Wednesday, March 23, 2005


The latest issue of National Review the magazine had an article about insurance.

I find many people do not understand what insurance is about. Insurance is essentially selling risk. Put in plainer terms it is gambling. You place a bet a bad thing is going to happen and the insurance company bets nothing bad is going to happen.

Now let us say The New England Patriots are going to play the The Einstein Middle School Ruffians. Who in their right mind would bet on the Ruffians? Now, gamblers have devised schemes to make the betting spread out a bit, in football the common method is the spread. In other sports odds are used. Without a spread no one would bet on the Ruffians.

Essentially in gambling there must be uncertainty to the outcome. If the outcome is uncertain then you can find people to bet on the outcome whether it be cockroach races, horse races, or football games.

So to it is with insurance. Uncertainty is key in the insurance markets. Now, some may point out actuaries have all this stuff figured out and this is true to a point. Put 1000 people of a given demographic in the room and the actuaries will be able to come up with some interesting and amazingly accurate predictions. However, when one person comes to an insurance agent then that predictive power is much less. That is the actuaries may say 10 people in the room (of 1000) will have a traffic accident in the next six months they will be hard pressed to say which 10. So individually speaking we are still dealing with uncertainty.

The two cases below are considered without the application of odds or a spread.

Now let us revisit football. Let us start off with a more reasonable game. Let us say my Beloved Packers vs. the detestable Minnesota Viqueens (Vikings). Who is going to win the game? This is a pretty even contest (or at least more so than the Patriots vs. The Ruffians) so there is going to be all sorts of people in this market. My guess is contracts for a Packer win will sell fairly easily as well as contracts for a Packer loss. In the end the contracts (bets) should be close to balancing each other out and the market maker (bookie) should make out with a modest income based on trading fees (grease).

Now let us look at the Patriots vs. The Ruffians. Obviously the only contracts to be sold are going to be Patriot winning contracts. So the foolish market maker that sells Patriot vs. Ruffian contracts is going to lose money. Why? Who in their right mind would buy a Patriots lose to the Ruffians?

This is what The National Review article is trying to relate. In certain markets malpractice insurance is a Patriots vs. the Ruffians with the trial lawyers the Patriots and the doctors the Ruffians. Write a malpractice contract for a doctor where the trial lawyers are especially powerful and you lose. It isn't a matter of greed or any such thing it is matter of survival.

What happens when the malpractice insurance is exorbitantly expensive or non-existent? Doctors, hospitals, and clinics either charge much more or close up and move. This is why we need tort reform.