem to think that buying an insurance somehow reduces the risk. She shows some examples of her study like
- people who are reminded that they have health insurance tend to think that the risk of needing operation, physiotherapy and nursing care are less than the control group
- people with insurance also think they are less likely to lose money than those without insurance
- insured travellers feel they they are less like to lose luggage, or get hospitalized
Ok, people with insurance will imagine that the risk is less than those without insurance. Well, what is the problem with that? According to the author of the talk, the problem is over insurance like insuring against a tsunami in Paris, or protecting against trivial losses, or having redundant covers. Of course Indians are notorious for having very less insurance cover, so this probably does not apply for our demographic. But what she says next may be relevant. People who are insured become negligent, they leave valuables in the open, they drive faster, etc. The reason for all this is the belief that somehow magically the risk becomes less for them.
Why is it important to know this information? Well, it is just to make sure we are aware of these biases and put more effort into counteracting them. So having a health insurance should not make you believe that you can be unhealthy. Whether you have an insurance or not, always try to be healthy. Live as if you have no insurance. Having a car insurance should not be the reason to drive rashly. The risk remains the same. It is just our imagination that leads us to believe that the car will not breakdown or we will not meet with an accident. Road side assistance should not be the reason to venture into the dark corners of the world. The car has no knowledge of your insurance and the risk of breakdown is absolutely the same. So drive as if you don’t have an insurance.